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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: June 30, 2015

 

¨	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                     to                      

Commission File Number: 0-26001

 

 

Hudson City Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware		22-3640393
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
West 80 Century Road Paramus, New Jersey		07652
(Address of Principal Executive Offices)		(Zip Code)

(201) 967-1900

(Registrant’s telephone number, including area code)

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

Yes  x    No   ¨

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

Yes  x    No  ¨

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

 

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨    No   x

As of August 4, 2015, the registrant had 529,529,490 shares of common stock, $0.01 par value, outstanding.

 

 

 

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Table of Contents

 

		Page Number
PART I – FINANCIAL INFORMATION
Item 1. – Financial Statements
Consolidated Statements of Financial Condition – June 30, 2015 (Unaudited) and December 31, 2014			5
Consolidated Statements of Income (Unaudited) – For the three and six months ended June 30, 2015 and 2014			6
Consolidated Statements of Comprehensive Income (Loss) (Unaudited) – For the three and six months ended June 30, 2015 and 2014			7
Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) – For the six months ended June 30, 2015 and 2014			8
Consolidated Statements of Cash Flows (Unaudited) – For the six months ended June 30, 2015 and 2014			9
Notes to Unaudited Consolidated Financial Statements			10
Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations			40
Item 3. – Quantitative and Qualitative Disclosures About Market Risk			77
Item 4. – Controls and Procedures			83
PART II – OTHER INFORMATION
Item 1. – Legal Proceedings			84
Item 1A. – Risk Factors			84
Item 2. – Unregistered Sales of Equity Securities and Use of Proceeds			85
Item 3. – Defaults Upon Senior Securities			85
Item 4. – Mine Safety Disclosures			85
Item 5. – Other Information			85
Item 6. – Exhibits			85
SIGNATURES			86

 

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Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 which may be identified by the use of such words as “may,” “believe,” “expect,” “anticipate,” “consider,” “should,” “plan,” “estimate,” “predict,” “continue,” “probable,” and “potential” or the negative of these terms or other comparable terminology. Examples of forward-looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of Hudson City Bancorp, Inc. and Hudson City Bancorp, Inc.’s strategies, plans, objectives, expectations and intentions, and other statements contained in this Quarterly Report on Form 10-Q that are not historical facts. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors (many of which are beyond our control) that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. These factors include, but are not limited to:

 

•

the timing and occurrence or non-occurrence of events may be subject to circumstances beyond our control;

 

•

there may be increases in competitive pressure among financial institutions or from non-financial institutions;

 

•

changes in the interest rate environment may reduce interest margins or affect the value of our investments;

 

•

changes in deposit flows, loan demand or real estate values may adversely affect our business;

 

•

changes in accounting principles, policies or guidelines may cause our financial condition to be perceived differently;

 

•

general economic conditions, including unemployment rates, either nationally or locally in some or all of the areas in which we do business, or conditions in the securities markets or the banking industry may be less favorable than we currently anticipate;

 

•

legislative or regulatory changes including, without limitation, the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Reform Act”), and any actions regarding foreclosures may adversely affect our business;

 

•

enhanced regulatory scrutiny may adversely affect our business and increase our cost of operation;

 

•

applicable technological changes may be more difficult or expensive than we anticipate;

 

•

success or consummation of new business initiatives may be more difficult or expensive than we anticipate;

 

•

litigation or matters before regulatory agencies, whether currently existing or commencing in the future;

 

•

the risks associated with adverse changes to credit quality, including changes in the level of loan delinquencies and non-performing assets and charge-offs, the length of time our non-performing assets remain in our portfolio and changes in estimates of the adequacy of the allowance for loan losses;

 

•

difficulties associated with achieving or predicting expected future financial results;

 

•

our ability to restructure our balance sheet, diversify our funding sources and access the capital markets;

 

•

our ability to comply with the terms of the Memorandum of Understanding with the Board of Governors of the Federal Reserve System (the “FRB”);

 

•

our ability to pay dividends, repurchase our outstanding common stock or execute capital management strategies each of which requires the approval of the Office of the Comptroller of the Currency (the “OCC”) and the FRB;

 

•

the effects of changes in existing U.S. government or U.S. government-sponsored mortgage programs;

 

•

the risk of an economic slowdown that would adversely affect credit quality and loan originations;

 

•

the potential impact on our operations and customers resulting from natural or man-made disasters, wars, acts of terrorism and cyberattacks;

 

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•

the actual results of the pending merger (the “Merger”) with Wilmington Trust Corporation (“WTC”), a wholly owned subsidiary of M&T Bank Corporation (“M&T”) could vary materially as a result of a number of factors, including the possibility that various closing conditions for the transaction may not be satisfied or waived, and the Merger Agreement (as defined below) with M&T could be terminated under certain circumstances;

 

•

the outcome of any judicial decision related to the settlement of existing class action lawsuits related to the Merger;

 

•

further delays in closing the Merger, including the possibility that the Merger may not be completed prior to the end of the extension period previously agreed to with M&T; and

 

•

difficulties and delays in the implementation of our strategic plan (“Strategic Plan”) initiatives in the event the Merger is further delayed or is not completed.

Our ability to predict results or the actual effects of our plans or strategies is inherently uncertain. As such, forward-looking statements can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Consequently, no forward-looking statement can be guaranteed. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect conditions only as of the date of this filing. We do not intend to update any of the forward-looking statements after the date of this Form 10-Q or to conform these statements to actual events.

As used in this Form 10-Q, unless we specify otherwise, “Hudson City Bancorp,” “Company,” “we,” “us,” and “our” refer to Hudson City Bancorp, Inc., a Delaware corporation. “Hudson City Savings” and “Bank” refer to Hudson City Savings Bank, a federal stock savings bank and the wholly-owned subsidiary of Hudson City Bancorp.

 

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PART I – FINANCIAL INFORMATION

Item 1. – Financial Statements

Hudson City Bancorp, Inc. and Subsidiary

Consolidated Statements of Financial Condition

 

		June 30, 2015				December 31, 2014
(In thousands, except share and per share amounts)		(unaudited)
Assets:
Cash and due from banks		$	102,957			$	122,484
Federal funds sold and other overnight deposits			6,599,793				6,163,082
Total cash and cash equivalents			6,702,750				6,285,566
Securities available for sale:
Mortgage-backed securities			2,730,493				2,963,304
Investment securities			5,360,431				3,611,045
Securities held to maturity:
Mortgage-backed securities (fair value of $1,356,160 at December 31, 2014)			—				1,272,137
Investment securities (fair value of $41,593 at December 31, 2014)			—				39,011
Total securities			8,090,924				7,885,497
Loans			19,781,722				21,564,974
Net deferred loan costs			90,608				99,155
Allowance for loan losses			(225,573	)			(235,317	)
Net loans			19,646,757				21,428,812
Federal Home Loan Bank of New York stock			309,892				320,753
Foreclosed real estate, net			100,193				79,952
Accrued interest receivable			20,355				31,665
Banking premises and equipment, net			52,420				56,633
Goodwill			152,109				152,109
Other assets			342,058				328,095
Total Assets		$	35,417,458			$	36,569,082
Liabilities and Shareholders’ Equity:
Deposits:
Interest-bearing		$	17,470,681			$	18,711,444
Noninterest-bearing			703,458				665,100
Total deposits			18,174,139				19,376,544
Repurchase agreements			6,150,000				6,150,000
Federal Home Loan Bank of New York advances			6,025,000				6,025,000
Total borrowed funds			12,175,000				12,175,000
Accrued expenses and other liabilities			246,574				236,128
Total liabilities			30,595,713				31,787,672
Common stock, $0.01 par value, 3,200,000,000 shares authorized;
741,466,555 shares issued; 529,529,490 and 528,908,735 shares outstanding at June 30, 2015 and December 31, 2014			7,415				7,415
Additional paid-in capital			4,753,106				4,751,778
Retained earnings			1,983,067				1,961,531
Treasury stock, at cost; 211,937,065 and 212,557,820 shares at June 30, 2015 and December 31, 2014			(1,704,412	)			(1,708,736	)
Unallocated common stock held by the employee stock ownership plan			(177,201	)			(180,204	)
Accumulated other comprehensive loss, net of tax			(40,230	)			(50,374	)
Total shareholders’ equity			4,821,745				4,781,410
Total Liabilities and Shareholders’ Equity		$	35,417,458			$	36,569,082

See accompanying notes to unaudited consolidated financial statements.

