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, 2010

 

Commission File number 001-34453

 

HUDSON VALLEY HOLDING CORP.

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code: (914) 961-6100

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

 

 

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  o  No  x

 

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  o  No  x

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 shorter period that the registrant is required to submit and post such files).  Yes  o  No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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.    o

 

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 definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer  o     Accelerated filer  x     Non-accelerated filer  o     Smaller reporting company o

 

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

 

 

 

 

The aggregate market value on June 30, 2010 of voting stock held by non-affiliates of the Registrant was approximately $268,028,000.

 

Documents incorporated by reference:

 

Portions of the registrant’s definitive Proxy Statement for the 2011 Annual Meeting of Stockholders is incorporated by reference in Part III of this report and will be filed no later than 120 days from December 31, 2010.

 

 

FORM 10-K

TABLE OF CONTENTS

 

 

 

General

 

Hudson Valley Holding Corp. (the “Company”) is a New York corporation founded in 1982. The Company is registered as a bank holding company under the Bank Holding Company Act of 1956.

 

The Company provides financial services through its wholly-owned subsidiary, Hudson Valley Bank, N.A. (“HVB” or “the Bank”), a national banking association established in 1972, with operational headquarters in Westchester County, New York. New York National Bank, (“NYNB”), a national banking association which the Company acquired effective January 1, 2006, was merged into HVB effective March 1, 2010. NYNB currently operates as a division of HVB. HVB has 18 branch offices in Westchester County, New York, 5 in Manhattan, New York, 4 in Bronx County, New York, 1 in Rockland County, New York, 1 in Queens County, New York, 1 in Kings County, New York, 5 in Fairfield County, Connecticut and 1 in New Haven County Connecticut.

 

The Company provides investment management services through a wholly-owned subsidiary of HVB, A.R. Schmeidler & Co., Inc. (“ARS”), a money management firm, thereby generating fee income. ARS has offices at 500 Fifth Avenue in Manhattan, New York.

 

We derive substantially all of our revenue and income from providing banking and related services to businesses, professionals, municipalities, not-for-profit organizations and individuals within our market area. See “Our Market Area.”

 

Our principal executive offices are located at 21 Scarsdale Road, Yonkers, New York 10707.

 

Our principal customers are businesses, professionals, municipalities, not-for-profit organizations and individuals. Our strategy is to operate community-oriented banking institutions dedicated to providing personalized service to customers and focusing on products and services for selected segments of the market. We believe that our ability to attract and retain customers is due primarily to our focused approach to our markets, our personalized and professional services, our product offerings, our experienced staff, our knowledge of our local markets and our ability to provide responsive solutions to customer needs. We provide these products and services to a diverse range of customers and do not rely on a single large depositor for a significant percentage of deposits. We anticipate that we will continue to expand in our current market and surrounding area by acquiring other banks and related businesses, adding staff and continuing to open new branch offices and loan production offices.

 

Forward-Looking Statements

 

The Company has made in this Annual Report on Form 10-K various forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to earnings, credit quality and other financial and business matters for periods subsequent to December 31, 2010. These statements may be identified by such forward-looking terminology as “expect”, “may”, “will”, “anticipate”, “continue”, “believe” or similar statements or variations of such terms. The Company cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, and that statements relating to subsequent periods increasingly are subject to greater uncertainty because of the increased likelihood of changes in underlying factors and assumptions. Actual results could differ materially from forward-looking statements.

 

Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements, in addition to those risk factors disclosed in this Annual Report on Form 10-K include, but are not limited to, statements regarding:

 

 

 

We assume no obligation for updating any such forward-looking statements at any given time.

 

Subsidiaries of the Bank and the Company

 

In 1993, HVB formed a wholly-owned subsidiary, Sprain Brook Realty Corp., primarily for the purpose of holding property obtained by HVB through foreclosure in its normal course of business.

 

In 1997, HVB formed a subsidiary (of which it owns more than 99 percent of the voting stock), Grassy Sprain Real Estate Holdings, Inc., a real estate investment trust, primarily for the purpose of acquiring and managing a portfolio of mortgage-backed securities, loans collateralized by real estate and other investment securities previously owned by HVB.

 

In 2001, HVB began originating lease financing transactions through a wholly owned subsidiary, HVB Leasing Corp.

 

In 2002, HVB formed two wholly-owned subsidiaries. HVB Realty Corp. owns and manages five branch locations in Yonkers, New York and HVB Employment Corp. leases certain branch staff to HVB.

 

In 2004, HVB acquired for cash A.R. Schmeidler & Co., Inc. as a wholly-owned subsidiary in a transaction accounted for as a purchase. This money management firm provides investment management services to its customers thereby generating fee income.

 

In 1997, NYNB formed a wholly-owned subsidiary, 369 East 149th Street Corp., primarily for the purpose of owning and operating certain commercial real estate property of which NYNB is a tenant.

 

In 2008, NYNB formed a wholly-owned subsidiary, 369 East Realty Corp., primarily for the purpose of holding property obtained by NYNB through foreclosure in its normal course of business.

 

In January 2010, the Company formed a wholly owned subsidiary, HVHC Risk Management Corp, which is a captive insurance company which underwrites certain insurance coverage for HVB and its subsidiary companies.

 

In February 2010, HVB formed three wholly owned subsidiaries. HVB Properties Corp. owns and manages two of HVB’s branches. HVB Fleet Services Corp. owns and manages company owned automobiles. 21 Scarsdale Road Corp. owns and manages the HVB headquarters buildings.

 

In February 2010, NYNB formed a wholly owned subsidiary, 2256 Second Avenue Corp., which owns and manages the Second Avenue branch in Manhattan, New York.

 

As a result of the merger of HVB and NYNB, effective March 1, 2010, all subsidiaries of NYNB became subsidiaries of HVB.

The Company has no separate operations or revenues apart from HVHC Risk Management Corp. and HVB and its subsidiaries.

 

Employees

 

At December 31, 2010, we employed 438 full-time employees and 40 part-time employees. We provide a variety of benefit plans, including group life, health, dental, disability, retirement and stock option plans. We consider our employee relations to be satisfactory.

 

Our Market Area

 

The banking and financial services business in our market area is highly competitive. Due to their proximity to and location within New York City, our branches compete with regional banks, as well as many other non-bank financial institutions. A number of these banks are larger than we are and are increasing their efforts to serve smaller commercial borrowers. Many of these competitors, by virtue of their size and resources, may enjoy efficiencies and competitive advantages over us in pricing, delivery and marketing of their products and services. We believe that, despite the continued growth of large institutions and the potential for large out-of-area banking and financial institutions to enter our market area, there will continue to be opportunities for efficiently-operated, service-oriented, well-capitalized, community-based banking organizations to grow by serving customers that are not well served by larger institutions or do not wish to bank with such large institutions.

 

Westchester County is a suburban county located in the northern sector of the New York metropolitan area. It has a large and varied economic base containing many corporate headquarters, research facilities, manufacturing firms as well as well-developed trade and service sectors. The median household income, based on 2009 census data, was $79,585. The County’s 2009 per capita income of $47,204 placed Westchester County among the highest of the nation’s counties. In December 2010, the County’s unemployment rate was 6.9 percent, as compared to New York State at 8.1 percent and the United States at 9.1 percent. The County has over 100,000 businesses, which form a large portion of our current and potential customer base. We continue to evaluate expansion opportunities in Westchester County.

 

New York City, which borders Westchester County, is the nation’s financial capital and the home of more than 8 million individuals representing virtually every race and nationality. According to the 2008 census data, the median household income in the city was $50,173, while the per capita income was $30,337. This places New York City in the top ranks of cities across the United States. In December 2010, New York City’s unemployment rate was 8.6%. The city also has a vibrant and diverse business community with more than 106,000 businesses and professional service firms. New York City is comprised of five counties or boroughs: Bronx, Kings (Brooklyn), New York (Manhattan), Queens and Richmond (Staten Island).

 

New York City has many attractive attributes and we believe that there is an opportunity for community banks to service our niche markets of businesses and professionals very effectively. We expanded into the New York City market with the opening of our first branch in the Bronx in 1999. Subsequent expansion in this borough was accomplished with the opening of a second branch in 2002, the addition of two additional branches as a result of the acquisition of NYNB in 2006, and a third branch in 2010. The two branches acquired with NYNB were consolidated into one branch in 2010. We entered the Manhattan market with the opening of a full-service branch in the Lincoln Building in 2002 and followed by the openings of three additional branches in 2004, 2005 and 2008. The NYNB acquisition also provided an additional Manhattan branch location. In 2008, we opened our first branch in the borough of Brooklyn. We continue to evaluate additional expansion opportunities in New York City.

 

We expanded into Rockland County, New York, by opening a full service branch in New City, New York in February 2007. Rockland County, New York, a suburban county, borders Westchester County, New York to the west. Rockland County’s 2009 per capita income was $34,071. In December 2010, the County’s unemployment rate was 6.9%. We believe Rockland County offers attractive opportunities for us to develop new customers within our niche markets of businesses, professionals and not-for-profit organizations.

 

We expanded our branch network into Fairfield County, Connecticut with the opening of a full-service branch in, Stamford, Connecticut in December 2007. We subsequently expanded our presence in Fairfield County to five full service locations with the additions of branch offices in Westport, Greenwich and Fairfield in 2008 and Stratford in 2009. Fairfield County, Connecticut, a suburban county, borders Westchester County, New York to the east. The County’s 2009 per capita income was $48,394. In December 2010, the County’s unemployment rate was 7.9% as

compared to the state of Connecticut’s unemployment rate of 8.6%. Fairfield County has very similar attributes to Westchester County, New York, where we have had success in attracting and retaining customers.

 

We expanded into New Haven County, Connecticut in 2009 with the opening of a full service branch in Milford. New Haven County, Connecticut borders Fairfield County to the east and is a mixed urban and suburban county. In December 2010, the County’s unemployment rate was 9.6%. We continue to explore additional opportunities for expansion in the Connecticut market.

 

Competition

 

The banking and financial services business in our market area is highly competitive. There are approximately 150 banking institutions with 2,510 branch banking offices in our Westchester County, Rockland County, Fairfield County, Connecticut and New York City market area. These banking institutions had deposits of approximately $542 billion as of June 30, 2008 according to Federal Deposit Insurance Corporation (“FDIC”) data. Our branches compete with local offices of large New York City commercial banks due to their proximity to and location within New York City. Other financial institutions, such as mutual funds, finance companies, factoring companies, mortgage bankers and insurance companies, also compete with us for both loans and deposits. We are smaller in size than most of our competitors. In addition, many non-bank competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks.

 

Competition for depositors’ funds and for credit-worthy loan customers is intense. A number of larger banks are increasing their efforts to serve smaller commercial borrowers. Competition among financial institutions is based upon interest rates and other credit and service charges, the quality of service provided, the convenience of banking facilities, the products offered and, in the case of larger commercial borrowers, relative lending limits.

 

Federal legislation permits adequately capitalized bank holding companies to expand across state lines to offer banking services. In view of this, it is possible for large organizations to enter many new markets, including our market area. Many of these competitors, by virtue of their size and resources, may enjoy efficiencies and competitive advantages over us in pricing, delivery and marketing of their products and services.

 

In response to competition, we have focused our attention on customer service and on addressing the needs of businesses, professionals and not-for-profit organizations located in the communities in which we operate. We emphasize community relations and relationship banking. We believe that, despite the continued growth of large institutions and the potential for large out-of-area banking and financial institutions to enter our market area, there will continue to be opportunities for efficiently-operated, service-oriented, well-capitalized, community-based banking organizations to grow by serving customers that are not served well by larger institutions or do not wish to bank with such large institutions.

 

Our strategy is to increase earnings through growth within our existing market. Our primary market area, which includes Westchester County, Rockland County and New York City in the State of New York, and Fairfield County and New Haven County in the State of Connecticut, has a high concentration of the types of customers that we desire to serve. We expect to continue to expand by opening new full-service banking facilities and loan production offices, by expanding deposit gathering and loan originations in our market area, by enhancing and expanding computerized and telephonic products, by diversifying our products and services, by acquiring other banks and related businesses and through strategic alliances and contractual relationships.

 

During the past five years, we have focused on maintaining existing customer relationships and adding new relationships by providing products and services that meet these customers’ needs. The focus of our products and services continues to be businesses, professionals, not-for-profit organizations and municipalities. We have expanded our market to additional sections of Westchester County and New York City and further expanded to include sections of Rockland County, New York, Fairfield County, Connecticut and New Haven County, Connecticut. We have opened or acquired seventeen new facilities during the past five years, three in Westchester County, New York, seven in New York City, one in Rockland County, New York, five in Fairfield County, Connecticut and one in New Haven County, Connecticut. We anticipate opening at least one additional facility during 2011. We expect to continue to open additional facilities in the future. We have invested in technology based products and services to meet customer needs. In addition, we have expanded products and services in our deposit gathering and lending programs, and our offering of investment management and trust services. As a result, our total assets have grown nearly 50 percent during this five year period.

Lending

 

We engage in a variety of lending activities which are primarily categorized as real estate, commercial and industrial, individual and lease financing. At December 31, 2010, gross loans totaled $1,732.3 million. Gross loans were comprised of the following loan types:

 

 

At December 31, 2010, HVB’s lending limit to one borrower under applicable regulations was approximately $39.7 million.

 

In managing our loan portfolios, we focus on:

 

 (i)   the application of established underwriting criteria,

 

 

 (iv) an awareness of concentration by industry or collateral, and

 

 (v) the monitoring of loans for timely payment and to seek to identify potential problem loans.

 

We utilize our Credit Department to assess acceptable and unacceptable credit risks based upon established underwriting criteria. We utilize our loan officers, branch managers and Credit Department to identify changes in a borrower’s financial condition that may affect the borrower’s ability to perform in accordance with loan terms. Lending policies and procedures place an emphasis on assessing a borrower’s income and cash flow as well as collateral values. Further, we utilize systems and analysis which assist in monitoring loan delinquencies. We utilize our loan officers, Asset Recovery Department and legal counsel in collection efforts on past due loans. Additional collateral or guarantees may be requested where delinquencies remain unresolved.

 

An independent qualified loan review firm reviews loans in our portfolios and confirms a risk grading to each reviewed loan. Loans are reviewed based upon the type of loan, the collateral for the loan, the amount of the loan and any other pertinent information. The loan review firm reports directly to the Audit Committee of the Board of Directors.

 

In addition, we have participated in loans originated by various other financial institutions within the normal course of business and within standard industry practices.

 

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Loan Portfolio” for further information related to our portfolio and lending activities.