 

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Hudson City Bancorp, Inc. and Subsidiary

Consolidated Statements of Income

(Unaudited)

 

		For the Three Months Ended June 30,								For the Six Months Ended June 30,
		2015				2014				2015				2014
		(In thousands, except share data)
Interest and Dividend Income:
First mortgage loans		$	201,401			$	247,124			$	418,689			$	500,263
Consumer and other loans			1,890				2,199				3,931				4,477
Mortgage-backed securities held to maturity			—				10,128				7,602				21,339
Mortgage-backed securities available for sale			16,109				31,595				28,643				69,085
Investment securities held to maturity			—				585				585				1,170
Investment securities available for sale			4,644				920				8,015				1,714
Dividends on Federal Home Loan Bank of New York stock			3,243				3,338				6,962				7,494
Federal funds sold and other overnight deposits			3,922				3,316				7,711				6,202
Total interest and dividend income			231,209				299,205				482,138				611,744
Interest Expense:
Deposits			33,371				40,173				68,910				80,811
Borrowed funds			141,282				141,350				281,044				280,915
Total interest expense			174,653				181,523				349,954				361,726
Net interest income			56,556				117,682				132,184				250,018
Provision for Loan Losses			—				—				—				—
Net interest income after provision for loan losses			56,556				117,682				132,184				250,018
Non-Interest Income:
Service charges and other income			1,534				1,645				2,927				3,460
Gain on securities transactions, net			67,064				19,539				74,411				35,482
Total non-interest income			68,598				21,184				77,338				38,942
Non-Interest Expense:
Compensation and employee benefits			34,163				32,405				68,594				66,016
Net occupancy expense			8,679				9,433				18,230				19,144
Federal deposit insurance assessment			7,949				13,086				18,895				27,010
Other expense			15,659				18,184				35,489				40,651
Total non-interest expense			66,450				73,108				141,208				152,821
Income before income tax expense			58,704				65,758				68,314				136,139
Income Tax Expense			23,047				26,576				26,767				54,436
Net income		$	35,657			$	39,182			$	41,547			$	81,703
Basic Earnings Per Share		$	0.07			$	0.08			$	0.08			$	0.16
Diluted Earnings Per Share		$	0.07			$	0.08			$	0.08			$	0.16
Weighted Average Number of Common Shares Outstanding:
Basic			501,078,623				498,874,695				500,585,010				498,646,420
Diluted			502,348,521				499,838,263				502,111,709				499,452,014

See accompanying notes to unaudited consolidated financial statements.

 

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Hudson City Bancorp, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

 

		For the Three Months Ended June 30,
		2015				2014
		(In thousands)
Net income		$	35,657			$	39,182
Other comprehensive income, net of tax:
Net unrealized gains (losses) on securities:
Net unrealized gains (losses) on securities available for sale arising during period, net of tax benefit (expense) of $5,520 for 2015 and ($11,788) for 2014			(7,994	)			17,069
Reclassification for securities transferred to available for sale, net of tax expense of $33,339 for 2015			48,275				—
Reclassification adjustment for realized gains in net income, net of tax benefit of $27,396 for 2015 and $7,459 for 2014			(39,668	)			(10,801	)
Postretirement benefit pension plans:
Amortization of net loss arising during period, net of tax expense of $888 for 2015 and $329 for 2014			1,286				475
Amortization or prior service cost included in net periodic pension cost, net of tax benefit of $145 for 2015 and $137 for 2014			(211	)			(196	)
Other comprehensive income			1,688				6,547
Total comprehensive income		$	37,345			$	45,729
		For the Six Months Ended June 30,
		2015				2014
		(In thousands)
Net income		$	41,547			$	81,703
Other comprehensive income, net of tax:
Net unrealized gains (losses) on securities:
Net unrealized gains (losses) on securities available for sale arising during period, net of tax expense of $1,814 for 2015 and $24,647 for 2014			2,626				35,827
Reclassification for securities transferred to available for sale, net of tax expense of $33,339 for 2015			48,275				—
Reclassification adjustment for realized gains in net income, net of tax benefit of $29,632 for 2015 and $11,741 for 2014			(42,906	)			(17,141	)
Postretirement benefit pension plans:
Amortization of net loss arising during period, net of tax expense of $1,775 for 2015 and $657 for 2014			2,571				951
Amortization or prior service cost included in net periodic pension cost, net of tax benefit of $290 for 2015 and $272 for 2014			(422	)			(394	)
Other comprehensive income			10,144				19,243
Total comprehensive income		$	51,691			$	100,946

See accompanying notes to unaudited consolidated financial statements.

 

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Hudson City Bancorp, Inc. and Subsidiary

Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

 

		For the Six Months Ended June 30,
		2015				2014
		(In thousands, except per share data)
Common Stock		$	7,415			$	7,415
Additional paid-in capital:
Balance at beginning of year			4,751,778				4,743,388
Stock option plan expense			5,806				6,072
Tax benefit from stock plans			1,033				307
Allocation of ESOP stock			1,661				1,619
Common stock issued for vested deferred stock unit awards			(7,172	)			(3,952	)
Balance at end of period			4,753,106				4,747,434
Retained Earnings:
Balance at beginning of year			1,961,531				1,883,754
Net income			41,547				81,703
Dividends paid on common stock ($0.04 and $0.08 per share, respectively)			(20,011	)			(40,076	)
Exercise of stock options			—				17
Balance at end of period			1,983,067				1,925,398
Treasury Stock:
Balance at beginning of year			(1,708,736	)			(1,712,107	)
Purchase of vested stock awards surrendered for witholding taxes			(2,848	)			(1,668	)
Exercise of stock options			—				96
Common stock issued for vested deferred stock unit awards			7,172				3,952
Balance at end of period			(1,704,412	)			(1,709,727	)
Unallocated common stock held by the ESOP:
Balance at beginning of year			(180,204	)			(186,210	)
Allocation of ESOP stock			3,003				3,003
Balance at end of period			(177,201	)			(183,207	)
Accumulated other comprehensive income (loss):
Balance at beginning of year			(50,374	)			6,336
Other comprehensive income, net of tax			10,144				19,243
Balance at end of period			(40,230	)			25,579
Total Shareholders’ Equity		$	4,821,745			$	4,812,892

See accompanying notes to unaudited consolidated financial statements.

 

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Hudson City Bancorp, Inc. and Subsidiary

Consolidated Statements of Cash Flows

(Unaudited)

 

		For the Six Months Ended June 30,
		2015				2014
		(In thousands)
Cash Flows from Operating Activities:
Net income		$	41,547			$	81,703
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, accretion and amortization expense			6,277				20,288
Gains on securities transactions, net			(74,411	)			(35,482	)
Share-based compensation, including committed ESOP shares			10,470				10,694
Deferred tax expense			10,240				8,927
Decrease in accrued interest receivable			11,310				7,206
(Increase) decrease in other assets			(27,770	)			10,696
Increase (decrease) in accrued expenses and other liabilities			10,446				(18,531	)
Net Cash (Used in) Provided by Operating Activities			(11,891	)			85,501
Cash Flows from Investing Activities:
Originations of loans			(301,444	)			(697,091	)
Purchases of loans			(115,252	)			(116,302	)
Principal payments on loans			2,155,066				1,715,277
Principal collection of mortgage-backed securities held to maturity			38,802				144,787
Principal collection of mortgage-backed securities available for sale			326,971				624,203
Purchases of mortgage-backed securities available for sale			(72,919	)			(94,422	)
Proceeds from sales of mortgage backed securities available for sale			1,250,961				891,265
Proceeds from sales of mortgage backed securities held to maturity			30,318				129,126
Proceeds from sales of investment securities available for sale			—				—
Purchases of investment securities available for sale			(1,701,877	)			(600,797	)
Redemption of Federal Home Loan Bank of New York stock			10,861				9,807
Purchases of premises and equipment, net			(203	)			(1,472	)
Net proceeds from sale of foreclosed real estate			32,022				36,143
Net Cash Provided by Investment Activities			1,653,306				2,040,524
Cash Flows from Financing Activities:
Net decrease in deposits			(1,202,405	)			(958,494	)
Dividends paid			(20,011	)			(40,076	)
Purchase of vested stock awards surrendered for withholding taxes			(2,848	)			(1,668	)
Exercise of stock options			—				113
Tax benefit from stock plans			1,033				307
Net Cash Used in Financing Activities			(1,224,231	)			(999,818	)
Net Increase in Cash and Cash Equivalents			417,184				1,126,207
Cash and Cash Equivalents at Beginning of Year			6,285,566				4,324,474
Cash and Cash Equivalents at End of Period		$	6,702,750			$	5,450,681
Supplemental Disclosures:
Interest paid		$	347,428			$	360,295
Loans transferred to foreclosed real estate		$	74,101			$	60,270
Income tax payments		$	20,489			$	50,238
Transfer of securities held to maturity to available for sale (at amortized cost)		$	1,220,137			$	—

See accompanying notes to unaudited consolidated financial statements.

 

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Notes to Unaudited Consolidated Financial Statements

1. Organization

Hudson City Bancorp is a Delaware corporation and is the savings and loan holding company for Hudson City Savings Bank and its subsidiaries. As a savings and loan holding company, Hudson City Bancorp is subject to the supervision and examination of the FRB. Hudson City Savings is a federally chartered stock savings bank subject to supervision and examination by the OCC.

On August 27, 2012, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with M&T and WTC. The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, the Company will merge with and into WTC, with WTC continuing as the surviving entity.

Subject to the terms and conditions of the Merger Agreement, in the Merger, Hudson City Bancorp shareholders will have the right to receive with respect to each of their shares of common stock of the Company, at their election (but subject to proration and adjustment procedures), 0.08403 of a share of common stock, or cash having a value equal to the product of 0.08403 multiplied by the average closing price of the M&T Common Stock for the ten days immediately prior to the completion of the Merger. The Merger Agreement also provides that at the closing of the Merger, 40% of the outstanding shares of Hudson City Bancorp common stock will be converted into the right to receive cash and the remainder of the outstanding shares of Hudson City Bancorp common stock will be converted into the right to receive shares of M&T common stock.

On four occasions, Hudson City Bancorp and M&T have agreed to extend the date after which either party may elect to terminate the Merger Agreement, with the latest extension to October 31, 2015. Each extension was documented with an amendment to the Merger Agreement and the most recent amendment, Amendment No. 4, provides that the Company may terminate the Merger Agreement at any time if it reasonably determines that M&T is unlikely to be able to obtain the requisite regulatory approvals in time to permit the closing to occur on or prior to October 31, 2015. Amendment No. 4, and applicable provisions from the prior amendments, permit the Company to take certain interim actions without the prior approval of M&T, including with respect to the Bank’s conduct of business, implementation of its Strategic Plan, retention incentives and certain other matters with respect to Bank personnel, prior to the completion of the Merger. There can be no assurances that the Merger will be completed by October 31, 2015 or that the Company will not exercise its right to terminate the Merger Agreement in accordance with its terms.

The Merger Agreement, as amended by Amendment No. 1, was approved by the shareholders of both Hudson City Bancorp and M&T. The Merger is subject to the receipt of regulatory approvals and the satisfaction of other customary closing conditions.

On March 30, 2012, the Bank entered into a memorandum of understanding with the OCC (the “Bank MOU”). In accordance with the Bank MOU, the Bank adopted and implemented enhanced operating policies and procedures, that are intended to enable us to continue to: (a) reduce our level of interest rate risk, (b) reduce our funding concentration, (c) diversify our funding sources, (d) enhance our liquidity position, (e) monitor and manage loan modifications and (f) maintain our capital position in accordance with our existing capital plan. In addition, we developed the Strategic Plan for the Bank, which establishes objectives for the Bank’s overall risk profile, earnings performance, growth and balance sheet mix and to enhance our enterprise risk management program. These initiatives require significant lead time for full implementation and roll out to our customers. On February 26, 2015 the OCC terminated the Bank MOU.

 

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Notes to Unaudited Consolidated Financial Statements

 

The Company entered into a separate memorandum of understanding with the FRB (the “Company MOU”) on April 24, 2012. The Company MOU requires the Company to: (a) obtain approval from the FRB prior to receiving a capital distribution from the Bank or declaring a dividend to shareholders, and (b) obtain approval from the FRB prior to repurchasing or redeeming any Company stock or incurring any debt with a maturity of greater than one year. In accordance with the Company MOU, the Company submitted a comprehensive Capital Plan and a comprehensive Earnings Plan to the FRB. While the Company believes it is in compliance in all material respects with the Company MOU, it will remain in effect until modified or terminated by the FRB.

2. Basis of Presentation

The accompanying consolidated financial statements include the accounts of Hudson City Bancorp and its wholly-owned subsidiary, Hudson City Savings.

In our opinion, all the adjustments (consisting of normal and recurring adjustments) necessary for a fair presentation of the consolidated financial condition and consolidated results of operations for the unaudited periods presented have been included. The results of operations and other data presented for the six months ended June 30, 2015 are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2015. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statements of financial condition and the results of operations for the period. Actual results could differ from these estimates.

During the second quarter of 2015, we transferred held to maturity securities with a carrying value of $1.22 billion and a fair value of $1.30 billion to available for sale. The after-tax net unrealized gain of $48.3 million ($81.6 million pre-tax) was recorded as a component of accumulated other comprehensive income (loss).

The allowance for loan losses (“ALL”) is a material estimate that is particularly susceptible to near-term change. The current economic environment has increased the degree of uncertainty inherent in this material estimate. In addition, bank regulators, as an integral part of their supervisory function, periodically review our ALL. These regulatory agencies have the ability to require us, as they can require all banks, to increase our provision for loan losses or to recognize further charge-offs based on their judgments, which may be different from ours. Any increase in the ALL required by these regulatory agencies could adversely affect our financial condition and results of operations.

The goodwill impairment analysis depends on the use of estimates and assumptions which are highly sensitive to, among other things, market interest rates and are therefore subject to change in the near-term. Goodwill is tested for impairment at least annually and is considered impaired if the carrying value of goodwill exceeds its implied fair value. Similar to the calculation of goodwill in a business combination, the implied fair value of goodwill is determined by measuring the excess of the fair value of the reporting unit over the aggregate estimated fair values of individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired at the impairment test date. The estimation of the fair value of the Company is based on, among other things, the market price of our common stock. In addition, the fair value of the individual assets, liabilities and identifiable intangibles are determined using estimates and assumptions that are highly sensitive to market interest rates. These estimates and assumptions are subject to change in the near-term and may result in the impairment in future periods of some or all of the goodwill on our balance sheet.

 

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Notes to Unaudited Consolidated Financial Statements

 

Certain information and note disclosures usually included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for the preparation of the Form 10-Q. The consolidated financial statements presented should be read in conjunction with Hudson City Bancorp’s audited consolidated financial statements and notes to consolidated financial statements included in Hudson City Bancorp’s 2014 Annual Report on Form 10-K.

3. Earnings Per Share

The following is a summary of our earnings per share calculations and reconciliation of basic to diluted earnings per share.

 

		For the Three Months								For the Six Months
		Ended June 30								Ended June 30
		2015				2014				2015				2014
		(In thousands, except share data)
Net income		$	35,657			$	39,182			$	41,547			$	81,703
Less: Income allocated to participating securities			—				(176	)			(8	)			(176	)
Net income available to common shareholders		$	35,657			$	39,006			$	41,539			$	81,527
Basic weighted average common shares outstanding			501,078,623				498,874,695				500,585,010				498,646,420
Effect of dilutive common stock equivalents			1,269,898				963,568				1,526,699				805,594
Diluted weighted average common shares outstanding			502,348,521				499,838,263				502,111,709				499,452,014
Basic EPS		$	0.07			$	0.08			$	0.08			$	0.16
Diluted EPS		$	0.07			$	0.08			$	0.08			$	0.16

Common stock equivalents for both the three and six months ended June 30, 2015 exclude outstanding options to purchase 20,422,500 shares of the Company’s common stock as their inclusion would be anti-dilutive. Common stock equivalents for both the three and six months ended June 30, 2014 exclude outstanding options to purchase 21,031,224 shares of common stock as their inclusion would be anti-dilutive.