 

Deposits

 

We offer deposit products ranging in maturity from demand-type accounts to certificates of deposit with maturities of up to 5 years. Deposits are generally derived from customers within our primary marketplace. We solicit only certain types of deposits from outside our market area, primarily from certain professionals and government agencies. We also utilize brokered certificates of deposits as a source of funding and to manage interest rate risk.

 

We set deposit rates to remain generally competitive with other financial institutions in our market, although we do not generally seek to match the highest rates paid by competing institutions. We have established a process to review interest rates on all deposit products and, based upon this process, update our deposit rates weekly. This process also established a procedure to set deposit interest rates on a relationship basis and to periodically review these deposit rates. Our Asset/Liability Management Policy and our Liquidity Policy set guidelines to manage overall interest rate risk and liquidity. These guidelines can affect the rates paid on deposits. Deposit rates are reviewed under these policies periodically since deposits are our primary source of liquidity.

We offer deposit pick up services for certain business customers. We have 27 automated teller machines, or ATMs, at various locations, which generate activity fees based on use by other banks’ customers.

 

For more information regarding our deposits, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Deposits.”

 

Portfolio Management Services

 

We provide investment management services to our customers and others through a subsidiary, A. R. Schmeidler & Co., Inc. The acquisition of this firm has allowed us to expand our investment management services to customers and to expand revenue by offering such services. We anticipate that we will continue to expand this line of business.

 

Other Services

 

We also provide a software application to a limited number of customers designed to meet the specific administrative needs of bankruptcy trustees through a marketing and licensing agreement with the application vendor. We have no current plans to expand this line of business.

 

Segments

 

We maintain only one business segment which is discussed in more detail in Notes 1 and 15 to the financial statements included elsewhere herein.

 

Supervision and Regulation

 

Banks and bank holding companies are extensively regulated under both federal and state law. We have set forth below brief summaries of various aspects of the supervision and regulation of the Banks. These summaries do not purport to be complete and are qualified in their entirety by reference to applicable laws, rules and regulations.

 

As a bank holding company, we are regulated by and subject to the supervision of the Board of Governors of the Federal Reserve System (the “FRB”) and are required to file with the FRB an annual report and such other information as may be required. The FRB has the authority to conduct examinations of the Company as well.

 

The Bank Holding Company Act of 1956 (the “BHC Act”) limits the types of companies which we may acquire or organize and the activities in which they may engage. In general, a bank holding company and its subsidiaries are prohibited from engaging in or acquiring control of any company engaged in non-banking activities unless such activities are so closely related to banking or managing and controlling banks as to be a proper incident thereto. Activities determined by the FRB to be so closely related to banking within the meaning of the BHC Act include operating a mortgage company, finance company, credit card company, factoring company, trust company or savings association; performing certain data processing operations; providing limited securities brokerage services; acting as an investment or financial advisor; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; providing tax planning and preparation service; operating a collection agency; and providing certain courier services. The FRB also has determined that certain other activities, including real estate brokerage and syndication, land development, property management and underwriting of life insurance unrelated to credit transactions, are not closely related to banking and therefore are not proper activities for a bank holding company.

 

The BHC Act requires every bank holding company to obtain the prior approval of the FRB before acquiring substantially all the assets of, or direct or indirect ownership or control of more than five percent of the voting shares of, any bank. Subject to certain limitations and restrictions, a bank holding company, with the prior approval of the FRB, may acquire an out-of-state bank.

 

In November 1999, Congress amended certain provisions of the BHC Act through passage of the Gramm-Leach-Bliley Act. Under this legislation, a bank holding company may elect to become a “financial holding company” and thereby engage in a broader range of activities than would be permissible for traditional bank holding companies. In order to qualify for the election, all of the depository institution subsidiaries of the bank holding company must be well capitalized and well managed, as defined under FRB regulations, and all such subsidiaries must have achieved a rating of “satisfactory” or better with respect to meeting community credit needs. Pursuant to the Gramm-Leach-Bliley Act, financial holding companies are permitted to engage in activities that are “financial

in nature” or incidental or complementary thereto, as determined by the FRB. The Gramm-Leach-Bliley Act identifies several activities as “financial in nature”, including, among others, insurance underwriting and agency activities, investment advisory services, merchant banking and underwriting, and dealing in or making a market in securities. The Company owns a financial subsidiary, A.R. Schmeidler & Co., Inc.

 

We believe we meet the regulatory criteria that would enable us to elect to become a financial holding company. At this time, we have determined not to make such an election, although we may do so in the future.

 

The Gramm-Leach-Bliley Act also makes it possible for entities engaged in providing various other financial services to form financial holding companies and form or acquire banks. Accordingly, the Gramm-Leach-Bliley Act makes it possible for a variety of financial services firms to offer products and services comparable to the products and services we offer.

 

There are various statutory and regulatory limitations regarding the extent to which present and future banking subsidiaries of the Company can finance or otherwise transfer funds to the Company or its non-banking subsidiaries, whether in the form of loans, extensions of credit, investments or asset purchases, including regulatory limitation on the payment of dividends directly or indirectly to the Company from the Bank. Federal bank regulatory agencies also have the authority to limit further the Bank’s payment of dividends based on such factors as the maintenance of adequate capital for such subsidiary bank, which could reduce the amount of dividends otherwise payable. Under applicable banking statutes, at December 31, 2010, the Bank could have declared additional dividends of approximately $3.9 million to the Company without prior regulatory approval.

 

Under the policy of the FRB, the Company is expected to act as a source of financial strength to its banking subsidiaries and to commit resources to support its banking subsidiaries in circumstances where we might not do so absent such policy. In addition, any subordinated loans by the Company to its banking subsidiaries would also be subordinate in right of payment to depositors and obligations to general creditors of such subsidiary banks. The Company currently has no loans to the Bank.

 

The FRB has established capital adequacy guidelines for bank holding companies that are similar to the FDIC capital requirements for the Bank described below. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources” and Note 10 to the Consolidated Financial Statements. The Company and HVB are subject to various regulatory capital guidelines. To be considered “well capitalized,” an institution must generally have a leverage ratio of at least 5 percent, a Tier 1 ratio of 6 percent and a total capital ratio of 10 percent. As a result of the increase in our non-performing loans, the high percentage of commercial real estate loans in our loan portfolio, and the increased potential for further possible deterioration in our loans, as of October 13, 2009 we were required by the OCC to maintain at the Bank, by no later than December 31, 2009, a total risk-based capital ratio of at least 12.0% (compared to 10.0% for a well capitalized bank), a Tier 1 risk-based capital ratio of at least 10.0% (compared to 6.0% for a well capitalized bank), and a Tier 1 leverage ratio of at least 8.0% (compared to 5.0% for a well capitalized bank). In October 2009 we raised approximately $93.3 million through an offering of our common stock and accordingly, at December 31, 2009, the Bank’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 12.7%, 11.4% and 8.4%, respectively. At December 31, 2010, the Bank’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 14.0%, 12.8% and 8.8%, respectively. Management intends to conduct the affairs of the Company and its subsidiary Bank so as to maintain a strong capital position in the future.

 

Basel III

 

In December 2010, the Basel Committee released its final framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as “Basel III”. Basel III, when implemented by the U.S. banking agencies and fully phased-in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity.

 

The Basel III final capital framework, among other things, (i) introduces as a new capital measure “Common Equity Tier 1” (“CET1”), (ii) specifies that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expands the scope of the adjustments as compared to existing regulations.

When fully phased in on January 1, 2019, Basel III requires banks to maintain (i) as a newly adopted international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) as a newly adopted international standard, a minimum leverage ratio of 3%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).

 

Basel III also provides for a “countercyclical capital buffer,” generally to be imposed when national regulators determine that excess aggregate credit growth becomes associated with a buildup of systemic risk, that would be a CET1 add-on to the capital conservation buffer in the range of 0% to 2.5% when fully implemented (potentially resulting in total buffers of between 2.5% and 5%). The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.

 

The implementation of the Basel III final framework will commence January 1, 2013. On that date, banking institutions will be required to meet the following minimum capital ratios:

 

 

The Basel III final framework provides for a number of new deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.

 

Implementation of the deductions and other adjustments to CET1 will begin on January 1, 2014 and will be phased-in over a five-year period (20% per year). The implementation of the capital conservation buffer will begin on January 1, 2016 at 0.625% and be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).

 

The U.S. banking agencies have indicated informally that they expect to propose regulations implementing Basel III in mid-2011 with final adoption of implementing regulations in mid-2012. Notwithstanding its release of the Basel III framework as a final framework, the Basel Committee is considering further amendments to Basel III, including the imposition of additional capital surcharges on globally systemically important financial institutions. In addition to Basel III, Dodd-Frank requires or permits the Federal banking agencies to adopt regulations affecting banking institutions’ capital requirements in a number of respects, including potentially more stringent capital requirements for systemically important financial institutions. Accordingly, the regulations ultimately applicable to the Company may be substantially different from the Basel III final framework as published in December 2010. Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact the Corporation’s net income and return on equity.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was signed into law on July 21, 2010. Generally, the Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the law. The Act, among other things:

 

 

 

The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on our operating environment in substantial and unpredictable ways. Consequently, the Dodd-Frank Act is likely to increase our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within our industry and market areas. The nature and extent of future legislative and regulatory changes affecting financial institutions, including as a result of the Dodd-Frank Act, is very unpredictable at this time. Our management is actively reviewing the provisions of the Dodd-Frank Act, many of which are phased-in over time, and assessing its probable impact on our business, financial condition, and results of operations. However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and us in particular, is uncertain at this time.

Emergency Economic Stabilization Act of 2008

 

In response to the financial crisis affecting the banking system and financial markets, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law and established the Troubled Asset Relief Program (“TARP”). As part of TARP, the Treasury established the Capital Purchase Program (“CPP”) to provide up to $700 billion of funding to eligible financial institutions through the purchase of capital stock and other financial instruments for the purpose of stabilizing and providing liquidity to the U.S. financial markets. In connection with EESA, there have been numerous actions by the Federal Reserve Board, Congress, the Treasury, the FDIC, the SEC and others to further the economic and banking industry stabilization efforts under EESA. The Company elected not to participate in the CPP.

 

Temporary Liquidity Guarantee Program

 

On November 21, 2008, the Board of Directors of the FDIC adopted a final rule relating to the Temporary Liquidity Guarantee Program (“TLG Program”), Under the TLG Program (as amended on March 17, 2009 the FDIC has (i) guaranteed through the earlier of maturity or December 31, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008, and before October 31, 2009 (the “Debt Guarantee Program”) and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying less than or equal to 0.5 percent interest per annum and Interest on Lawyers Trust Accounts (“IOLTAs”) held at participating FDIC- insured institutions through June 30, 2010 (the “TAG Program”). On April 13, 2010, the FDIC announced a second extension of the TAG Program until December 31, 2010. Coverage under the TLG Program was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for deposit insurance coverage ranges from 15 to 25 basis points based upon the Bank’s CAMELS rating by the OCC on amounts in covered accounts exceeding $250,000.

 

We elected to participate in both the Debt Guarantee Program and the TAG Program. We have not issued debt under the Debt Guarantee Program.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act included a two-year extension of the TAG Program, though the extension does not apply to all accounts covered under the original program. The extension through December 31, 2012 applies only to non-interest bearing transaction accounts and IOLTAs. Beginning January 1, 2011, NOW accounts will no longer be eligible for the unlimited guarantee. Unlike the original TAG Program, which allowed banks to opt in, the extended program will apply at all FDIC-insured institutions and will no longer be funded by separate premiums. The FDIC will account for the additional TAG insurance coverage in determining the amount of the general assessment it charges under the risk-based assessment system.

 

Regulation of HVB

 

The Bank is subject to the supervision of, and to regular examination by, the OCC. Various laws and the regulations thereunder applicable to the Company and the Bank impose restrictions and requirements in many areas, including capital requirements, the maintenance of reserves, establishment of new offices, the making of loans and investments, consumer protection, employment practices, bank acquisitions and entry into new types of business. There are various legal limitations, including Sections 23A and 23B of the Federal Reserve Act, which govern the extent to which a bank subsidiary may finance or otherwise supply funds to its holding company or its holding company’s non-bank subsidiaries. Under federal law, no bank subsidiary may, subject to certain limited exceptions, make loans or extensions of credit to, or investments in the securities of, its parent or the non-bank subsidiaries of its parent (other than direct subsidiaries of such bank which are not financial subsidiaries) or take their securities as collateral for loans to any borrower. The Bank is also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions.

 

Dividend Limitations

 

The Company is a legal entity separate and distinct from its subsidiaries. The Company’s revenues (on a parent company only basis) result in substantial part from dividends paid by the Bank. The Bank’s dividend payments, without prior regulatory approval, are subject to regulatory limitations. Under the National Bank Act, dividends may be declared only if, after payment thereof, capital would be unimpaired and remaining surplus would equal

100 percent of capital. Moreover, a national bank may declare, in any one year, dividends only in an amount aggregating not more than the sum of its net profits for such year and its retained net profits for the preceding two years. In addition, the bank regulatory agencies have the authority to prohibit the Bank from paying dividends or otherwise supplying funds to the Company if the supervising agency determines that such payment would constitute an unsafe or unsound banking practice. Under applicable banking statutes, at December 31, 2010, the Bank could have declared additional dividends of approximately $3.9 million to the Company without prior regulatory approval.

 

Capital Standards

 

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), defines specific capital categories based upon an institution’s capital ratios. The capital categories, in declining order, are: (i) well capitalized; (ii) adequately capitalized; (iii) undercapitalized; (iv) significantly undercapitalized; and (v) critically undercapitalized. Under FDICIA and the FDIC’s prompt corrective action rules, the FDIC may take any one or more of the following actions against an undercapitalized bank: restrict dividends and management fees, restrict asset growth and prohibit new acquisitions, new branches or new lines of business without prior FDIC approval. If a bank is significantly undercapitalized, the FDIC may also require the bank to raise capital, restrict interest rates a bank may pay on deposits, require a reduction in assets, restrict any activities that might cause risk to the bank, require improved management, prohibit the acceptance of deposits from correspondent banks and restrict compensation to any senior executive officer. When a bank becomes critically undercapitalized, (i.e., the ratio of tangible equity to total assets is equal to or less than 2 percent), the FDIC must, within 90 days thereafter, appoint a receiver for the bank or take such action as the FDIC determines would better achieve the purposes of the law. Even where such other action is taken, the FDIC generally must appoint a receiver for a bank if the bank remains critically undercapitalized during the calendar quarter beginning 270 days after the date on which the bank became critically undercapitalized.