 

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4. Securities

The amortized cost and estimated fair market value of investment securities and mortgage-backed securities available-for-sale at June 30, 2015 and December 31, 2014 are as follows:

 

						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair Market
		Cost				Gains				Losses				Value
						(In thousands)
June 30, 2015
Investment Securities:
United States government
-sponsored enterprises debt		$	5,340,027			$	4,324			$	(1,342	)		$	5,343,009
Equity securities			17,077				345				—				17,422
Total investment securities available for sale		$	5,357,104			$	4,669			$	(1,342	)		$	5,360,431
Mortgage-backed securities:
GNMA pass-through certificates		$	611,380			$	17,038			$	(398	)		$	628,020
FNMA pass-through certificates			1,472,077				20,563				(11,776	)			1,480,864
FHLMC pass-through certificates			585,227				16,196				(1,441	)			599,982
FHLMC and FNMA—REMICs			20,685				942				—				21,627
Total mortgage-backed securities available for sale		$	2,689,369			$	54,739			$	(13,615	)		$	2,730,493
December 31, 2014
Investment securities:
United States government
-sponsored enterprises debt		$	3,600,085			$	72			$	(6,508	)		$	3,593,649
Equity securities			16,985				411				—				17,396
Total investment securities available for sale		$	3,617,070			$	483			$	(6,508	)		$	3,611,045
Mortgage-backed securities:
GNMA pass-through certificates		$	633,629			$	20,056			$	(277	)		$	653,408
FNMA pass-through certificates			1,688,568				19,247				(11,917	)			1,695,898
FHLMC pass-through certificates			604,147				12,191				(2,340	)			613,998
Total mortgage-backed securities available for sale		$	2,926,344			$	51,494			$	(14,534	)		$	2,963,304

 

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Notes to Unaudited Consolidated Financial Statements

 

The amortized cost and estimated fair market value of investment securities and mortgage-backed securities held to maturity at December 31, 2014 is as follows:

 

						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair Market
		Cost				Gains				Losses				Value
						(In thousands)
December 31, 2014
Investment securities:
United States government
-sponsored enterprises debt		$	39,011			$	2,582			$	—			$	41,593
Total investment securities held to maturity		$	39,011			$	2,582			$	—			$	41,593
Mortgage-backed securities:
GNMA pass-through certificates		$	54,301			$	1,840			$	—			$	56,141
FNMA pass-through certificates			278,953				20,209				(1	)			299,161
FHLMC pass-through certificates			865,364				58,097				—				923,461
FHLMC and FNMA—REMICs			73,519				3,878				—				77,397
Total mortgage-backed securities held to maturity		$	1,272,137			$	84,024			$	(1	)		$	1,356,160

During 2014, we supplemented our earnings with gains on the sales of securities. This strategy was key to maintaining earnings despite a decreasing net interest margin as rates remained low and we continued to carry excess liquidity with very little appetite for reinvesting this liquidity into longer-term investments or fixed-rate residential mortgage loans. In addition, the market demand and prices provided a strong opportunity for us to sell these securities. However, in anticipation of the closing of the Merger, which was expected to close on May 1, 2015, we suspended the sale of securities during the first quarter of 2015. The unexpected news in early April that there would be a further delay in completing the Merger came too late for us to resume the sale of securities before the end of the first quarter and, as a result, our net income for the first six months of 2015 was adversely affected. We resumed the sale of securities during the second quarter of 2015. To facilitate these securities sales, in the second quarter of 2015 we transferred held to maturity securities with a carrying value of $1.22 billion and a fair value of $1.30 billion to available for sale. The after-tax net unrealized gain of $48.3 million ($81.6 million pre-tax) was recorded as a component of accumulated other comprehensive income (loss). As a result of this transfer, we are precluded from classifying any future security purchases as held to maturity for a period of two years.

 

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Notes to Unaudited Consolidated Financial Statements

 

The following tables summarize the fair values and unrealized losses of our securities held to maturity and available-for-sale with an unrealized loss at June 30, 2015 and December 31, 2014, segregated between securities that had been in a continuous unrealized loss position for less than twelve months or longer than twelve months at the respective dates.

 

		Less Than 12 Months								12 Months or Longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
		(In thousands)
June 30, 2015
Available for sale:
United States goverment
-sponsored enterprises debt		$	1,150,171			$	(582	)		$	99,402			$	(760	)		$	1,249,573			$	(1,342	)
GNMA pass-through certificates			10,073				(43	)			10,064				(355	)			20,137				(398	)
FNMA pass-through certificates			318,311				(4,245	)			408,436				(7,531	)			726,747				(11,776	)
FHLMC pass-through certificates			69,617				(305	)			94,600				(1,136	)			164,217				(1,441	)
Total temporarily impaired securities available for sale			1,548,172				(5,175	)			612,502				(9,782	)			2,160,674				(14,957	)
Total		$	1,548,172			$	(5,175	)		$	612,502			$	(9,782	)		$	2,160,674			$	(14,957	)
December 31, 2014
Held to maturity:
FNMA pass-through certificates		$	—			$	—			$	90			$	(1	)		$	90			$	(1	)
Total temporarily impaired securities held to maturity			—				—				90				(1	)			90				(1	)
Available for sale:
United States goverment
-sponsored enterprises debt		$	3,047,275			$	(3,342	)		$	196,674			$	(3,166	)		$	3,243,949			$	(6,508	)
GNMA pass-through certificates			—				—				11,251				(277	)			11,251				(277	)
FNMA pass-through certificates			48,955				(54	)			664,779				(11,863	)			713,734				(11,917	)
FHLMC pass-through certificates			—				—				151,889				(2,340	)			151,889				(2,340	)
Total temporarily impaired securities available for sale			3,096,230				(3,396	)			1,024,593				(17,646	)			4,120,823				(21,042	)
Total		$	3,096,230			$	(3,396	)		$	1,024,683			$	(17,647	)		$	4,120,913			$	(21,043	)

The unrealized losses of our securities available for sale at June 30, 2015 are primarily due to the changes in market interest rates subsequent to purchase. At June 30, 2015, a total of 50 securities were in an unrealized loss position compared to 51 at December 31, 2014. We do not consider these investments to be other-than-temporarily impaired at June 30, 2015 and December 31, 2014 since the decline in market value is attributable to changes in interest rates and not credit quality. In addition, the Company does not intend to sell and does not believe that it is more likely than not that we will be required to sell these investments until there is a full recovery of the unrealized loss, which may be at maturity. As a result no impairment loss was recognized during the six months ended June 30, 2015.

 

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Notes to Unaudited Consolidated Financial Statements

 

The amortized cost and estimated fair market value of our securities available-for-sale at June 30, 2015, by contractual maturity, are shown below. The table does not include the effect of prepayments or scheduled principal amortization. The expected maturity may differ from the contractual maturity because issuers may have the right to call or prepay obligations. Equity securities have been excluded from this table.

 

		Amortized Cost								Estimated
		Mortgage-backed				Investment				Fair Market
		securities				securities				Value
						(In thousands)
June 30, 2015
Available for Sale:
Due in one year or less		$	62			$	5,002,219			$	5,004,173
Due after one year through five years			1,840				298,797				300,112
Due after five years through ten years			53,554				—				57,250
Due after ten years			2,633,913				39,011				2,711,967
Total available for sale		$	2,689,369			$	5,340,027			$	8,073,502

Sales of mortgage-backed securities held to maturity amounted to $28.4 million for the six months ended June 30, 2015, resulting in a realized gain of $1.9 million. Sales of mortgage-backed securities held to maturity amounted to $122.5 million for the six months ended June 30, 2014, resulting in a realized gain of $6.6 million. The sales of the held to maturity securities were made after the Company had collected at least 85% of the initial principal balance.

Sales of mortgage-backed securities available for sale amounted to $1.18 billion for the six months ended June 30, 2015, resulting in a realized gain of $72.5 million. Sales of mortgage-backed securities available for sale amounted to $862.4 million for the six months ended June 30, 2014, resulting in a realized gain of $28.9 million.

There were no sales of investment securities available for sale or held to maturity for both the six months ended June 30, 2015 and 2014. Gains and losses on the sale of all securities are determined using the specific identification method.

In April 2015, the Company transferred to available for sale all securities that were classified as held to maturity.

5. Stock Repurchase Programs

Pursuant to our stock repurchase programs, shares of Hudson City Bancorp common stock may be purchased in the open market or through other privately negotiated transactions, depending on market conditions. The repurchased shares are held as treasury stock for general corporate use. In accordance with the terms of the Company MOU, future share repurchases must be approved by the FRB. In addition, pursuant to the terms of the Merger Agreement, we may not repurchase shares of Hudson City Bancorp common stock without the consent of M&T. We did not purchase any of our common shares pursuant to the repurchase programs during the six months ended June 30, 2015. Included in treasury stock are vested shares related to stock awards that were surrendered for withholding taxes. These shares

 

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Notes to Unaudited Consolidated Financial Statements

 

are included in purchases of vested stock awards surrendered for withholding taxes in the consolidated statements of cash flows and amounted to 297,253 shares for the six months ended June 30, 2015. Shares surrendered for withholding taxes for the six months ended June 30, 2014 amounted to 169,091 shares. As of June 30, 2015, there remained 50,123,550 shares that may be purchased under the existing stock repurchase programs.