 

The OCC’s standard regulations implementing these provisions of FDICIA provide that an institution will be classified as “well capitalized” if it (i) has a total risk-based capital ratio of at least 10.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 6.0 percent, (iii) has a Tier 1 leverage ratio of at least 5.0 percent, and (iv) meets certain other requirements. An institution will be classified as “adequately capitalized” if it (i) has a total risk-based capital ratio of at least 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 4.0 percent, (iii) has a Tier 1 leverage ratio of (a) at least 4.0 percent or (b) at least 3.0 percent if the institution was rated 1 in its most recent examination, and (iv) does not meet the definition of “well capitalized.” An institution will be classified as “undercapitalized” if it (i) has a total risk-based capital ratio of less than 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 4.0 percent, or (iii) has a Tier 1 leverage ratio of (a) less than 4.0 percent or (b) less than 3.0 percent if the institution was rated 1 in its most recent examination. An institution will be classified as “significantly undercapitalized” if it (i) has a total risk-based capital ratio of less than 6.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 3.0 percent, or (iii) has a Tier 1 leverage ratio of less than 3.0 percent. An institution will be classified as “critically undercapitalized” if it has a tangible equity to total assets ratio that is equal to or less than 2.0 percent. An insured depository institution may be deemed to be in a lower capitalization category if it receives an unsatisfactory examination rating. Similar categories apply to bank holding companies.

 

As a result of the increase in our non-performing loans, the high percentage of commercial real estate loans in our loan portfolio, and the increased potential for further possible deterioration in our loans, as of October 13, 2009 we were required by the OCC to maintain at the Bank, by no later than December 31, 2009, a total risk-based capital ratio of at least 12.0% (compared to 10.0% for a well capitalized bank), a Tier 1 risk-based capital ratio of at least 10.0% (compared to 6.0% for a well capitalized bank), and a Tier 1 leverage ratio of at least 8.0% (compared to 5.0% for a well capitalized bank). In October 2009 we raised approximately $93.3 million through an offering of our common stock and accordingly, at December 31, 2009, the Bank’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 12.7%, 11.4% and 8.4%, respectively. At December 31, 2010, the Bank’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 14.0%, 12.8% and 8.8%, respectively.

 

In addition, significant provisions of FDICIA required federal banking regulators to impose standards in a number of other important areas to assure bank safety and soundness, including internal controls, information

systems and internal audit systems, credit underwriting, asset growth, compensation, loan documentation and interest rate exposure.

 

See Note 10 to the Consolidated Financial Statements.

 

Insurance of Deposit Account

 

The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”). The Deposit Insurance Fund is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged in 2006. Under the FDIC’s risk-based system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors with less risky institutions paying lower assessments on their deposits.

 

On November 12, 2009, the FDIC issued a final rule that required insured depository institutions to prepay, on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012, together with their quarterly risk-based assessment for the third quarter 2009. The Bank paid approximately $13.4 million, in assessments as of December 31, 2009 of which approximately $12.5 million was recorded as a prepaid asset. Prepaid assessments are to be applied against the actual quarterly assessments until exhausted, and may not be applied to any special assessments that may occur in the future. Any unused prepayments will be returned to the Bank on June 30, 2013. The balance of the prepaid FDIC assessment fees at December 31, 2010 was $8.8 million.

 

In November 2010, as required by the Dodd-Frank Act, the FDIC proposed to revise the assessment base to consist of average consolidated total assets during the assessment period minus the average tangible equity during the assessment period. In addition, the proposed revisions would eliminate the adjustment for secured borrowings and make certain other changes to the impact of unsecured borrowings and brokered deposits on an institution’s deposit insurance assessment. The proposed rule also revises the assessment rate schedule to provide assessments ranging from 5 to 45 basis points. No assurance can be given as to the final form of the proposed regulations or its impact on the Bank.

 

As previously noted above, the Dodd-Frank Act makes permanent the $250 thousand limit for federal deposit insurance and provides unlimited federal deposit insurance through December 31, 2012 for non-interest bearing demand transaction accounts and IOLTAs at all insured depository institutions.

 

The FDIC has authority to further increase insurance assessments. A significant increase in insurance premiums may have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

 

Loans to Related Parties

 

The Bank’s authority to extend credit to its directors, executive officers and 10 percent stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of the National Bank Act, Sarbanes-Oxley Act and Regulation O of the FRB thereunder. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with other persons not related to the lender and that do not involve more than the normal risk of repayment or present other unfavorable features and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. In addition, extensions of credit in excess of certain limits must be approved by the Bank’s Board of Directors. Under the Sarbanes-Oxley Act, the Company and its subsidiaries, other than the Bank, may not extend or arrange for any personal loans to its directors and executive officers.

 

FIRREA

 

Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. These provisions have commonly been referred to as FIRREA’s “cross guarantee” provisions. Further, under

FIRREA, the failure to meet capital guidelines could subject a bank to a variety of enforcement remedies available to federal regulatory authorities.

 

FIRREA also imposes certain independent appraisal requirements upon a bank’s real estate lending activities and further imposes certain loan-to-value restrictions on a bank’s real estate lending activities. The bank regulators have promulgated regulations in these areas.

 

Community Reinvestment Act and Fair Lending Developments

 

Under the Community Reinvestment Act (“CRA”), as implemented by Interagency Appraisal and Evaluation guidelines, the Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of our entire community, including low and moderate income neighborhoods. The CRA does not prescribe 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 regulatory agencies, in connection with its examination of a bank, 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. FIRREA amended the CRA to require public disclosure of an institution’s CRA rating and require the regulatory agencies to provide a written evaluation of an institution’s CRA performance utilizing a four-tiered descriptive rating system. Institutions are evaluated and rated by the regulatory agencies as “Outstanding”, “Satisfactory”, “Needs to Improve” or “Substantial Non Compliance.” Failure to receive at least a “Satisfactory” rating may inhibit an institution from undertaking certain activities, including acquisitions of other financial institutions, which require regulatory approval based, in part, on CRA Compliance considerations. As of its last CRA examination in March 2010, the Bank received a rating of “Satisfactory.”

 

USA Patriot Act

 

The USA Patriot Act of 2001, signed into law on October 26, 2001, enhances the powers of domestic law enforcement organizations and makes numerous other changes aimed at countering the international terrorist threat to the security of the United States. Title III of the legislation most directly affects the financial services industry. It is intended to enhance the federal government’s ability to fight money laundering by monitoring currency transactions and suspicious financial activities. The USA Patriot Act has significant implications for depository institutions and other businesses involved in the transfer of money. Under the USA Patriot Act, a financial institution must establish due diligence policies, procedures and controls reasonably designed to detect and report money laundering through correspondent accounts and private banking accounts. Financial institutions must follow regulations adopted by the Treasury Department to encourage financial institutions, their regulatory authorities, and law enforcement authorities to share information about individuals, entities, and organizations engaged in or suspected of engaging in terrorist acts or money laundering activities. Financial institutions must follow regulations adopted by the Treasury Department setting forth minimum standards regarding customer identification. These regulations require financial institutions to implement reasonable procedures for verifying the identity of any person seeking to open an account, maintain records of the information used to verify the person’s identity, and consult lists of known or suspected terrorists and terrorist organizations provided to the financial institution by government agencies. Every financial institution must establish anti-money laundering programs, including the development of internal policies and procedures, designation of a compliance officer, employee training, and an independent audit function. The passage of the USA Patriot Act has increased our compliance activities, but has not otherwise affected our operations.

 

Sarbanes-Oxley Act of 2002

 

The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) added new legal requirements for public companies affecting corporate governance, accounting and corporate reporting.

 

The Sarbanes-Oxley Act provides for, among other things:

 

 

 

Governmental Monetary Policy

 

Our business and earnings depend in large part on differences in interest rates. One of the most significant factors affecting our earnings is the difference between (1) the interest rates paid by us on our deposits and other borrowings (liabilities) and (2) the interest rates received by us on loans made to our customers and securities held in our investment portfolios (assets). The value of and yield on our assets and the rates paid on our liabilities are sensitive to changes in prevailing market rates of interest. Therefore, our earnings and growth will be influenced by general economic conditions, the monetary and fiscal policies of the federal government, including the Federal Reserve System, whose function is to regulate the national supply of bank credit in order to influence inflation and overall economic growth. Its policies are used in varying combinations to influence overall growth of bank loans, investments and deposits and may also affect interest rates charged on loans, earned on investments or paid for deposits.

 

In view of changing conditions in the national and local economies, we cannot predict possible future changes in interest rates, deposit levels, loan demand, or availability of investment securities and the resulting effect our business or earnings.

 

Investment Advisers Act of 1940

 

A.R. Schmeidler & Co., Inc., is a money manager registered as an investment adviser under the federal Investment Advisers Act of 1940. ARS and its representatives are also registered under the laws of various states regulating investment advisers and their representatives. Regulation under the Investment Advisers Act requires the filing and updating of a Form ADV, filed with the Securities and Exchange Commission. The Investment Advisers Act regulates, among other things, the fees that may be charged to advisory clients, the custody of client funds, relationships with brokers and the maintenance of books and records.

 

Available Information

 

We make available free of charge on our website (http://www.hudsonvalleybank.com) our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. We provide electronic or paper copies of filings free of charge upon request.

 

Risks Related to Our Business

 

Further increases in our nonperforming loans may occur and adversely affect our results of operations and financial condition.

 

As a result of the effects of the recent economic downturn, we are facing higher levels of delinquencies in our loans. At December 31, 2010 and 2009, our non-accrual loans totaled $43.7 million and $50.6 million, or 2.5% and 2.8% of the loan portfolio, respectively. At December 31, 2010 and 2009, our nonperforming assets (which include non-accrual loans, accruing loans 90 days or more past due and foreclosed real estate, also called other real estate owned) totaled $56.3 million and $66.7 million, or 2.1% and 2.5% of total assets, respectively. In addition, we had $21.0 million and $32.0 million of accruing loans that were 31-89 days delinquent at December 31, 2010 and 2009, respectively and $7.8 million on non-performing loans held for sale at December 31, 2010.

 

Until economic and market conditions improve, we expect to continue to incur additional losses relating to an increase in non-performing loans. Our non-performing assets adversely affect our net income in various ways. First, we do not record interest income on non-accrual loans or other real estate owned, thereby adversely affecting our income and increasing our loan administration costs. Second, when we take collateral in foreclosures and similar proceedings, we are required to mark the related loan to the then fair market value of the collateral, which may result in a loss. Third, these loans and other real estate owned also increase our risk profile and the capital our regulators believe is appropriate in light of such risks. Adverse changes in the value of our problem assets, or the underlying collateral, or in these borrowers’ performance or financial conditions, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. There can be no assurance that we will not experience further increases in nonperforming loans in the future, or that our nonperforming assets will not result in further losses in the future.

 

A further downturn in the market areas we serve could increase our credit risk associated with our loan portfolio, as it could have a material adverse effect on both the ability of borrowers to repay loans as well as the value of the real property or other property held as collateral for such loans. Further deterioration of our loan portfolio will likely cause a significant increase in nonperforming loans, which would have an adverse impact on our results of operations and financial condition. There can be no assurance that we will not experience further increases in nonperforming loans in the future.

 

As regulated entities, the Company and the Bank are subject to extensive supervision and prudential regulation, including maintaining certain capital requirements, which may limit their operations and potential growth. Failure to meet any such requirements would subject us to regulatory action.

 

The Company is supervised by the Federal Reserve and the Bank is supervised by the OCC. As such, each is subject to extensive supervision and prudential regulation, including risk-based and leverage capital requirements. The Company and the Bank must maintain certain risk-based and leverage capital ratios as required by the Federal Reserve or the OCC, respectively, that may change depending upon general economic conditions and the particular condition, risk profile and growth plans of the Company and the Bank.

 

In today’s economic and regulatory environment, banking regulators, including the OCC, continue to direct greater scrutiny to banks with higher levels of commercial real estate loans like us. As a general matter, such banks, including the Bank, are expected to maintain higher capital levels as well as other measures due to commercial real estate lending growth and exposures. As a result of the higher levels of our non-performing loans, the high percentage of commercial real estate loans in our loan portfolio, and the increased potential for further possible deterioration in our loans, since December 31, 2009 we have been required by the OCC to maintain at the Bank, by no later than December 31, 2009, a total risk-based capital ratio of at least 12.0% (compared to 10.0% for a well capitalized bank), a Tier 1 risk-based capital ratio of at least 10.0% (compared to 6.0% for a well capitalized bank), and a Tier 1 leverage ratio of at least 8.0% (compared to 5.0% for a well capitalized bank). At December 31, 2010, the Bank’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 14.0%, 12.8% and 8.8%, respectively, and the Company’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 15.2%, 13.9% and 9.6%, respectively.

If we do not maintain these higher capital levels we may be subject to enforcement actions. More generally, compliance with capital requirements may limit loan growth or other operations that require the use of capital and could adversely affect our ability to expand or maintain present business levels.

 

If we fail to meet any regulatory capital requirement or are otherwise deemed to be operating in an unsafe and unsound manner or in violation of law, we may be subject to a variety of informal or formal remedial measures and enforcement actions. Such informal remedial measures and enforcement actions may include a memorandum of understanding which is initiated by the regulator and outlines an institution’s agreement to take specified actions within specified time periods to correct violations of law or unsafe and unsound practices. In addition, as part of our regular examination process, regulators may advise us to operate under various restrictions as a prudential matter. Any of these restrictions, in whatever manner imposed, could have a material adverse effect on our business and results of operations.

 

In addition to informal remedial actions, we may also be subject to formal enforcement actions. Failure to comply with an informal enforcement action could cause us to be subject to formal enforcement actions. Formal enforcement actions include written agreements, cease and desist orders, the imposition of substantial fines and other civil penalties and, in the most severe cases, the termination of deposit insurance or the appointment of a conservator or receiver for our bank subsidiary. Furthermore, if the Bank fails to meet any regulatory capital requirement, it will be subject to the prompt corrective action framework of the Federal Deposit Insurance Corporation Improvements Act of 1991, which imposes progressively more restrictive constraints on operations, management and capital distributions as the capital category of an institution declines, up to and including, ultimately, the appointment of a conservator or receiver. A failure to meet regulatory capital requirements could also subject us to capital raising requirements. Additional capital raisings would be dilutive to holders of our common stock. See “Risk Factors — Risks Relating to Our Common Stock” for more information.

 

Any remedial measure or enforcement action, whether formal or informal, could impose restrictions on our ability to operate our business and adversely affect our prospects, financial condition or results of operations. In addition, any formal enforcement action could harm our reputation and our ability to retain and attract customers and impact the trading price of our common stock.