6. Loans and Allowance for Loan Losses

Loans at June 30, 2015 and December 31, 2014 are summarized as follows:

 

		June 30, 2015				December 31, 2014
		(In thousands)
First mortgage loans:
One- to four-family
Amortizing		$	16,342,897			$	17,746,149
Interest-only			2,459,933				2,874,024
FHA/VA			638,835				648,070
Multi-family and commercial			157,838				102,323
Construction			177				177
Total first mortgage loans			19,599,680				21,370,743
Consumer and other loans:
Fixed–rate second mortgages			65,736				72,309
Home equity credit lines			100,013				104,372
Other			16,293				17,550
Total consumer and other loans			182,042				194,231
Total loans		$	19,781,722			$	21,564,974

There were no loans held for sale at June 30, 2015 and December 31, 2014.

The following tables present the composition of our loan portfolio by credit quality indicator at the dates indicated:

 

Credit Risk Profile based on Payment Activity
(In thousands)
		One-to four- family								Other first																				Total
		first mortgage loans								Mortgages								Consumer and Other												Loans
										Multi-family								Fixed-rate
										and								second				Home Equity
		Amortizing				Interest-only				Commercial				Construction				mortgages				credit lines				Other
June 30, 2015
Performing		$	16,282,895			$	2,369,644			$	151,780			$	—			$	64,778			$	96,253			$	14,539			$	18,979,889
Non-performing			698,837				90,289				6,058				177				958				3,760				1,754				801,833
Total		$	16,981,732			$	2,459,933			$	157,838			$	177			$	65,736			$	100,013			$	16,293			$	19,781,722
December 31, 2014
Performing		$	17,652,318			$	2,774,245			$	100,780			$	—			$	71,056			$	100,607			$	13,955			$	20,712,961
Non-performing			741,901				99,779				1,543				177				1,253				3,765				3,595				852,013
Total		$	18,394,219			$	2,874,024			$	102,323			$	177			$	72,309			$	104,372			$	17,550			$	21,564,974

 

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Credit Risk Profile by Internally Assigned Grade
(In thousands)
		One-to four- family first mortgage loans								Other first Mortgages								Consumer and Other												Total Loans
		Amortizing				Interest-only				Multi-family and Commercial				Construction				Fixed-rate second mortgages				Home Equity credit lines				Other
June 30, 2015
Pass		$	16,091,630			$	2,338,240			$	150,663			$	—			$	63,730			$	93,332			$	14,521			$	18,752,116
Special mention			72,810				14,509				430				—				88				432				18				88,287
Substandard			817,292				107,184				6,745				177				1,918				6,249				1,754				941,319
Total		$	16,981,732			$	2,459,933			$	157,838			$	177			$	65,736			$	100,013			$	16,293			$	19,781,722
December 31, 2014
Pass		$	17,447,845			$	2,744,846			$	94,858			$	—			$	70,669			$	97,905			$	13,385			$	20,469,508
Special mention			89,166				10,926				1,180				—				71				252				118				101,713
Substandard			857,208				118,252				6,285				177				1,569				6,215				4,047				993,753
Total		$	18,394,219			$	2,874,024			$	102,323			$	177			$	72,309			$	104,372			$	17,550			$	21,564,974

Loan classifications are defined as follows:

 

•

Pass – These loans are protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less cost to acquire and sell, of any underlying collateral in a timely manner.

 

•

Special Mention – These loans have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of repayment prospects.

 

•

Substandard – These loans are inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.

 

•

Doubtful – These loans have all the weaknesses inherent in a loan classified substandard with the added characteristic that the weaknesses make the full recovery of our principal balance highly questionable and improbable on the basis of currently known facts, conditions, and values. The likelihood of a loss on an asset or portion of an asset classified Doubtful is high. Its classification as Loss is not appropriate, however, because pending events are expected to materially affect the amount of loss.

 

•

Loss – These loans are considered uncollectible and of such little value that a charge-off is warranted. This classification does not necessarily mean that an asset has no recovery or salvage value; but rather, there is much doubt about whether, how much, or when the recovery will occur.

We evaluate the classification of our one-to four-family mortgage loans, consumer loans and other loans primarily on a pooled basis by delinquency. Loans that are past due 60 to 89 days are classified as special mention and loans that are past due 90 days or more, as well as impaired loans, are classified as substandard. We obtain updated valuations for one- to four- family mortgage loans by the time a loan becomes 180 days past due. If necessary, we charge-off an amount to reduce the carrying value of the loan to the value of the underlying property, less estimated selling costs. Since we record the charge-off when we receive the updated valuation, we typically do not have any residential first mortgages classified as doubtful or loss. We evaluate troubled debt restructurings individually, as well as multi-family, commercial and construction loans when they become 120 days past due and base our classification on the debt service capability of the underlying property as well as secondary sources of repayment such as the

 

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borrower’s and any guarantor’s ability and willingness to provide debt service. Residential mortgage loans that are classified as troubled debt restructurings are individually evaluated for impairment based on the present value of each loan’s expected future cash flows.

Originating loans secured by residential real estate is our primary business. Our financial results may be adversely affected by changes in prevailing economic conditions, either nationally or in our local New Jersey and metropolitan New York market areas, including decreases in real estate values, adverse employment conditions, the monetary and fiscal policies of the federal and state government and other significant external events. As a result of our lending practices, we have a concentration of loans secured by real property located primarily in New Jersey, New York and Connecticut (the “New York metropolitan area”). At June 30, 2015, approximately 85.1% of our total loans are in the New York metropolitan area.

Included in our loan portfolio at June 30, 2015 and December 31, 2014 are $2.46 billion and $2.87 billion, respectively, of interest-only one-to four- family residential mortgage loans. These loans are originated as adjustable-rate mortgage (“ARM”) loans with initial terms of five, seven or ten years with the interest-only portion of the payment based upon the initial loan term, or offered on a 30-year fixed-rate loan with interest-only payments for the first 10 years of the obligation. At the end of the initial 5-, 7- or 10-year interest-only period, the loan payment will adjust to include both principal and interest and will amortize over the remaining term so the loan will be repaid at the end of its original life. We had $90.3 million and $99.8 million of non-performing interest-only one-to four-family residential mortgage loans at June 30, 2015 and December 31, 2014, respectively.

Prior to January 2014, we originated loans to certain eligible borrowers as reduced documentation loans. Loans that were eligible for reduced documentation processing were ARM loans, interest-only first mortgage loans and 10-, 15-, 20- and 30-year fixed-rate loans to owner-occupied primary and second home applicants. These loans were available in amounts up to 65% of the lower of the appraised value or purchase price of the property. Generally the maximum loan amount for reduced documentation loans was $750,000 and these loans were subject to higher interest rates than our full documentation loan products. Reduced documentation loans have an inherently higher level of risk compared to loans with full documentation. Reduced documentation loans represent 21.9% of our one-to four-family first mortgage loans at June 30, 2015. Included in our loan portfolio at June 30, 2015 are $3.73 billion of amortizing reduced documentation loans and $532.7 million of reduced documentation interest-only loans as compared to $3.99 billion and $620.0 million, respectively, at December 31, 2014. Non-performing loans at June 30, 2015 include $151.2 million of amortizing reduced documentation loans and $33.5 million of interest-only reduced documentation loans as compared to $168.2 million and $39.8 million, respectively, at December 31, 2014.