 

Further increases to the allowance for loan losses may cause our earnings to decrease.

 

In determining our loan loss reserves for each quarter, we make various assumptions and judgments about the future performance of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. In determining the amount of the allowance for loan losses, we rely on loan quality reviews, past experience, and an evaluation of economic conditions, among other factors. If our assumptions prove to be incorrect, our allowance for credit losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to the allowance and a corresponding decrease in income. In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities or otherwise could have a material adverse effect on our results of operations or financial condition.

 

Our concentration of commercial real estate loans has resulted in increased loan losses and could result in further increases in future periods.

 

Commercial real estate is cyclical and poses risks of loss to us due to concentration levels and similar risks of the asset. Of our loan portfolio, 46.0% was concentrated in commercial real estate loans as of December 31, 2010 and 43.1% as of December 31, 2009. As discussed above, banking regulators direct greater scrutiny to banks with higher levels of commercial real estate loans. Due to the high percentage of commercial real estate loans in our loan portfolio, we are among the banks subject to greater regulatory scrutiny of their activities.

 

We have significant exposure to commercial real estate in our loan portfolio and have substantially increased our provision for loan losses primarily because of an increase in expected losses relating to adverse economic conditions, particularly in the real estate market in our primary lending areas. During 2010, we added $46.5 million in provision for loan losses compared to $24.3 million in 2009 and $11.0 million in 2008, in part reflecting collateral evaluations in response to recent changes in the market values of real estate development loans. We may be required to add additional provision for loan loss in 2011.

Given our high concentration in commercial real estate and the greater scrutiny directed to this asset class by banking regulators, our regulators may impose specific concentration limits on our lending activity in this area in the future. Such limitations may restrict our business opportunities and adversely affect our operating results. In addition, further deterioration in our loan portfolio, including further declines in the market values of real estate supporting certain commercial real estate loans, would result in further provisions for loan losses in future periods, which would have a material adverse affect on our business and results of operations.

 

Declines in value may adversely impact the carrying amount of our investment portfolio and result in other-than-temporary impairment charges.

 

As of December 31, 2010, we owned pooled trust preferred debt securities with an aggregate book value of $11.6 million and an unrealized loss of approximately $8.0 million. As a result of recent adverse economic banking conditions, we incurred pretax impairment charges to earnings on these securities of approximately $2.6 million in 2010, $5.5 million in 2009 and $1.1 million during 2008. We may be required to record additional impairment charges on these pooled trust preferred debt securities or other of our investment securities if they suffer a decline in value that is considered other-than-temporary. Numerous factors, including lack of liquidity for resales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate or adverse actions by regulators could have a negative impact on the valuation of our investment portfolio in future periods. If an impairment charge is significant enough, it could affect the ability of the Bank to upstream dividends to us, which could have a material adverse effect on our liquidity and our ability to pay dividends to stockholders, and could also negatively impact our regulatory capital ratios and result in us not being classified as “well capitalized” for regulatory purposes.

 

A prolonged or worsened downturn in the economy in general and the real estate market in our key market areas in particular would adversely affect our loan portfolio and our growth potential.

 

Our primary lending market area is Westchester County, New York and New York City and to an increasing extent, Rockland County, New York and Fairfield County and New Haven County, Connecticut, with a primary focus on businesses, professionals and not-for-profit organizations located in this area. Accordingly, the asset quality of our loan portfolio largely depends upon the area’s economy and real estate markets. The Bank’s primary lending market area and asset quality have been adversely affected by the current economic downturn. A prolonged or worsened downturn in the economy in our primary lending area would adversely affect our asset quality, operations and limit our future growth potential.

 

In particular, a downturn in our local real estate market could negatively affect our business because a significant portion (approximately 88% as of December 31, 2010) of our loans are secured, either on a primary or secondary basis, by real estate. Our ability to recover on defaulted loans by selling the real estate collateral would then be diminished and we would be more likely to suffer losses on defaulted loans. The Bank’s loans have already been adversely affected by the current decline in the real estate market. Continuation or worsening of such conditions could have additional negative effects on our business in the future.

 

A downturn in the real estate market could also result in lower customer demand for real estate loans. This could in turn result in decreased profits as our alternative investments, such as securities, generally yield less than real estate loans.

 

Difficult market conditions have adversely affected our industry.

 

Substantial declines in the real estate markets over the past two years, with falling prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. These write-downs have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. A worsening of these conditions

would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry.

 

As a result of the foregoing, there is a potential for new laws and regulations regarding lending and funding practices and liquidity and capital standards, and financial institution regulatory agencies are now expected to be very aggressive in responding to concerns and trends identified in examinations, including the more frequent issuance of informal remedial measures and formal enforcement orders. These negative developments in the financial services industry and the impact of new legislation in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate loans and work with borrowers to collect loans, and adversely impact our financial performance.

 

Higher FDIC deposit insurance premiums and assessments could adversely affect our financial condition.

 

FDIC insurance premiums increased substantially in 2009 and we may have to pay significantly higher FDIC premiums in the future. Market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. The FDIC adopted a revised risk-based deposit insurance assessment schedule on February 27, 2009, which raised regular deposit insurance premiums. On May 22, 2009, the FDIC also implemented a five basis point special assessment of each insured depository institution’s total assets minus Tier 1 capital as of June 30, 2009, but no more than 10 basis points times the institution’s assessment base for the second quarter of 2009, collected by the FDIC on September 30, 2009. The amount of this special assessment for HVB and NYNB was $1.2 million. Additional special assessments may be imposed by the FDIC for future quarters at the same or higher levels.

 

In addition, the FDIC adopted a rule that required insured depository institutions, including our Bank subsidiaries, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The prepaid assessments were collected on December 30, 2009.  The total prepaid assessments for HVB and NYNB was $12.5 million, which was recorded as a prepaid expense (asset) as of December 30, 2009. As of December 31, 2009 and each quarter thereafter, HVB (for itself and as successor to NYNB) would record an expense for its regular quarterly assessment for the quarter and an offsetting credit to the prepaid assessment until the asset is exhausted.

 

The Dodd-Frank Act made the FDIC’s TAG Program mandatory for all FDIC-insured banks. This additional insurance coverage will be accounted for by likely increases in general assessment charges under its risk-based assessment system. These changes, along with the use of all of our remaining FDIC insurance assessment credits in early 2009, may cause the premiums charged by the FDIC to increase. These actions could significantly increase our noninterest expense in 2011 and in future periods.

 

A substantial decline in the value of our Federal Home Loan Bank of New York common stock may adversely affect our financial condition.

 

We own common stock of the Federal Home Loan Bank of New York (“FHLB”), in order to qualify for membership in the Federal Home Loan Bank system, which enables us to borrow funds under the Federal Home Loan Bank advance program. The amount of FHLB common stock we own fluctuates in relation to the amount of our borrowing from the FHLB. As of December 31, 2010 the carrying value of our FHLB common stock was $7.0 million. In an extreme situation, it is possible that the capitalization of a Federal Home Loan Bank, including the FHLB, could be substantially diminished or reduced to zero. If this occurs, it may adversely affect our results of operations and financial condition.

 

Certain of our goodwill and intangible assets may become impaired in the future.

 

We test our goodwill and intangible assets for impairment on a periodic basis. It is possible that future impairment testing could result in a value of our goodwill and intangibles which may be less than the carrying value and, as a result, may adversely affect our financial condition and results of operations. If we determine that impairment exists at a given time, our earnings and the book value of the related goodwill and intangibles will be reduced by the amount of the impairment.

The opening of new branches could reduce our profitability.

 

We have expanded our branch network by opening new branches. We intend to continue our branch expansion strategy by opening new branches, which requires us to incur a number of up-front expenses associated with the leasing and build-out of the space to be occupied by the branch, the staffing of the branch and similar matters. These expenses are typically greater than the income generated by the branch until it builds up its customer base, which, depending on the branch, could take 18 months or more. In opening branches in a new locality, we may also encounter problems in adjusting to local market conditions, such as the inability to gain meaningful market share and the stronger than expected competition. Numerous factors contribute to the performance of a new branch, such as a suitable location, qualified personnel, and an effective marketing strategy.

 

Our income is sensitive to changes in interest rates.

 

Our profitability, like that of most banking institutions, depends to a large extent upon our net interest income. Net interest income is the difference between interest income received on interest-earning assets, including loans and securities, and the interest paid on interest-bearing liabilities, including deposits and borrowings. Accordingly, our results of operations and financial condition depend largely on movements in market interest rates and our ability to manage our assets and liabilities in response to such movements. Management estimates that, as of December 31, 2010, a 200 basis point increase in interest rates would result in a 1.3% increase in net interest income and a 100 basis point decrease would result in a 1.6% decrease in net interest income.

 

In addition, changes in interest rates may result in an increase in higher cost deposit products within our existing portfolios, as well as a flow of funds away from bank accounts into direct investments (such as U.S. Government and corporate securities and other investment instruments such as mutual funds) to the extent that we may not pay rates of interest competitive with these alternative investments.

 

We may need to raise additional capital in the future and such capital may not be available when needed or at all.

 

We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial performance. We cannot assure you that such capital will be available to us on acceptable terms or at all. Our inability to raise sufficient additional capital on acceptable terms when needed could adversely affect our businesses, financial condition and results of operations.

 

Our markets are intensely competitive, and our principal competitors are larger than us.

 

We face significant competition both in making loans and in attracting deposits. This competition is based on, among other things, interest rates and other credit and service charges, the quality of services rendered, the convenience of the banking facilities, the range and type of products offered and the relative lending limits in the case of loans to larger commercial borrowers. Our market area has a very high density of financial institutions, many of which are branches of institutions that are significantly larger than we are and have greater financial resources and higher lending limits than we do. Many of these institutions offer services that we do not or cannot provide. Nearly all such institutions compete with us to varying degrees.

 

Our competition for loans comes principally from commercial banks, savings banks, savings and loan associations, credit unions, mortgage banking companies, insurance companies and other financial service companies. Our most direct competition for deposits has historically come from commercial banks, savings banks, savings and loan associations, and money market funds and other securities funds offered by brokerage firms and other similar financial institutions. We face additional competition for deposits from non-depository competitors such as the mutual fund industry, securities and brokerage firms, and insurance companies. Competition may increase in the future as a result of recently proposed regulatory changes in the financial services industry.

 

Impact of inflation and changing prices

 

The consolidated financial statements and notes thereto incorporated by reference herein have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollar amounts or estimated fair value without considering the changes in the relative purchasing power of

money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, nearly all of our assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.

 

Extensive Regulation and Supervision.

 

The Company, primarily through its principal subsidiary and certain non-bank subsidiaries, is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole. Such laws are not designed to protect the Company’s stockholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. The Company is also subject to a number of Federal laws, which, among other things, require it to lend to various sectors of the economy and population, and establish and maintain comprehensive programs relating to anti-money laundering and customer identification. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition and results of operations. The Company’s compliance with certain of these laws will be considered by banking regulators when reviewing bank merger and bank holding company acquisitions.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act May Affect Our Business Activities, Financial Position and Profitability By Increasing Our Regulatory Compliance Burden and Associated Costs, Placing Restrictions on Certain Products and Services, and Limiting Our Future Capital Raising Strategies.

 

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by the President of the United States. The Dodd-Frank Act implements significant changes in financial regulation and will impact all financial institutions, including the Company and the Bank. Among the Dodd-Frank Act’s significant regulatory changes, it creates a new financial consumer protection agency, known as the Bureau of Consumer Financial Protection (the “Bureau”), that is empowered to promulgate new consumer protection regulations and revise existing regulations in many areas of consumer protection. The Bureau has exclusive authority to issue regulations, orders and guidance to administer and implement the objectives of federal consumer protection laws. The Bureau will also have the ability to participate, with the OCC, in our consumer compliance examinations. Moreover, the Dodd-Frank Act permits states to adopt stricter consumer protection laws and authorizes state attorney generals’ to enforce consumer protection rules issued by the Bureau. The Dodd-Frank Act also restricts the authority of the Comptroller of the Currency to preempt state consumer protection laws applicable to national banks, such as the Bank, and may affect the preemption of state laws as they affect subsidiaries and agents of national banks, changes the scope of federal deposit insurance coverage, and potentially increases the FDIC assessment payable by the Bank. We expect that the Bureau and certain other provisions in the Dodd-Frank Act will significantly increase our regulatory compliance burden and costs and may restrict the financial products and services we offer to our customers.

 

Because many of the Dodd-Frank Act’s provisions require regulatory rulemaking, we are uncertain as to the impact that some of the provisions of the Dodd-Frank Act will have on the Company and the Bank and cannot provide assurance that the Dodd-Frank Act will not adversely affect our financial condition and results of operations for other reasons.

 

Technological change may affect our ability to compete.

 

The banking industry continues to undergo rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. There can be no assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to the public.

In addition, because of the demand for technology-driven products, banks are increasingly contracting with outside vendors to provide data processing and core banking functions. The use of technology-related products, services, delivery channels and processes exposes a bank to various risks, particularly transaction, strategic, reputation and compliance risks. There can be no assurance that we will be able to successfully manage the risks associated with our increased dependency on technology.

 

Changes in Accounting Policies or Accounting Standards.

 

The Company’s accounting policies are fundamental to understanding its financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of the Company’s assets or liabilities and financial results. The Company identified its accounting policies regarding the allowance for loan losses, security valuations, goodwill and other intangible assets, and income taxes to be critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain. Under each of these policies, it is possible that materially different amounts would be reported under different conditions, using different assumptions, or as new information becomes available.

 

From time to time the Financial Accounting Standards Board (“FASB”) and the Securities and Exchange Commission (“SEC”) change their guidance governing the form and content of the Company’s external financial statements. In addition, accounting standard setters and those who interpret U.S. generally accepted accounting principles (“GAAP”), such as the FASB, SEC, banking regulators and the Company’s outside auditors, may change or even reverse their previous interpretations or positions on how these standards should be applied. Such changes are expected to continue, and may accelerate as the FASB and International Accounting Standards Board have reaffirmed their commitment to achieving convergence between U.S. GAAP and International Financial Reporting Standards. Changes in U.S. GAAP and changes in current interpretations are beyond the Company’s control, can be hard to predict and could materially impact how the Company reports its financial results and condition. In certain cases, the Company could be required to apply a new or revised guidance retroactively or apply existing guidance differently (also retroactively) which may result in the Company restating prior period financial statements for material amounts. Additionally, significant changes to U.S. GAAP may require costly technology changes, additional training and personnel, and other expenses that will negatively impact our results of operations.

 

We may incur liabilities under federal and state environmental laws with respect to foreclosed properties.

 

Approximately 88% of the loans held by the Company as of December 31, 2010 were secured, either on a primary or secondary basis, by real estate. Approximately half of these loans were commercial real estate loans, with most of the remainder being for single or multi-family residences. We currently own seven properties acquired in foreclosure, totaling $11.0 million. Under federal and state environmental laws, we could face liability for some or all of the costs of removing hazardous substances, contaminants or pollutants from properties we acquire on foreclosure. While other persons might be primarily liable, such persons might not be financially solvent or able to bear the full cost of the clean-up. It is also possible that a lender that has not foreclosed on property but has exercised unusual influence over the borrower’s activities may be required to bear a portion of the clean-up costs under federal or state environmental laws.

 

We Are Subject to Environmental Liability Risk Associated With Lending Activities.

 

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review prior to originating certain commercial real estate loans, as well as before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.

Risks Relating to Our Common Stock

 

Market conditions and other factors may affect the value of our common stock.

 

The trading price of the shares of our common stock will depend on many factors, which may change from time to time, including:

 

 

Accordingly, the shares of common stock that an investor purchases may trade at a price lower than that at which they were purchased.

 

There may be future dilution of our common stock.

 

The Company is currently authorized to issue up to 25 million shares of common stock, of which 17,665,908 shares were outstanding as of December 31, 2010, and up to 15 million shares of preferred stock, of which no shares are outstanding. The Company’s certificate of incorporation authorizes the Board of Directors to, among other things, issue additional shares of common or preferred stock, or securities convertible or exchangeable into common or preferred stock, without stockholder approval. We may issue such additional equity or convertible securities to raise additional capital in connection with acquisitions, as part of our employee and director compensation or otherwise. The issuance of any additional shares of common or preferred stock or convertible securities could substantially dilute holders of our common stock. Moreover, to the extent that we issue restricted stock, stock options, or warrants to purchase our common stock in the future and those stock options or warrants are exercised or the restricted stock vests, our stockholders may experience further dilution. Holders of our shares of common stock have no preemptive rights that entitle them to purchase their pro rata share of any offering of shares of any class or series and, therefore, such sales or offerings could result in increased dilution to our stockholders.

 

We may further reduce or eliminate the cash dividend on our common stock.

 

We reduced our total per share dividend in 2010 to $0.65 per share. Holders of our common stock are only entitled to receive such cash dividends as our Board of Directors may declare out of funds legally available for such payments. Although we have historically declared cash dividends on our common stock, we are not required to do so and may further reduce or eliminate our common stock cash dividend in the future. This could adversely affect the market price of our common stock. Also, as a bank holding company, the Company’s ability to declare and pay dividends depends on certain federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.

 

Government regulation restricts our ability to pay cash dividends.

 

Dividends from the Bank are the only current significant source of cash for the Company. There are various statutory and regulatory limitations regarding the extent to which the Bank can pay dividends or otherwise transfer funds to the Company. Federal bank regulatory agencies also have the authority to limit further the Bank’s payment of dividends based on such factors as the maintenance of adequate capital for the Bank, which could reduce the amount of dividends otherwise payable. We paid a cash dividend to our stockholders of $0.65 per share in 2010 and $1.15 per share in 2009 (adjusted for subsequent stock dividends). We currently expect to pay substantially reduced per share dividends in 2011. Under applicable banking statutes, at December 31, 2010, the Bank could have declared dividends of approximately $3.9 million to the Company without prior regulatory approval. No assurance can be given that the Bank will have the profitability necessary to permit the payment of dividends in the future; therefore, no assurance can be given that the Company would have any funds available to pay dividends to stockholders.

Federal bank regulators require us to maintain certain levels of regulatory capital. The failure to maintain these capital levels or to comply with applicable laws, regulations and supervisory agreements could subject us to a variety of informal and formal enforcement actions. Moreover, dividends can be restricted by any of our regulatory authorities if the agency believes that our financial condition warrants such a restriction.

 

The Company’s ability to declare and pay dividends is restricted under the New York Business Corporation Law, which provides that dividends may only be paid by a corporation out of its surplus.

 

The Federal Reserve issued a supervisory letter dated February 24, 2009 to bank holding companies that contains guidance on when the board of directors of a bank holding company should eliminate, defer or severely limit dividends including, for example, when net income available for stockholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends. The letter also contains guidance on the redemption of stock by bank holding companies which urges bank holding companies to advise the Federal Reserve of any such redemption or repurchase of common stock for cash or other value which results in the net reduction of a bank holding company’s capital during the quarter.

 

In the event of a liquidation or reorganization of the Bank, the ability of holders of debt and equity securities of the Company to benefit from the distribution of assets from the Bank upon any such liquidation or reorganization would be subordinate to prior claims of creditors of the Bank (including depositors), except to the extent that the Company’s claim as a creditor may be recognized. The Company is not currently a creditor of the Bank.

 

Our common stock price may fluctuate due to the potential sale of stock by our existing stockholders.

 

We are aware that several of our large stockholders may in the future liquidate some or all of their shares of Company common stock for estate planning and other reasons. In addition, other stockholders may sell their shares of common stock from time to time on the NASDAQ Global Select Market or otherwise. As a result, substantial amounts of our common stock are eligible for future sale. While we cannot predict either the magnitude or the timing of such sales, if a large number of common shares are sold during a short time frame, it may have the effect of reducing the market price of our common stock.

 

Our earnings may be subject to increased volatility.

 

Our earnings may experience volatility as a result of several factors. These factors include, among others:

 

 

If any one or more of these events occur, we may experience significant declines in our net interest margin and non-interest income, or we may be required to record substantial charges to our earnings, including increases in the provision for loan losses, credit-related impairment on securities (both permanent and other-than-temporary), and impairment on goodwill and other intangible assets, in future periods.

 

Our certificate of incorporation, the New York Business Corporation Law and federal banking laws and regulations may prevent a takeover of our company.

 

Provisions of the Company’s certificate of incorporation, the New York Business Corporation Law and federal banking laws and regulations, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our stockholders. The combination of these provisions may inhibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

 

None.

 

Our principal executive offices, including administrative and operating departments, are located at 21 Scarsdale Road, Yonkers, New York, in premises we own. HVB’s main branch is located at 1055 Summer Street, Stamford, Connecticut, in premises we lease.

 

HVB operates 36 branches. HVB owns the following branch locations :

 

 

HVB leases the following branch locations:

 

 

Of the above leased properties, 4 properties located in Bronx, White Plains, New Rochelle and New York, New York, have lease terms that expire within the next 2 years. We currently expect to renew the leases of each of these properties.

 

A. R. Schmeidler & Co., Inc is located at 500 Fifth Avenue, New York, New York in leased premises.

 

We currently operate 27 ATM machines, 24 of which are located in the Banks’ facilities. Three ATMs are located at off-site locations: St. Joseph’s Hospital, Yonkers, College of Mount Saint Vincent, Riverdale, New York, and Concordia College, Bronxville, New York.

 

In our opinion, the premises, fixtures and equipment are adequate and suitable for the conduct of our business. All facilities are well maintained and provide adequate parking.

 

Various claims and lawsuits are pending against the Company and its subsidiaries in the ordinary course of business. In the opinion of management, resolution of each matter is not expected to have a material effect on the financial condition or results of operations of the Company and its subsidiaries.

 

Our common stock was held of record as of March 1, 2011 by approximately 894 registered shareholders. Our common stock trades on the NASDAQ Global Select Market under the symbol “HUVL”. Trading in this market is limited. Prior to our listing on the NASDAQ Global Select Market on September 21, 2009, our common stock traded sporadically on the OTC Bulletin Board. We historically created a secondary market for our stock by issuing offers to repurchase shares from any stockholder based on the appraised value of the Company. However we have discontinued this program.

 

The table below sets forth the price range of our common stock since being listed on the NASDAQ Global Select Market on September 21, 2009. Prices have been adjusted to reflect the 10% stock dividend to shareholders in December 2010.

 

 

 

(1) Prior to the fourth quarter of 2009, there was no established public trading market for the Company’s common stock.

 

In 1998, the Board of Directors of the Company adopted a policy of paying quarterly cash dividends to holders of its common stock. Quarterly cash dividends were paid as follows: In 2010, $0.21 per share to shareholders of record on February 11 and May 10, $0.09 per share to shareholders of record on August 9 and $0.14 per share to shareholders of record on November 8. In 2009, $0.38 per share to shareholders of record on February 13, $0.33 per share to shareholders of record on May 22, $0.25 per share to shareholders of record on August 21 and $0.19 per share to shareholders of record on November 13. Dividends per share have been adjusted to reflect the 10 percent stock dividends to shareholders in December 2010 and 2009.

 

Stock dividends of 10 percent each (one share for every 10 outstanding shares) were declared by the Company for shareholders of record on November 29, 2010 and December 7, 2009.

 

Any funds which the Company may require in the future to pay cash dividends, as well as various Company expenses, are expected to be obtained by the Company chiefly in the form of cash dividends from HVB and secondarily from sales of common stock pursuant to the Company’s stock option plan. The ability of the Company to declare and pay dividends in the future will depend not only upon its future earnings and financial condition, but also upon the future earnings and financial condition of the Bank and its ability to transfer funds to the Company in the form of cash dividends and otherwise. See further discussion in “Supervision and Regulation” under Item 1 of this Annual Report on Form 10-K. The Company is a separate and distinct legal entity from HVB. The Company’s right to participate in any distribution of the assets or earnings of HVB is subordinate to prior claims of creditors of HVB.

 

The Company sold 3,993,395 shares of common stock at an issue price of $25.00 per share in an underwritten common stock offering during the fourth quarter of 2009. Net proceeds from the offering were $93.3 million. In conjunction with this common stock offering, the Company listed its common stock on the NASDAQ Global Select Market under the symbol “HUVL”. Concurrent with listing its common stock on the NASDAQ, the Company lifted all restrictions on transferability of its common stock that previously applied to certain shareholders and a majority of the shares outstanding. A total of $59.0 million of the net proceeds from this offering was contributed to HVB and NYNB during 2010 and 2009 increasing the Banks’ capital ratios, as required of the Banks’ by the OCC, to levels in excess of “well capitalized” levels generally applicable to banks under current regulations. See further discussion in

“Supervision and Regulation” under Item 1 of this Annual Report on Form 10-K. The remaining net proceeds of this offering are available for general corporate purposes. There were no sales of common stock by the Company during the fourth quarter of 2010.

 

There were no purchases made by the Company of its common stock during the year ended December 31, 2010.

 

Stockholder Return Performance Graph

 

The following graph compares the Company’s total stockholder return for the years 2006, 2007, 2008, 2009 and 2010 based on prices as reported on the over-the-counter bulletin board and as reported on the NASDAQ Global Select Market effective with the Company’s listing in September 2009, with (1) the Russell 2000 and (2) the SNL $1 billion to $5 billion Bank Index.

 

Total Return Performance

 

 

 

The graph assumes $100 was invested on December 31, 2005 and dividends were reinvested. Returns are market capitalization weighted.

 

The following table sets forth selected historical consolidated financial data for the years ended and as of the dates indicated. The selected historical consolidated financial data as of December 31, 2010 and 2009, and for the years ended December 31, 2010, 2009 and 2008, are derived from our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected historical consolidated financial data as of December 31, 2008, 2007 and 2006 and for the years ended December 31, 2007 and 2006 are derived from our consolidated financial statements that are not included in this Annual Report on Form 10-K. Share and per share data have been restated to reflect the effects of 10 percent stock dividends issued in 2010, 2009, 2008 and 2007. The information set forth below should be read in conjunction with the consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Annual Report on Form 10-K.

 

 

Financial Ratios

 

Significant ratios of the Company for the periods indicated are as follows:

 

 

 

This section presents discussion and analysis of the Company’s consolidated financial condition at December 31, 2010 and 2009, and consolidated results of operations for each of the three years in the period ended December 31, 2010. The Company is consolidated with its wholly-owned subsidiaries Hudson Valley Bank, N.A. and its subsidiaries (collectively “HVB” or “the Bank”) and HVHC Risk Management Corp. This discussion and analysis should be read in conjunction with the financial statements and supplementary financial information contained elsewhere in this Annual Report on Form 10-K.

 

Overview of Management’s Discussion and Analysis

 

This overview is intended to highlight selected information included in this Annual Report on Form 10-K. It does not contain sufficient information for a complete understanding of the Company’s financial condition and operating results and, therefore, should be read in conjunction with this entire Annual Report on Form 10-K.

 

The Company derives substantially all of its revenue from providing banking and related services to businesses, professionals, municipalities, not-for profit organizations and individuals within its market area, primarily Westchester County and Rockland County, New York, portions of New York City and Fairfield County and New Haven County, Connecticut. The Company’s assets consist primarily of loans and investment securities, which are funded by deposits, borrowings and capital. The primary source of revenue is net interest income, the difference between interest income on loans and investments, and interest expense on deposits and borrowed funds. The Company’s basic strategy is to grow net interest income and non interest income by the retention of its existing customer base and the expansion of its core businesses and branch offices within its current market and surrounding areas. Considering current economic conditions, the Company’s primary market risk exposures are interest rate risk, the risk of deterioration of market values of collateral supporting the Company’s loan portfolio, particularly commercial and residential real estate and potential risks associated with the impact of regulatory changes that may take place in reaction to current conditions in the financial system. Interest rate risk is the exposure of net interest income to changes in interest rates. Commercial and residential real estate are the primary collateral for the majority of Company’s loans.

 

The wide ranging economic downturn, which began in 2008 and continued throughout 2009 and 2010, has had extremely negative effects on all financial sectors both domestic and foreign. Perhaps the most severe impact of this downturn has been felt by the real estate industry, which is a major source of both the deposit and loan businesses of the Company. Although recent indications suggest that the economic decline has begun to turn around, the Company expects this recovery to be slow and expects to continue to experience some negative pressure from these adverse conditions into the first quarter of 2011 and beyond.

 

Net income for 2010 was $5.1 million or $0.29 per diluted share, a decrease of $13.9 million or 73.2 percent compared to $19.0 million or $1.37 per diluted share in 2009. The overall decline in earnings in 2010, compared to 2009, resulted primarily from significant increases in the provision for loan losses which totaled $46.5 million for the year ended December 31, 2010, compared to $24.3 million for the prior year period. Earnings were also adversely affected by real estate owned valuation provisions of $1.4 million and $0.6 million, respectively, in the second and third quarters of 2010. These provisions are reflective of continued weakness in the overall economy which has resulted in the Company’s decision to follow a more aggressive strategy for problem asset resolution further discussed below.