 

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The following table is a comparison of our delinquent loans by class as of the dates indicated:

 

		30-59 Days				60-89 Days				90 Days or more				Total Past Due				Current Loans				Total Loans				90 Days or more and accruing (1)
		(In thousands)
At June 30, 2015
One- to four-family first mortgages:
Amortizing		$	215,083			$	90,631			$	698,837			$	1,004,551			$	15,977,181			$	16,981,732			$	39,378
Interest-only			18,730				15,402				90,289				124,421				2,335,512				2,459,933				—
Multi-family and commercial mortgages			—				688				6,058				6,746				151,092				157,838				—
Construction loans			—				—				177				177				—				177				—
Consumer and other loans:																											—
Fixed-rate second mortgages			938				143				958				2,039				63,697				65,736				—
Home equity lines of credit			301				432				3,760				4,493				95,520				100,013				—
Other			69				18				1,754				1,841				14,452				16,293				—
Total		$	235,121			$	107,314			$	801,833			$	1,144,268			$	18,637,454			$	19,781,722			$	39,378
At December 31, 2014
One- to four-family first mortgages:
Amortizing		$	243,560			$	111,420			$	741,901			$	1,096,881			$	17,297,338			$	18,394,219			$	33,383
Interest-only			30,256				12,507				99,779				142,542				2,731,482				2,874,024				—
Multi-family and commercial mortgages			2,782				4,743				1,543				9,068				93,255				102,323				—
Construction loans			—				—				177				177				—				177				—
Consumer and other loans:
Fixed-rate second mortgages			272				71				1,253				1,596				70,713				72,309				—
Home equity lines of credit			1,077				252				3,765				5,094				99,278				104,372				—
Other			589				118				3,595				4,302				13,248				17,550				—
Total		$	278,536			$	129,111			$	852,013			$	1,259,660			$	20,305,314			$	21,564,974			$	33,383

 

(1)	Loans that are past due 90 days or more and still accruing interest are loans that are guaranteed by the FHA.

The following table presents the geographic distribution of our loan portfolio as a percentage of total loans and of our non-performing loans as a percentage of total non-performing loans:

 

		At June 30, 2015								At December 31, 2014
						Non-performing								Non-performing
		Total loans				Loans				Total loans				Loans
New Jersey			42.4	%			41.9	%			42.4	%			42.6	%
New York			28.1				29.4				27.8				27.8
Connecticut			14.6				7.9				14.6				7.8
Total New York metropolitan area			85.1				79.2				84.8				78.2
Pennsylvania			4.8				1.8				4.8				1.5
Massachusetts			2.0				1.8				2.0				1.8
Virginia			1.6				2.0				1.6				1.9
Maryland			1.6				4.6				1.6				5.2
Illinois			1.5				4.3				1.5				4.7
All others			3.4				6.3				3.7				6.7
Total Outside New York metropolitan area			14.9				20.8				15.2				21.8
			100.0	%			100.0	%			100.0	%			100.0	%

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

The following is a summary of loans, by class, on which the accrual of income has been discontinued and loans that are contractually past due 90 days or more but have not been classified as non-accrual at June 30, 2015 and December 31, 2014:

 

		June 30, 2015				December 31, 2014
		(In thousands)
Non-accrual loans:
One-to four-family amortizing loans		$	659,459			$	708,518
One-to four-family interest-only loans			90,289				99,779
Multi-family and commercial mortgages			6,058				1,543
Construction loans			177				177
Fixed-rate second mortgages			958				1,253
Home equity lines of credit			3,760				3,765
Other loans			1,754				3,595
Total non-accrual loans			762,455				818,630
Accruing loans delinquent 90 days or more (1)			39,378				33,383
Total non-performing loans		$	801,833			$	852,013

 

(1)	Loans that are past due 90 days or more and still accruing interest are loans that are insured by the FHA.

The total amount of interest income on non-accrual loans that would have been recognized during the first six months of 2015, if interest on all such loans had been recorded based upon original contract terms, amounted to approximately $23.5 million as compared to $27.8 million for the same period in 2014. Hudson City Savings is not committed to lend additional funds to borrowers on non-accrual status.

Non-performing loans exclude troubled debt restructurings that are accruing and have been performing in accordance with the terms of their restructure agreement for at least six months. The following table presents information regarding loans modified in a troubled debt restructuring at June 30, 2015 and December 31, 2014:

 

		June 30, 2015				December 31, 2014
		(In thousands)
Troubled debt restructurings:
Current		$	144,502			$	137,249
30-59 days			23,571				20,344
60-89 days			10,790				17,079
90 days or more			153,974				157,744
Total troubled debt restructurings		$	332,837			$	332,416

 

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Notes to Unaudited Consolidated Financial Statements

 

The following table presents loan portfolio by class that were modified as troubled debt restructurings at June 30, 2015 and December 31, 2014. The pre-restructuring and post-restructuring outstanding recorded investments disclosed in the table below represent the loan carrying amounts immediately prior to the restructuring and the carrying amounts, respectively at June 30, 2015 and December 31, 2014:

 

		June 30, 2015												December 31, 2014
						Pre-restructuring				Post-restructuring								Pre-restructuring				Post-restructuring
		Number				Outstanding				Outstanding				Number				Outstanding				Outstanding
		of				Recorded				Recorded				of				Recorded				Recorded
		Contracts				Investment				Investment				Contracts				Investment				Investment
		(Dollars in thousands)
Troubled debt restructurings:
One-to four- family first mortgages:
Amortizing			978			$	341,432			$	292,327				980			$	341,398			$	291,404
Interest-only			55				33,425				30,021				59				35,025				31,257
Multi-family and commercial mortgages			3				8,650				5,432				3				8,650				5,441
Consumer and other loans			42				5,381				5,057				36				4,594				4,314
Total			1,078			$	388,888			$	332,837				1,078			$	389,667			$	332,416

Loans evaluated for impairment include loans classified as troubled debt restructurings and non-performing multi-family, commercial and construction loans. The following table presents our loans evaluated for impairment by class at the date indicated as well as the related allowance for loan losses based on the impairment analysis:

 

		Recorded				Unpaid								Average				Interest
		Investment,				Principal				Related				Recorded				Income
		Net of Allowance				Balance				Allowance				Investment				Recognized
		(In thousands)
June 30, 2015
One-to four-family amortizing loans		$	292,327			$	336,192			$	—			$	294,525			$	4,233
One-to four-family interest-only loans			30,021				34,081				—				30,037				440
Multi-family and commercial mortgages			6,552				10,308				193				6,863				26
Construction loans			177				292				—				177				—
Consumer and other loans			5,555				6,233				283				6,063				77
Total		$	334,632			$	387,106			$	476			$	337,665			$	4,776
December 31, 2014
One-to four-family amortizing loans		$	291,404			$	337,174			$	—			$	295,986			$	7,496
One-to four-family interest-only loans			31,257				35,732				—				31,447				936
Multi-family and commercial mortgages			5,525				9,039				126				7,033				359
Construction loans			177				292				—				293				—
Consumer and other loans:			3,971				4,314				343				4,367				109
Total		$	332,334			$	386,551			$	469			$	339,126			$	8,900

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

The following table presents the activity in our ALL for the periods indicated:

 

		For the Three Months Ended June 30,								For the Six Months Ended June 30,
		2015				2014				2015				2014
		(In thousands)
Balance at beginning of period		$	230,489			$	265,732			$	235,317			$	276,097
Charge-offs			(11,278	)			(15,709	)			(20,556	)			(32,241	)
Recoveries			6,362				4,988				10,812				11,155
Net charge-offs			(4,916	)			(10,721	)			(9,744	)			(21,086	)
Provision for loan losses			—				—				—				—
Balance at end of period		$	225,573			$	255,011			$	225,573			$	255,011

The following table presents the activity in our ALL by portfolio segment.

 

		One-to four- Family Mortgages				Multi-family and Commercial Mortgages				Construction				Consumer and Other Loans				Total
		(In thousands)
Balance at December 31, 2014		$	230,862			$	571			$	—			$	3,884			$	235,317
Provision for loan losses			431				126				—				(557	)			—
Charge-offs			(19,759	)			(220	)			—				(577	)			(20,556	)
Recoveries			10,735				—				—				77				10,812
Net charge-offs			(9,024	)			(220	)			—				(500	)			(9,744	)
Balance at June 30, 2015		$	222,269			$	477			$	—			$	2,827			$	225,573
Loan portfolio:
Balance at June 30, 2015
Individually evaluated for impairment		$	322,348			$	6,745			$	177			$	5,838			$	335,108
Collectively evaluated for impairment			19,119,317				151,093				—				176,204				19,446,614
Allowance
Individually evaluated for impairment		$	16,046			$	193			$	—			$	283			$	16,522
Collectively evaluated for impairment			206,223				284				—				2,544				209,051