 

Total loans decreased $84.2 million during the year ended December 31, 2010. This decline resulted from a number of factors including decreased loan demand, charge-offs, pay downs of existing loans and the transfer of $21.9 million of nonperforming loans to the loans held-for-sale category. The Company recognized $46.2 million of net charge-offs during 2010. Despite the weakness in loan demand, and the continuation of pressure on overall asset quality caused by the ongoing effects of the economic downturn, the Company continues to provide lending availability to both new and existing customers.

 

Overall asset quality continued to be adversely affected by the current state of the economy and the real estate market. Nonperforming assets, which include nonaccrual loans, accruing loans delinquent over 90 days and other

real estate owned, decreased to $56.3 million at December 31, 2010, compared to $66.7 million at December 31, 2009. The decrease included the transfer of $21.9 million of nonperforming loans to the loans held-for-sale category. The Company has continued to experience a slowdown in payments of certain loans, such as construction loans, whose repayment is often dependent on sales of completed properties, as well as increases in delinquent and nonperforming loans in other sectors of the loan portfolio, all of which have been adversely impacted by the economic downturn and decline in the real estate market. These conditions have resulted in severe declines in the demand for and values of virtually all commercial and residential real estate properties. These declines, together with the limited availability of residential mortgage financing, resulted in continued downward pressure on the overall asset quality of the Company’s loan portfolio during 2010. In addition, recent significant increases in filings of bankruptcy and foreclosure proceedings have overloaded the court systems and have resulted in what the Company believes to be unacceptable delays in attempts to obtain title to real estate and other collateral through conventional foreclosure.

 

As a result of above factors, since the second quarter of 2010, the Company has followed a more aggressive strategy for resolving problem assets. As part of the revised resolution strategy, the Company has reevaluated each problem loan and has made a determination of net realizable value based on management’s estimation of the best possible outcome considering the individual characteristics of each asset against the likelihood of resolution with the current borrower, expectations for resolution through the court system, or other available market opportunities. The severity of the decline in real estate values has provided new market opportunities for the disposition of distressed assets as investors search for yield in the current low interest rate environment and our more aggressive policy has begun to take advantage of those opportunities. As part of this revised strategy, during the third quarter of 2010, the Company transferred twenty five loans totaling $21.9 million to the loans held-for-sale category. Partial charge-offs of these loans to adjust their carrying amount to estimated fair value accounted for $14.1 million of the $46.2 million of net charge-offs recorded during the full year of 2010. Approximately $14.1 million of these loans were sold in December of 2010 without further loss. The remaining $7.8 million are expected to be disposed of in the first or second quarters of 2011. As noted above, despite recent indications suggesting that the economic decline may have begun to turn around, the Company expects any recovery to be slow and expects to continue to experience some negative pressure from these adverse conditions into the first quarter of 2011 and beyond.

 

Total deposits increased $61.8 million during the year ended December 31, 2010, as the Company continued to experience significant growth in new customers both in existing branches and new branches added during the last two years. Overall deposit growth was partially offset by planned reductions in certain non-core deposit balances. Proceeds from deposit growth were used to reduce maturing term borrowings or were retained in liquid investments, principally interest earning bank deposits.

 

As a result of the aforementioned activity in the Company’s core businesses of loans and deposits and other asset/liability management activities, tax equivalent basis net interest income declined by $4.6 million or 3.9 percent to $113.8 million for the year ended December 31, 2010, compared to $118.4 million for the year ended December 31, 2009. The effect of the adjustment to a tax equivalent basis was $3.1 million in 2010 and $4.1 million in 2009.

 

Non interest income was $13.7 million in 2010, an increase of $3.2 million or 30.5 percent, compared to $10.5 million in 2009. The increase was partially due to an increase in investment advisory fees. Fee income from this source increased primarily as a result of the effects of recent improvement in both domestic and international equity markets. Assets under management were approximately $1.5 billion at December 31, 2010 and $1.3 billion at December 31, 2009. The overall increases in non interest income also included growth in deposit service charges. Non interest income also included recognized pre-tax impairment charges on securities available for sale of $2.6 million in 2010 and $5.5 million in 2009. The impairment charges were related to the Company’s investments in pooled trust preferred securities. Non interest income for 2010 and 2009 also included $2.0 million and $0.3 million of valuation losses on other real estate owned.

 

Non interest expense was $74.1 million for both 2010 and 2009. Increases in non interest expense resulting from the Company’s continued investment in its branch offices, technology and personnel to accommodate growth, the expansion of services and products available to new and existing customers and the upgrading of certain internal processes were more than offset by cost saving measures implemented by the Company during 2009 and 2010. In

addition, 2010 reflected significantly lower FDIC deposit insurance premiums. Additional premiums imposed by the FDIC in 2009 to replenish shortfalls in the FDIC Insurance Fund were not imposed to the same degree in 2010. However, additional premium increases and special assessments may continue to be imposed by the FDIC in the future. Decreases resulting from the lower FDIC premiums and other cost saving measures were offset by significant increases in costs related to problem loan resolutions and other real estate owned.

 

The Company uses a simulation analysis to estimate the effect that specific movements in interest rates would have on net interest income. Excluding the effects of planned growth and anticipated new business, the simulation analysis at December 31, 2010 shows the Company’s net interest income decreasing slightly if rates fall and increasing slightly if rates rise.

 

The Company has established specific policies and operating procedures governing its liquidity levels to address future liquidity needs, including contingent sources of liquidity. While the current adverse economic situation has put pressure on the availability of liquidity in the marketplace, the Company believes that its present liquidity and borrowing capacity are sufficient for its current business needs. In addition, the Company and the Bank are subject to various regulatory capital guidelines. In today’s economic and regulatory environment the OCC, which is the primary federal regulator of the Bank, has directed greater scrutiny to banks with higher levels of commercial real estate loans. During the fourth quarter of 2009, the OCC required HVB to maintain, by December 31, 2009, a total risk-based capital ratio of at least 12.0%, a Tier 1 risk-based capital ratio of at least 10.0%, and a Tier 1 leverage ratio of at least 8.0%. These capital levels are in excess of “well capitalized” levels generally applicable to banks under current regulations. To meet these increased capital ratios and to support future growth, the Company successfully raised a net $93.3 million in an underwritten common stock offering in the fourth quarter of 2009. As of December 31, 2010, and 2009, the Company and HVB exceeded all required regulatory capital levels.

 

Critical Accounting Policies

 

Application of Critical Accounting Policies — The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The Company’s significant accounting policies are more fully described in Note 1 to the Consolidated Financial Statements. Certain accounting policies require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. On an on-going basis, management evaluates its estimates and assumptions, and the effects of revisions are reflected in the financial statements in the period in which they are determined to be necessary. The accounting policies described below are those that most frequently require management to make estimates and judgements, and therefore, are critical to understanding the Company’s results of operations. Senior management has discussed the development and selection of these accounting estimates and the related disclosures with the Audit Committee of the Company’s Board of Directors.

 

Securities — Securities are classified as either available for sale, representing securities the Company may sell in the ordinary course of business, or as held to maturity, representing securities that the Company has determined that it is more likely than not that it would not be required to sell prior to maturity or recovery of cost. Securities available for sale are reported at fair value with unrealized gains and losses (net of tax) excluded from operations and reported in other comprehensive income. Securities held to maturity are stated at amortized cost. Interest income includes amortization of purchase premium and accretion of purchase discount. The amortization of premiums and accretion of discounts is determined by using the level yield method. Securities are not acquired for purposes of engaging in trading activities. Realized gains and losses from sales of securities are determined using the specific identification method. The Company regularly reviews declines in the fair value of securities below their costs for purposes of determining whether such declines are other-than-temporary in nature. In estimating other-than-temporary impairment (“OTTI”), management considers adverse changes in expected cash flows, the length of time and extent that fair value has been less than cost and the financial condition and near term prospects of the issuer. The Company also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as

follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.

 

Allowance for Loan Losses — The Company maintains an allowance for loan losses to absorb probable losses incurred in the loan portfolio based on ongoing quarterly assessments of the estimated losses. The Company’s methodology for assessing the appropriateness of the allowance consists of a specific component for identified problem loans, and a formula component which addresses historical loan loss experience together with other relevant risk factors affecting the portfolio.

 

The specific component incorporates the results of measuring impaired loans as required by the “Receivables” topic of the FASB Accounting Standards Codification. These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan’s contractual terms. In addition, a loan which has been renegotiated with a borrower experiencing financial difficulties for which the terms of the loan have been modified with a concession that the Company would not otherwise have granted are considered troubled debt restructurings and are also recognized as impaired. A loan is not deemed to be impaired if there is a short delay in receipt of payment or if, during a longer period of delay, the Company expects to collect all amounts due including interest accrued at the contractual rate during the period of delay. Measurement of impairment can be based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. If the fair value of an impaired loan is less than the related recorded amount, a specific valuation component is established within the allowance for loan losses or, if the impairment is considered to be permanent, a partial charge-off is recorded against the allowance for loan losses. Individual measurement of impairment does not apply to large groups of smaller balance homogenous loans that are collectively evaluated for impairment such as portions of the Company’s portfolios of home equity loans, real estate mortgages, installment and other loans.

 

The formula component is calculated by first applying historical loss experience factors to outstanding loans by type. This component is then adjusted to reflect additional risk factors not addressed by historical loss experience. These factors include the evaluation of then-existing economic and business conditions affecting the key lending areas of the Company and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan portfolio. Senior management reviews these conditions quarterly. Management’s evaluation of the loss related to each of these conditions is quantified by loan type and reflected in the formula component. The evaluations of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty due to the subjective nature of such evaluations and because they are not identified with specific problem credits.

 

Actual losses can vary significantly from the estimated amounts. The Company’s methodology permits adjustments to the allowance in the event that, in management’s judgment, significant factors which affect the collectibility of the loan portfolio as of the evaluation date have changed.

 

Management believes the allowance for loan losses is the best estimate of probable losses which have been incurred as of December 31, 2010. There is no assurance that the Company will not be required to make future adjustments to the allowance in response to changing economic conditions, particularly in the Company’s service area, since the majority of the Company’s loans are collateralized by real estate. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments at the time of their examinations.

 

Other Real Estate Owned (“OREO”) — Real estate properties acquired through loan foreclosure are recorded at estimated fair value, net of estimated selling costs, at time of foreclosure establishing a new cost basis. Credit losses arising at the time of foreclosure are charged against the allowance for loan losses. Subsequent valuations are

periodically performed by management and the carrying value is adjusted by a charge to expense to reflect any subsequent declines in the estimated fair value. Routine holding costs are charged to expense as incurred.

 

Goodwill and Other Intangible Assets — Goodwill and identified intangible assets with indefinite useful lives are not subject to amortization. Identified intangible assets that have finite useful lives are amortized over those lives by a method which reflects the pattern in which the economic benefits of the intangible asset are used up. All goodwill and identified intangible assets are subject to impairment testing on an annual basis, or more often if events or circumstances indicate that impairment may exist. If such testing indicates impairment in the values and/or remaining amortization periods of the intangible assets, adjustments are made to reflect such impairment. The Company’s impairment evaluations as of December 31, 2010 and December 31, 2009 did not indicate impairment of its goodwill or identified intangible assets.

 

Income Taxes — Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period the change is enacted.

 

Results of Operations for Each of the Three Years in the Period Ended December 31, 2010

 

Summary of Results

 

The Company reported net income of $5.1 million in 2010, a decrease of $13.9 million or 73.2 percent compared to $19.0 million in 2009, which decreased $11.9 million or 38.5 percent compared to $30.9 million in 2008. The decrease in 2010 net income, compared to 2009, reflected a significantly higher provision for loan losses, lower net interest income and slightly higher noninterest expense, partially offset by higher non interest income and a lower effective tax rate. The decrease in 2009 net income, compared to 2008, reflected a significantly higher provision for loan losses, higher noninterest expense including significantly higher FDIC deposit insurance premiums and lower non interest income, partially offset by higher net interest income and a lower effective tax rate. Provisions for loan losses totaled $46.5 million, $24.3 million and $11.0 million in 2010, 2009 and 2008 respectively. Non interest income includes $2.6 million, $5.5 million and $1.5 million of pretax recognized impairment charges related to certain securities in the Company’s investment portfolio in 2010, 2009 and 2008, respectively. Non interest income also includes $2.0 million and $0.3 million of valuation losses on other real estate owned in 2010 and 2009, respectively. Non interest expense includes $4.7 million, $5.5 million and $0.9 million of FDIC deposit insurance premiums in 2010, 2009 and 2008, respectively. The significantly higher levels of the provisions for loan losses, recognized impairment charges, valuation losses on other real estate owned and FDIC deposit insurance premiums in 2010 and 2009, compared to 2008, are a direct result of the significantly negative effects that the ongoing economic downturn has had on the performance and collateral values of the Company’s loan portfolios, the underlying credit and marketability of certain securities in its investment portfolio, and the overall performance of the financial services industry in general.

 

Diluted earnings per share were $0.29 in 2010, a decrease of $1.08 or 78.8 percent compared to $1.37 in 2009, which decreased $0.90 or 39.6 percent compared to $2.27 in 2008. These changes are a direct result of the changes in net income in the respective years compared to the prior year period. Prior period per share amounts have been adjusted to reflect the 10 percent stock dividend distributed in December 2010. Returns on average stockholders’ equity and average assets were 1.7 percent and 0.2 percent for 2010, compared to 8.7 percent and 0.7 percent in 2009 and 14.8 percent and 1.3 percent in 2008. Returns on adjusted average stockholders’ equity were 1.8 percent, 8.8 percent and 14.6 percent in 2010, 2009 and 2008, respectively. Adjusted average stockholders’ equity excludes the effects of net unrealized gains, net of tax of $3,078 and $981 and unrealized losses, net of tax, of $2,955 on securities available for sale in 2010, 2009 and 2008, respectively. The annualized return on adjusted average stockholders’ equity is, under SEC regulations, a non-GAAP financial measure. Management believes that this non-GAAP financial measures more closely reflects actual performance, as it is more consistent with the Company’s stated asset/liability management strategies, which do not contemplate significant realization of market gains or

losses on securities available for sale which were primarily related to changes in interest rates or illiquidity in the marketplace.

 

Net interest income for 2010 was $110.7 million, a decrease of $3.6 million or 3.1 percent compared to $114.3 million in 2009, which increased $4.3 million or 3.9 percent compared to $110.0 million in 2008. The 2010 decrease compared to 2009 was primarily due to a decrease in the tax equivalent basis net interest margin to 4.36% from 4.90%, partially offset by $193.2 million growth in the average balance of interest earning assets which was in excess of the $85.0 million growth in the average balance of interest bearing liabilities. The 2010 decrease in the tax equivalent basis net interest margin, compared to the prior year, resulted primarily from the effects significant increases in the average balance of low yielding interest bearing deposits in banks as a percentage of interest earning assets resulting primarily from weak loan demand, the completion of a planned reduction of the Company’s investment portfolio and the effects of maturing, higher yielding loans and investments being renewed or replaced in a significantly lower interest rate environment. The 2009 increase over 2008 was primarily due to $187.3 million growth in the average balance of interest earning assets which was in excess of the $143.4 million growth in the average balance of interest bearing liabilities, partially offset by a reduction in the tax equivalent basis net interest margin to 4.90% in 2009 from 5.14% in 2008. The 2009 decrease in the tax equivalent basis net interest margin, compared to the prior year, was primarily as a result of a slight reduction in the incremental spread between interest earning assets and interest bearing liabilities, partially offset by a $43.9 million increase in the excess of interest earning assets over interest bearing liabilities. The 2009 increase in the average balance of interest earning assets reflected growth in loans and short-term funds, partially offset by a planned reduction in investments. The 2009 increase in interest bearing liabilities reflected growth in deposits, partially offset by a planned reduction in short-term and other borrowed funds.

 

The provision for loan losses for 2010 was $46.5 million compared to $24.3 million in 2009 and $11.0 million in 2008. The significant increases in 2010 and 2009, compared to their respective prior year periods is primarily directly related to negative effects on the loan portfolio of conditions resulting from the ongoing crisis in the financial markets. As a result of the severe economic downturn, the Company has experienced significant levels of delinquent and nonperforming loans and a continuation of the slowdowns in repayments and declines in the loan-to-value ratios on existing loans which began in the second half of 2008 and has continued throughout 2009 and 2010. These conditions, together with the shortage of available residential mortgage financing, have put downward pressure on the overall asset quality of virtually all financial institutions, including the Company. In addition since the second quarter of 2010, the Company has followed the more aggressive strategy for resolving problem assets including the transfer of $21.9 million of nonperforming loans, to the held-for-sale category. The Company believes that the overall revised strategy will continue to address new and existing problem loans in the most appropriate and timely manner given current conditions in the economy.

 

Non interest income increased $3.2 million or 30.5 percent to $13.7 million in 2010 compared to $10.5 million in 2009, which decreased $8.1 million or 43.5 percent compared to $18.6 million in 2008. The increase of noninterest income in 2010, compared to the prior year period, was primarily due to increases in investment advisory fees of A.R. Schmeidler & Co., Inc., growth in deposit activity and other service fees and a decrease in recognized impairment charges on securities available-for-sale, partially offset by an increase in valuation losses on other real estate owned. The Company’s non interest income decreased in 2009, compared to the prior year period, primarily as a result of a significant increase in recognized impairment charges on securities available-for-sale and a significant decrease in investment advisory fees, partially offset by a decline in deposit activity and other service income. Investment advisory fee income experienced significant declines beginning in the fourth quarter of 2008 and continued to decline during the first half of 2009 as a result of significant declines in both domestic and international equity markets. Although there was significant improvement in the financial markets in late 2009 and 2010, continued improvement and the continued acquisition of new customers will be necessary for this source of non interest income to return to past levels. The Company recorded pre-tax recognized impairment charges on securities available-for-sale of $2.6 million, $5.5 million and $1.5 million in 2010, 2009 and 2008, respectively. Other dispositions of securities available for sale resulted in net realized gains of $0.2 million, $0.1 million and $0.1 million in 2010, 2009 and 2008, respectively. The sales were conducted as part of the Company’s ongoing asset/liability management process. Non interest income also includes $2.0 million and $0.3 million of valuation losses on other real estate owned in 2010 and 2009, respectively.

Non interest expense was $74.1 million for both 2010 and 2009. The 2009 amount reflected an increase of $3.0 million or 4.2 percent compared to $71.1 million in 2008. Increases in 2010 non interest expense resulting from the Company’s continued investment in its branch offices, technology and personnel to accommodate growth, the expansion of services and products available to new and existing customers and the upgrading of certain internal processes were more than offset by cost saving measures implemented by the Company during 2009 and 2010. In addition, 2010 reflected significantly lower FDIC deposit insurance premiums compared to 2009. Additional premiums imposed by the FDIC in 2009 to replenish shortfalls in the FDIC Insurance Fund were not imposed to the same degree in 2010. However, additional premium increases and special assessments may continue to be imposed by the FDIC in the future. Decreases resulting from the lower FDIC premiums and other cost saving measures were offset by significant increases in costs related to problem loan resolutions and other real estate owned. Increases in 2009 resulting from the Company’s continued investment in its branch offices, technology and personnel to accommodate growth in loans and deposits, the expansion of services and products available to new and existing customers and the upgrading of certain internal processes were effectively offset by significant other cost saving measures implemented by the Company during the year, including the elimination of all 2009 incentive compensation and bonuses for employees of the Bank. However, overall 2009 non interest expense increased, compared to the prior year period, primarily due to aforementioned significant increase in FDIC deposit premiums.

 

The effective tax rate in 2010 decreased to (37.9) percent, compared to 27.8 percent in 2009 and 33.6 percent in 2008. The tax benefit recorded in 2010 resulted from the effects of tax-exempt income exceeding taxable income for the year primarily due to the significant 2010 loan loss provision. The 2009 decrease, compared to the prior year period, was primarily as a result of tax-exempt income constituting a greater percentage of pretax income due to the significant increase in the loan loss provision and recognized impairment charges on securities available for sale.

Average Balances and Interest Rates

 

The following table sets forth the daily average balances of interest earning assets and interest bearing liabilities for each of the last three years as well as total interest and corresponding yields and rates.

 

HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
Average Balances and Interest Rates
Non-GAAP disclosures

		Year ended December 31,
		2010				2009				2008
Total interest earning assets:
As reported		$	2,615,461			$	2,418,855			$	2,225,320
Unrealized gain (loss) on securities available-for-sale(1)			4,909				1,463				(4,810	)
Adjusted total interest earning assets		$	2,610,552			$	2,417,392			$	2,230,130
Net interest earnings:
As reported		$	110,656			$	114,275			$	110,029
Adjustment to tax equivalency basis(2)			3,161				4,124				4,646
Adjusted net interest earnings		$	113,817			$	118,399			$	114,675
Net yield on interest earning assets:
As reported			4.23	%			4.72	%			4.94	%
Effects of (1) and (2) above			0.13	%			0.18	%			0.20	%
Adjusted net interest earnings			4.36	%			4.90	%			5.14	%

Interest Differential

 

The following table sets forth the dollar amount of changes in interest income, interest expense and net interest income between the years ended December 31, 2010 and 2009, and the years ended December 31, 2009 and 2008, on a tax equivalent basis.

 

 

Net Interest Income

 

Net interest income, the difference between interest income and interest expense, is the most significant component of the Company’s consolidated earnings. During the three year period ended December 31, 2010, the overall economic picture, both globally and in the Company’s market area, has been one of historic low interest rates, severe economic downturn in virtually every sector of the economy, sharp declines in asset values particularly in the commercial and residential real estate sectors, weak loan demand and shrinking margins. The Company’s overall asset quality has continued to be adversely affected by the current state of the economy. During 2010 and 2009, the Company has experienced significant levels of delinquent and nonperforming loans and a continuation of the slowdowns in repayments and declines in the loan-to-value ratios on existing loans which began in the second half of 2008. Changes in the levels of nonperforming loans have a direct impact on net interest income. While there are recent signs that the economic downturn has begun to reverse, the Company expects some continued downward pressure on net interest income for the near future as a result of ongoing lag effect of these conditions.

 

The Company has made efforts throughout this period of severe economic uncertainty and low interest rates to minimize the impact on its net interest income by appropriately repositioning its securities portfolio and funding

sources while maintaining prudence and awareness of the potential consequences that the current economic crisis could have on its asset quality and interest rate risk profiles. During 2010 and 2009, the Company was able to repay maturing long-term borrowings, all of its brokered certificates of deposit and non-customer related short-term borrowings with liquidity provided primarily by core deposit growth and planned utilization of run-off from our investment securities. Additional liquidity from deposit growth was retained in the Company’s short-term liquidity portfolios, available to fund future loan growth. With interest rates remaining at historically low levels, this increase in liquidity contributed to margin compression. Also during 2010 and 2009, the Company increased the number of loans originated with interest rate floors and, as part of the continuation of a planned reduction of the Company’s investment portfolio, targeting cash flow from maturing investment securities to fund current and future loan growth. These actions were conducted partially in reaction to severely declining interest rates. The Company’s ability to make changes in its asset mix allows management to capitalize on more desirable yields, as available, on various interest earning assets. Management believes that the result of these efforts has enabled the Company, given the difficulties being encountered in the current economic crisis, to maximize the effective repositioning of its portfolios from both asset and interest rate risk perspectives.

 

Net interest income, on a tax equivalent basis, decreased $4.6 million or 3.9 percent to $113.8 million in 2010, compared to $118.4 million in 2009, which increased $3.7 million or 3.2 percent from $114.7 million in 2008. The decrease in 2010, compared to 2009, primarily resulted from a decrease in the tax equivalent basis net interest margin to 4.36 percent in 2010 from 4.90 percent in 2009, partially offset by an increase of $108.2 million or 14.3 percent in the excess of adjusted average interest earning assets over average interest bearing liabilities to $867.4 million in 2010 from $759.2 million in 2009. The increase in 2009, compared to 2008, primarily resulted from an increase of $43.9 million or 6.1 percent in the excess of adjusted average interest earning assets over interest bearing liabilities to $759.2 million in 2009 from $715.3 million in 2008, partially offset by a decrease in the tax equivalent basis net interest margin to 4.90 percent in 2009 from 5.14 percent in 2008. For purposes of the financial information included in this section, the Company adjusts average interest earning assets to exclude the effects of unrealized gains and losses on securities available for sale and adjusts net interest income to a tax equivalent basis. Management believes that this alternate presentation more closely reflects actual performance, as it is consistent with the Company’s stated asset/liability management strategies. The effects of these non-GAAP adjustments to tax equivalent basis net interest income and adjusted average assets are included in the table presented in “Average Balances and Interest Rates” section herein.

 

Interest income is determined by the volume of and related rates earned on interest earning assets. Volume decreases in loans and investments and a lower average yield on interest earning assets, partially offset by volume increases in interest earning deposits and Federal funds sold resulted in lower interest income in 2010, compared to 2009. A volume decrease in investments and a lower average yield on interest earning assets, partially offset by volume increases in loans, Federal funds sold and interest earning deposits resulted in slightly lower interest income in 2009, compared to 2008. Adjusted average interest earning assets in 2010 increased $193.2 million or 8.0 percent to $2,610.6 million from $2,417.4 million in 2009, which increased $187.3 million or 8.4 percent from $2,230.1 million in 2008.

 

Loans are the largest component of interest earning assets. Net loans decreased $83.4 million or 4.7 percent to $1,689.2 million at December 31, 2010 from $1,772.6 million at December 31, 2009, which increased $95.0 million or 5.7 percent from $1,677.6 million at December 31, 2008. Average net loans decreased $25.1 million or 1.4 percent to $1,714.3 million in 2010 from $1,739.4 million in 2009, which increased $256.2 million or 17.3 percent from $1,483.2 million in 2008. The decrease in average net loans in 2010, compared to 2009 resulted from insufficient loan demand to offset payoffs and pay downs, significant charge-offs taken during the year and sales of other nonperforming loans, partially offset by significant growth in the multi-family sector of the portfolio. The increase in average net loans during 2009, compared to 2008, reflected the Company’s continuing emphasis on making new loans, expansion of loan production capabilities and more effective market penetration. The average yield on loans was 6.28 percent in 2010, compared to 6.36 percent in 2009 and 7.12 percent in 2008. As a result, interest income on loans decreased in 2010, compared to 2009, due to lower volume and lower interest rates, and interest income on loans increased in 2009, compared to 2008, due to higher volume, partially offset by lower interest rates.

Total securities, including Federal Home Loan Bank (“FHLB”) stock and excluding net unrealized gains and losses, decreased $66.4 million or 12.5 percent to $464.1 million at December 31, 2010 from $530.5 million at December 31, 2009, which decreased $166.3 million or 23.9 percent from $696.8 million at December 31, 2008. Average total securities, including FHLB stock and excluding net unrealized gains and losses, decreased $81.8 million or 13.7 percent to $516.8 million in 2010 from $598.6 million in 2009, which decreased $118.1 million or 16.5 percent from $716.7 million in 2008. The decreases in average total securities in 2010 and 2009, compared to their respective prior year periods, resulted primarily from a planned reduction in the portfolio conducted by the Company as part of its ongoing asset/liability management efforts. During 2010, cash flow from maturing investments was either redeployed into new mortgage backed securities, or retained in interest bearing bank balances to fund future loan growth. The decrease in average total securities in 2010 compared to 2009 reflects volume decreases in U.S. Treasury and Agency securities, mortgage-backed securities including collateralized mortgage obligations, obligations of state and political subdivisions and FHLB stock, partially offset by a volume increase in other securities. The average tax equivalent basis yield on securities was 4.44 percent for 2010 compared to 4.99 percent in 2009. As a result, tax equivalent basis interest income on securities decreased in 2010, compared to 2009, due to lower volume and lower interest rates. During 2009, management utilized cash flow from maturing investments to fund loan growth and to reduce short-term and other borrowings. The decrease in average total securities in 2009 compared to 2008 reflects volume decreases in U.S. Treasury and Agency securities, mortgage-backed securities including collateralized mortgage obligations, obligations of state and political subdivisions, FHLB stock and other securities. The average tax equivalent basis yield on securities was 4.99 percent for 2009 compared to 5.32 percent in 2008. As a result, tax equivalent basis interest income on securities decreased in 2009, compared to 2008, due to lower volume and lower interest rates. Increases and decreases in average FHLB stock results from purchases or redemptions of stock in order to maintain required levels to support FHLB borrowings.

 

Interest expense is a function of the volume of, and rates paid for, interest bearing liabilities, comprised of deposits and borrowings. Interest expense decreased $4.6 million or 20.6 percent to $17.7 million in 2010 from $22.3 million in 2009, which decreased $7.8 million or 25.9 percent from $30.1 million in 2008. Average interest bearing liabilities increased $85.0 million or 5.1 percent to $1,743.2 million in 2010 from $1,658.2 million in 2009, which increased $143.4 million or 9.5 percent from $1,514.8 million in 2008.