Historically, our primary lending emphasis has been the origination and purchase of one- to four-family first mortgage loans on residential properties and, to a lesser extent, second mortgage loans on one- to four-family residential properties resulting in a loan concentration in residential first mortgage loans at June 30, 2015. As a result of our lending practices, we also have a concentration of loans secured by real property located primarily in New Jersey, New York and Connecticut. As of June 30, 2015, approximately 85.1% of our total loans are in the New York metropolitan area. Additionally, the states of Pennsylvania, Massachusetts, Virginia, Maryland and Illinois, accounted for 4.8%, 2.0%, 1.6%, 1.6%, and 1.5%, respectively of total loans. The remaining 3.4% of the loan portfolio is secured by real estate primarily in the remainder of our lending markets. Based on the composition of our loan portfolio, we believe the primary risks inherent in our portfolio relate to the conditions in our lending market areas including economic conditions, unemployment levels, rising interest rates and a decline in real estate market values. Any one or a combination of these adverse trends may adversely affect our loan portfolio resulting in increased delinquencies, non-performing assets, charge-offs and future levels of loan loss provisions. We consider these trends in market conditions in determining the ALL.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

Due to the nature of our loan portfolio, our evaluation of the adequacy of our ALL is performed primarily on a “pooled” basis. Each quarter we prepare an analysis which categorizes the entire loan portfolio by certain risk characteristics such as loan type (fixed and variable one- to four-family, interest-only, reduced documentation, multi-family, commercial, construction, etc.), loan source (originated or purchased) and payment status (i.e., current or number of days delinquent). Loans with known potential losses are categorized separately. We assign estimated loss factors to the payment status categories on the basis of our assessment of the potential risk inherent in each loan type. These factors are periodically reviewed for appropriateness giving consideration to our loss experience, delinquency trends, portfolio growth and environmental factors such as the status of the regional economy and housing market, in order to ascertain that the loss factors cover probable and estimable losses inherent in the portfolio. We define our loss experience on non-performing loans as the ratio of the excess of the loan balance (including selling costs) over the updated collateral value to the principal balance of loans for which we have updated valuations. We obtain updated collateral values by the time a loan becomes 180 days past due and on an annual basis thereafter for as long as the loan remains non-performing. Based on our analysis, our loss experience on our non-performing one- to four-family first mortgage loans was approximately 10.9% at June 30, 2015 compared to 12.1% at December 31, 2014.

One-to four-family mortgage loans that are individually evaluated for impairment consist primarily of troubled debt restructurings. If our evaluation indicates that the loan is impaired, we record a charge-off for the amount of the impairment. Loans that were individually evaluated for impairment, but would otherwise be evaluated on a pooled basis, are included in the collective evaluation if the individual evaluation indicated no impairment existed. This collective evaluation of one-to four-family mortgage loans that were also individually evaluated for impairment (but for which no impairment existed) resulted in an ALL of $16.0 million at June 30, 2015, which is intended to capture the risk that the net present value calculation did not account for such as changes in collateral, unemployment and other environmental factors.

The ultimate ability to collect the loan portfolio is subject to changes in the real estate market and future economic conditions. Economic conditions in our primary market area continued to improve modestly during the first six months of 2015 as evidenced by increased levels of home sale activity, higher real estate valuations and a decrease in the unemployment rate. We continue to closely monitor the local and national real estate markets and other factors related to risks inherent in our loan portfolio.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

7. Borrowed Funds

Borrowed funds at June 30, 2015 and December 31, 2014 are summarized as follows:

 

		June 30, 2015								December 31, 2014
						Weighted								Weighted
						Average								Average
		Principal				Rate				Principal				Rate
		(Dollars in thousands)
Securities sold under agreements to repurchase:
Other financial institutions		$	6,150,000				4.44			$	6,150,000				4.44	%
Total securities sold under agreements to repurchase			6,150,000				4.44				6,150,000				4.44
Advances from the FHLB			6,025,000				4.75				6,025,000				4.75
Total borrowed funds		$	12,175,000				4.59	%		$	12,175,000				4.59	%
Accrued interest payable		$	65,106							$	64,080

The average balances of borrowings and the maximum amount outstanding at any month-end are as follows:

 

		At or For the Six				At or For the
		Months Ended				Year Ended
		June 30, 2015				December 31, 2014
		(Dollars in thousands)
Repurchase Agreements:
Average balance outstanding during the period		$	6,150,000			$	6,274,932
Maximum balance outstanding at any month-end during the period		$	6,150,000			$	6,950,000
Weighted average rate during the period			4.44	%			4.49	%
FHLB Advances:
Average balance outstanding during the period		$	6,025,000			$	5,900,068
Maximum balance outstanding at any month-end during the period		$	6,025,000			$	6,025,000
Weighted average rate during the period			4.75	%			4.82	%

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

At June 30, 2015, $3.33 billion of our borrowed funds may be put back to us at the discretion of the lender. At that date, borrowed funds had scheduled maturities and potential put dates as follows:

 

		Borrowings by Scheduled								Borrowings by Earlier of Scheduled
		Maturity Date								Maturity or Next Potential Put Date
						Weighted								Weighted
						Average								Average
Year		Principal				Rate				Principal				Rate
		(Dollars in thousands)
2015		$	75,000				4.62	%		$	3,400,000				4.42	%
2016			3,925,000				4.92				3,925,000				4.92
2017			2,475,000				4.39				200,000				4.04
2018			700,000				3.65				500,000				3.54
2019			1,725,000				4.62				1,325,000				4.69
2020			3,275,000				4.53				2,825,000				4.52
Total		$	12,175,000				4.59	%		$	12,175,000				4.59	%

The following table provides the contractual maturity and weighted average interest rate of repurchase agreements, all of which are accounted for as secured borrowings, at June 30, 2015:

 

										Mortgage-backed								U.S. government-sponsored
										securities								enterprise securities
Contractual Maturity		Amount				Weighted Average Interest Rate				Amortized Cost				Fair Value				Amortized Cost				Fair Value
(dollars in thousands)
Over 90 days		$	6,150,000				4.44	%		$	2,114,035			$	2,141,960			$	5,142,803			$	5,144,040

Our repurchase agreements are recorded as financing transactions and the obligations to repurchase are reflected as a liability in the consolidated financial statements. The underlying securities used as collateral for the repurchase agreements remain registered in the name of the Company and are returned upon maturity of the repurchase agreement. We retain the right of substitution of collateral throughout the terms of the agreements. As both the borrowing and collateral are valued in determining collateral levels, changes in prices of either instrument could result in additional collateral requirements. The difference between the principal balance of our repurchase agreement and the carrying amount of the underlying securities used as collateral could result in a potential loss to the Bank should we be unable to recover our securities.

The Bank had two collateralized borrowings in the form of repurchase agreements totaling $100.0 million with Lehman Brothers, Inc. that were secured by mortgage-backed securities with an amortized cost of approximately $114.1 million. The trustee for the liquidation of Lehman Brothers, Inc. (the “Trustee”) notified the Bank in the fourth quarter of 2011 that it considered our claim to be a non-customer claim, which has a lower payment preference than a customer claim and that the value of such claim is approximately $13.9 million representing the excess of the fair value of the collateral over the $100.0 million repurchase price. At that time we established a reserve of $3.9 million against the receivable balance at December 31, 2011. On June 25, 2013, the Bankruptcy Court affirmed the Trustee’s determination that the repurchase agreements did not entitle the Bank to customer status and on February 26, 2014, the U.S. District Court upheld the Bankruptcy Court’s decision that our claim should be treated as a non-customer claim. As a result, we increased our reserve by $3.0 million to $6.9 million against the receivable balance during 2014. During the six months ended June 30, 2015, the Bank received a partial payment on our non-customer claim of $1.4 million.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

8. Goodwill and Other Intangible Assets

Goodwill and other intangible assets amounted to $152.2 million and were recorded as a result of Hudson City Bancorp’s acquisition of Sound Federal Bancorp, Inc. (“Sound Federal”) in 2006.

The first step (“Step 1”) used to identify potential impairment involves comparing each reporting unit’s estimated fair value to its carrying amount, including goodwill. As a community-oriented bank, substantially all of the Company’s operations involve the delivery of loan and deposit products to customers and these operations constitute the Company’s only segment for financial reporting purposes. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill is not considered to be impaired. If the carrying amount exceeds the estimated fair value, there is an indication of potential impairment and the second step (“Step 2”) is performed to measure the amount. Step 2 involves calculating an implied fair value of goodwill for each reporting unit for which impairment was indicated in Step 1. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination by measuring the excess of the estimated fair value of the reporting unit, as determined in Step 1, over the aggregate estimated fair values of the individual assets, liabilities, and identifiable intangibles, as if the reporting unit was being acquired at the impairment test date. We perform our goodwill impairment analysis annually and also perform interim impairment reviews if certain triggering events occur which may indicate that the fair value of goodwill is less than the carrying value. Subsequent reversal of goodwill impairment losses is not permitted.