 

The increase in average interest bearing liabilities in 2010, compared to 2009, was due to volume increases in money market deposits, savings deposits and checking with interest, partially offset by volume decreases in time deposits, short-term borrowings and other borrowed funds. The Company continued to experience significant growth in new customers both in existing branches and new branches added during the last two years. Proceeds from deposit growth were used to reduce maturing term borrowings or were retained in liquid investments, principally interest earning bank deposits. The average interest rate paid on interest bearing liabilities was 1.01 percent in 2010, compared to 1.35 percent in 2009. As a result of these factors, interest expense was lower in 2010, compared to 2009, due to lower interest rates, partially offset by higher volume.

 

The increase in average interest bearing liabilities in 2009, compared to 2008, was due to volume increases in interest bearing demand deposits, partially offset by volume decreases in securities sold under repurchase agreements and other short-term borrowings and other borrowings, and a slight volume decrease in time deposits. The increases in average interest bearing demand deposits include approximately $101 million of growth which resulted from the transfer of certain money market mutual fund investments of existing customers to interest bearing demand deposits. This transfer was primarily due to the increase in FDIC insurance coverage of certain deposit products which was part of the legislation enacted in response to the current economic crisis. In addition to above mentioned deposit growth, the Company experienced significant growth in new customers both in existing branches and new branches added during 2008 and 2009. Overall deposit growth in 2009 was partially offset by some declines in balances of existing customers, primarily those customers directly involved in or supported by the real estate industry. Proceeds from deposit growth were used primarily to reduce long term and short term debt and to fund loan growth. The decreases in average short-term and other borrowings in 2009, compared to 2008, resulted from management’s decision to utilize cash flow from deposit growth and maturing investment securities to reduce borrowings as part of the Company’s ongoing asset/liability management efforts. The average interest rate paid on interest bearing liabilities was 1.35 percent in 2009, compared to 1.99 percent in 2008. As a result of these factors,

interest expense on average interest bearing liabilities was lower in 2009, compared to the prior year period due to lower interest rates, partially offset by higher volume.

 

Average non interest bearing demand deposits increased $69.3 million or 10.3 percent to $745.3 million in 2010 from $676.0 million in 2009, which increased $50.4 million or 8.1 percent from $625.6 million in 2008. Non interest bearing demand deposits are an important component of the Company’s ongoing asset liability management, and also have a direct impact on the determination of net interest income.

 

The interest rate spread on a tax equivalent basis for each of the three years in the period ended December 31, 2010 is as follows:

 

 

In 2010 and 2009, the interest rate spreads decreased reflecting greater increases in interest rates on interest bearing liabilities compared to interest rates on interest earning assets. Management cannot predict what impact market conditions will have on its interest rate spread and future compression in net interest rate spread may occur.

 

Provision for Loan Losses

 

The provision for loan losses in 2010 was $46.5 million compared to $24.3 million in 2008 and $11.0 million in 2008. The significant increases in 2010 and 2009, compared to their respective prior years, are directly related to negative effects on the Company’s loan portfolio of conditions resulting from the ongoing crisis in the financial markets. In addition, the 2010 increase, compared to 2009, partially resulted from a decision by the Company to implement a more aggressive workout strategy for the resolution of problem assets in light of a sluggish economic recovery, continued weakness in local real estate activity and market values and growing difficulty in resolving problem loans in a timely fashion through traditional foreclosure proceedings due to increased bankruptcy filings and overcrowded court systems. Continuation or worsening of such conditions could result in additional significant provisions for loan losses in the future.

 

Non Interest Income

 

Non interest income increased $3.2 million or 30.5 percent to $13.7 million in 2010 compared to $10.5 million in 2009, which decreased $8.1 million or 43.5 percent compared to $18.6 million in 2008. The increase in 2010, compared to the prior year period, was primarily due to an increase in investment advisory fees of A.R. Schmeidler & Co., Inc. and also reflects growth in deposit activity and other service fees and a decrease in recognized impairment charges on securities available for sale, partially offset by an increase in valuation losses on other real estate owned and a slight decrease in other income. The decrease in 2009, compared to the prior year period, was primarily the result of a significant increase in impairment charges related to the Company’s investment in certain pooled trust preferred securities and a sharp decrease in investment advisory fees. The above mentioned changes in investment advisory fees, impairment charges on securities and valuation losses on other real estate owned are directly related to the current economic crisis, which has had significant negative effects on the financial services industry, the real estate industry and the domestic and international equity markets.

 

Service charges increased by $0.7 million or 11.9 percent to $6.6 million in 2010 compared to $5.9 million in 2009, which decreased slightly by $0.1 million or 1.7 percent from $6.0 million in 2008. The 2010 increase, compared to 2009, was primarily due to growth service charges related to new products introduced in 2009 and 2010. The 2009 decrease, compared to 2008, resulted primarily from increases in fees related to growth in deposits being offset by declines in activity fees on existing deposits.

 

Investment advisory fees increased $1.4 million or 18.2 percent to $9.1 million in 2010 from $7.7 million in 2009, which decreased $3.5 million or 31.3 percent from $11.2 million in 2008. The 2010 increase, compared to 2009, was due to a net increase in assets under management from existing customers, addition of new customers and net increases in asset value. Fee income from this source, however, experienced sharp declines beginning in the

fourth quarter of 2008 and continued to decline during the first half of 2009 as a result of the effects of significant declines in both domestic and international equity markets which resulted in the sharp decline in fees in 2009, compared to 2008. Although there has been recent improvement in the financial markets, continued improvement and the acquisition of new customers will be necessary for this source of non interest income to return to past levels.

 

The Company recognized impairment charges on securities available for sale of $2.6 million, $5.5 million and $0.6 million for the years ended December 31, 2010, 2009 and 2008 respectively. The entire 2010 and 2009 charges and $1.1 million of the 2008 charge related to the Company’s investments in certain pooled trust preferred securities. These securities are primarily backed by U.S. financial institutions many of which are experiencing severe financial difficulties as a result of the current economic downturn. Continuation of these conditions may result in additional impairment charges on these securities in the future. The Company has decided to hold its investments in trust preferred securities as it does not believe that the current market quotes for these investments are indicative of their underlying value. The $0.4 million remainder of the 2008 impairment charge was related to the Company’s investment in a mutual fund. This investment was sold in April 2008 without additional loss. Other dispositions of securities available for sale resulted in net realized gains of $0.2 million, $0.1 million and $0.1 million in 2010, 2009 and 2008, respectively. The sales were conducted as part of the Company’s ongoing asset/liability management process. Non interest income also includes $2.0 million and $0.3 million of valuation losses on other real estate owned in 2010 and 2009, respectively. These valuation losses are a direct result of the significantly negative effects that the ongoing economic downturn has had on the values of the Company’s real estate related assets.

 

Other income decreased $0.2 million or 7.7 percent to $2.4 million in 2010 from $2.6 million in 2009, which decreased $0.3 million or 10.3 percent from $2.9 million in 2008. The decrease in 2010, compared to 2009, resulted from decreases in income on bank owned life insurance, rental income and miscellaneous customer fees, partially offset by increases in debit card income. The decrease in 2009, compared to 2008, resulted primarily from a decrease in miscellaneous service fees and rental income, partially offset by increases in income from bank owned life insurance and debit card income.

 

Non Interest Expense

 

Non interest expense was $74.1 million, $74.1 million and $71.1 million for the years ended December 31, 2010, 2009 and 2008, respective. Increases in non interest expense resulting from the Company’s continued investment in its branch offices, technology and personnel to accommodate growth, the expansion of services and products available to new and existing customers and the upgrading of certain internal processes were more than offset by cost saving measures implemented by the company during 2009 and 2010. The Company’s efficiency ratio (a lower ratio indicates greater efficiency) which compares non interest expense to total adjusted revenue (taxable equivalent net interest income, plus non interest income, excluding gain or loss on securities transactions) was 56.2 percent in 2010, compared to 55.2 percent in 2009 and 52.8 percent in 2008.

 

Salaries and employee benefits, the largest component of non interest expense, decreased $0.2 million or 0.5 percent to $38.5 million in 2010 from $38.7 million in 2009, which was a decrease of $3.2 million or 7.6 percent from $41.9 million in 2008. The decrease in 2010 resulted from the planned reduction in certain staffing levels and a reduction in employee retirements plans partially offset by increased incentive compensation. The decrease in 2009 resulted from decreased incentive compensation and the reduction of certain benefits which were partially offset by additional staff requirements which resulted from the opening of new branches.

 

 

 

Occupancy expense increased $0.1 million or 1.2 percent to $8.4 million in 2010 from $8.3 million in 2009 which increased $0.8 million or 10.7 percent from $7.5 million in 2008. The increases in both 2010 and 2009 reflect increased costs related to the opening of new branch offices and also included rising costs on leased facilities, real estate taxes, utility costs, maintenance costs and other costs to operate the Company’s facilities.

 

Professional services increased $0.8 million or 18.2 percent to $5.2 million in 2010 from $4.4 million in 2009, which was a $0.1 million or 2.3 percent increase from $4.3 million for 2008. The increase in 2010 was primarily due to costs related to the formation of a new subsidiary, expenses related to the operational merger of New York National Bank into HVB and the engagement of consultants to assist with new systems implementations and certain personnel related projects. The slight increase in 2009 was related to a core processing study.

 

Equipment expense decreased $0.4 million or 9.1 percent to $4.0 million in 2010 from $4.4 million in 2009, which was an increase of $0.2 million or 4.8 percent from $4.2 million in 2008. The 2010 decrease reflects reduced equipment rental costs and cost saving measures implemented in late 2009. The 2009 increase reflects increased maintenance expense for the Company’s equipment and offices due to higher costs and the addition of new branch offices.

 

Business development expense was $2.0 million at December 31, 2010 which was unchanged as compared to $2.0 million in 2009, which was a $0.1 million or 4.8 percent decrease from $2.1 million in 2008. The 2009 decrease was due to a decreased participation in public relations events and a reduction in annual report expenses.

 

The assessment of the Federal Deposit Insurance Corporation (“FDIC”) was $4.7 million for 2010, $5.5 million in 2009 and $0.9 million for 2008. The 2010 decrease was due to additional premiums that were imposed by the FDIC, during 2009, to replenish shortfalls in the FDIC Insurance Fund which resulted from the current economic crisis.

Other operating expenses, as reflected in the following table increased 4.2 percent in 2010 and increased 5.6 percent in 2009.

 

 

The 2010 increases reflect higher loan expenses, including increased expenses related to properties held as other real estate owned and increased loan collection costs, increased costs related to couriers and higher outside service fees. The 2010 decreases reflect lower stationary and printing costs, lower communications expense and lower insurance costs.

 

The 2009 increases reflect higher loan expenses, including increased expenses related to properties held as other real estate owned and increased loan collection costs and higher outside service fees. The 2009 decreases reflect lower stationary and printing costs, lower communications expense, lower courier costs due to greater efficiencies gained due to a change in service providers and decreased participation in meetings and seminars.

 

Income Taxes

 

Income taxes (benefits) of $(1.4) million, $7.3 million and $15.6 million were recorded in 2010, 2009, and 2008, respectively. The Company is currently subject to a statutory Federal tax rate of 35 percent, a New York State tax rate of 7.1 percent plus a 17 percent surcharge, a Connecticut State tax rate of 7.5 percent, and a New York City tax rate of approximately 9 percent. The Company’s overall effective tax rate was (37.9) percent in 2010, 27.8 percent in 2009 and 33.6 percent in 2008. The tax benefit in 2010 and the decrease in the overall effective tax rate in 2009, compared to 2008, resulted primary from tax-exempt income exceeding book pre-tax income in 2010 and representing a larger percentage of book pre-tax income in 2009, compared to 2008.

 

In the normal course of business, the Company’s Federal, New York State and New York City corporation tax returns are subject to audit. The Company is currently open to audit by the Internal Revenue Service under the statute of limitations for years after 2006. The Company is currently undergoing an audit by New York State for years 2005 through 2007. This audit has not yet been completed, however, no significant issues have as yet been raised. Other pertinent tax information is set forth in the Notes to Consolidated Financial Statements included elsewhere herein.

 

Financial Condition at December 31, 2010 and 2009

 

Cash and Due from Banks

 

Cash and due from banks was $284.2 million at December 31, 2010, an increase of $117.2 million or 70.2 percent from $167.0 million at December 31, 2009. Included in cash and due from banks is interest earning deposits of $258.3 million at December 31, 2010 and $127.7 million at December 31, 2009. The increase was a result of deposit growth and loan paydowns which have not yet been deployed into investments or loans.

Federal Funds Sold

 

Federal funds sold totaled $72.1 million at December 31, 2010, an increase of $20.2 million or 38.9 percent from $51.9 million at December 31, 2009. The increase resulted from timing differences in the redeployment of available funds into loans and longer term investments and volatility in certain deposit types and relationships.

 

Securities Portfolio

 

Securities are selected to provide safety of principal, liquidity, pledging capabilities (to collateralize certain deposits and borrowings), income and to leverage capital. The Company’s investment strategy focuses on maximizing income while providing for safety of principal, maintaining appropriate utilization of capital, providing adequate liquidity to meet loan demand or deposit outflows and to manage overall interest rate risk. The Company selects individual securities whose credit, cash flow, maturity and interest rate characteristics, in the aggregate, affect the stated strategies.

 

The securities portfolio consists of various debt and equity securities totaling $459.9 million, $522.3 million and $671.4 million and FHLB stock totaling $7.0 million, $8.5 million and $20.5 million at December 31, 2010, 2009, and 2008, respectively.

 

Securities are classified as either available for sale, representing securities the Company may sell in the ordinary course of business, or as held to maturity, representing securities the Company has the ability and positive intent to hold until maturity. Securities available for sale are reported at fair value with unrealized gains and losses (net of tax) excluded from operations and reported in other comprehensive income. Securities held to maturity are stated at amortized cost. The available for sale portfolio totaled $443.7 million, $500.6 million and $642.4 million at December 31, 2010, 2009 and 2008 respectively. The held to maturity portfolio totaled $16.3 million, $21.7 million and $29.0 million at December 31, 2010, 2009 and 2008, respectively.

 

Average aggregate securities and FHLB stock represented 19.8 percent, 24.8 percent and 32.1 percent of average interest earning assets in 2010, 2009 and 2008, respectively. Emphasis on the securities portfolio will continue to be an important part of the Company’s investment strategy. The size of the securities portfolio will depend on loan and deposit growth, the level of capital and the Company’s ability to take advantage of leveraging opportunities.

 

The following table sets forth the amortized cost, gross unrealized gains and losses and the estimated fair value of securities classified as available for sale and held to maturity at December 31:

 

2010 (000’s)