We performed our annual goodwill impairment analysis as of June 30, 2015 and concluded that goodwill was not impaired. Therefore, we did not recognize any impairment of goodwill or other intangible assets during 2015.

The estimation of the fair value of the Company requires the use of estimates and assumptions that results in a greater degree of uncertainty. In addition, the estimated fair value of the Company is based on, among other things, the market price of our common stock as calculated per the terms of the Merger. As a result of the current volatility in market and economic conditions, these estimates and assumptions are subject to change in the near-term and may result in the impairment in future periods of some or all of the goodwill on our balance sheet.

9. Fair Value Measurements

a) Fair Value Measurements

We use fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. We did not have any liabilities that were measured at fair value at June 30, 2015 and December 31, 2014. Our securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets or liabilities on a non-recurring basis, such as foreclosed real estate owned, certain impaired loans and goodwill. These non-recurring fair value adjustments generally involve the write-down of individual assets due to impairment losses.

 

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Notes to Unaudited Consolidated Financial Statements

 

In accordance with ASC Topic 820, Fair Value Measurements and Disclosures, we group our assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

•

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

 

•

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.

 

•

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques. The results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability.

We base our fair values on the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. ASC Topic 820 requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Assets that we measure on a recurring basis are limited to our available-for-sale securities portfolio. Our available-for-sale portfolio is carried at estimated fair value with any unrealized gains and losses, net of taxes, reported as accumulated other comprehensive income or loss in shareholders’ equity. Substantially all of our available-for-sale portfolio consists of mortgage-backed securities and investment securities issued by U.S. government-sponsored entities (the “GSEs”). The fair values for substantially all of these securities are obtained monthly from an independent nationally recognized pricing service. On a monthly basis, we assess the reasonableness of the fair values obtained by reference to a second independent nationally recognized pricing service. Based on the nature of our securities, our independent pricing service provides us with prices which are categorized as Level 2 since quoted prices in active markets for identical assets are generally not available for the majority of securities in our portfolio. Various modeling techniques are used to determine pricing for our mortgage-backed securities, including option pricing and discounted cash flow models. The inputs to these models include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. On an annual basis, we obtain the models, inputs and assumptions utilized by our pricing service and review them for reasonableness. We also own equity securities with a carrying value of $17.4 million at both June 30, 2015 and December 31, 2014 for which fair values are obtained from quoted market prices in active markets and, as such, are classified as Level 1.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

The following table provides the level of valuation assumptions used to determine the carrying value of our assets measured at fair value on a recurring basis at June 30, 2015 and December 31, 2014.

 

						Fair Value Measurements at June 30, 2015 using
						Quoted Prices in Active				Significant Other				Significant
		Carrying				Markets for Identical				Observable Inputs				Unobservable Inputs
Description		Value				Assets (Level 1)				(Level 2)				(Level 3)
										(In thousands)
Available for sale debt securities:
Mortgage-backed securities		$	2,730,493			$	—			$	2,730,493			$	—
U.S. government-sponsored enterprises debt			5,343,009				—				5,343,009				—
Total available for sale debt securities		$	8,073,502			$	—			$	8,073,502			$	—
Available for sale equity securities:
Financial services industry		$	17,422			$	17,422			$	—			$	—
Total available for sale equity securities			17,422				17,422				—				—
Total available for sale securities		$	8,090,924			$	17,422			$	8,073,502			$	—
						Fair Value at December 31, 2014 using
						Quoted Prices in Active				Significant Other				Significant
		Carrying				Markets for Identical				Observable Inputs				Unobservable Inputs
Description		Value				Assets (Level 1)				(Level 2)				(Level 3)
										(In thousands)
Available for sale debt securities:
Mortgage-backed securities		$	2,963,304			$	—			$	2,963,304			$	—
U.S. government-sponsored enterprises debt			3,593,649				—				3,593,649				—
Total available for sale debt securities		$	6,556,953			$	—			$	6,556,953			$	—
Available for sale equity securities:
Financial services industry		$	17,396			$	17,396			$	—			$	—
Total available for sale equity securities			17,396				17,396				—				—
Total available for sale securities		$	6,574,349			$	17,396			$	6,556,953			$	—

Assets that were measured at fair value on a non-recurring basis at June 30, 2015 and December 31, 2014 were limited to non-performing commercial and construction loans that are collateral dependent, troubled debt restructurings and foreclosed real estate. Loans evaluated for impairment in accordance with accounting guidance amounted to $335.1 million and $332.8 million at June 30, 2015 and December 31, 2014, respectively. Based on this evaluation, we established an ALL of $476,000 and $469,000 for those same respective periods. These impaired loans are individually assessed to determine that the loan’s carrying value is not in excess of the fair value of the collateral, less estimated selling costs or the present value of the loan’s expected future cash flows. Impaired loans for which the carrying value exceeded the fair value and which are recorded at fair value at June 30, 2015 and December 31, 2014 amounted to $155.4 million and $156.2 million, respectively. For impaired loans that are secured by real estate, fair value is estimated through current appraisals, where practical, or an inspection and a comparison of the property securing the loan with similar properties in the area by either a licensed appraiser or real estate broker and, as such, are classified as Level 3.

 

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Notes to Unaudited Consolidated Financial Statements

 

Foreclosed real estate represents real estate acquired as a result of foreclosure or by deed in lieu of foreclosure and is carried at the lower of cost or fair value less estimated selling costs. Fair value is estimated through current appraisals, where practical, or an inspection and a comparison of the property securing the loan with similar properties in the area by either a licensed appraiser or real estate broker and, as such, foreclosed real estate properties are classified as Level 3. Foreclosed real estate consisted primarily of one-to four-family properties and amounted to $100.2 million and $80.0 million at June 30, 2015 and December 31, 2014, respectively. Foreclosed real estate for which the carrying value exceeded fair value and which are recorded at fair value at June 30, 2015 and December 31, 2014 amounted to $20.2 million and $22.1 million, respectively.

The following table provides the level of valuation assumptions used to determine the carrying value, included in the Consolidated Statements of Financial Condition, of our assets measured at fair value on a non-recurring basis at June 30, 2015 and December 31, 2014.

 

		Fair Value Measurements at June 30, 2015 using
		Quoted Prices in Active				Significant Other				Significant				Total
		Markets for Identical				Observable Inputs				Unobservable Inputs				Gains
Description		Assets (Level 1)				(Level 2)				(Level 3)				(Losses)
		(In thousands)
Impaired loans		$	—			$	—			$	155,384			$	(2,295	)
Foreclosed real estate			—				—				20,182				(1,125	)
		Fair Value Measurements at December 31, 2014 using
		Quoted Prices in Active				Significant Other				Significant				Total
		Markets for Identical				Observable Inputs				Unobservable Inputs				Gains
Description		Assets (Level 1)				(Level 2)				(Level 3)				(Losses)
		(In thousands)
Impaired loans		$	—			$	—			$	156,194			$	(6,415	)
Foreclosed real estate			—				—				22,116				(5,770	)

The following table presents quantitative information about Level 3 fair value measurements for financial assets measured at fair value on a non-recurring basis at June 30, 2015.

 

		June 30, 2015
Description		Fair Value				Valuation Technique		Significant Unobservable Input		Range of Inputs
								(Dollars in thousands)
Impaired loans		$	155,384			Net Present Value		Discount rate		Varies
						Appraisal Value		Discount for costs to sell		13.0%
								Adjustment for differences between comparable sales.		Varies
Foreclosed real estate			20,182			Appraisal Value		Discount for costs to sell		13.0%
								Adjustment for differences between comparable sales.		Varies

 

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Notes to Unaudited Consolidated Financial Statements

 

b) Fair Value Disclosures

The fair value of financial instruments represents the estimated amounts at which the asset or liability could be exchanged in a current transaction between willing parties, other than in a forced liquidation sale. These estimates are subjective in nature, involve uncertainties and matters of judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Further, certain tax implications related to the realization of the unrealized gains and losses could have a substantial impact on these fair value estimates and have not been incorporated into any of the estimates.

Cash and due from Banks

Carrying amounts of cash, due from banks and federal funds sold are considered to approximate fair value (Level 1).

Securities held to maturity

The fair values for our securities held to maturity are obtained from an independent nationally recognized pricing service utilizing similar modeling techniques and assumptions as used for our securities available-for-sale which are measured at fair value on a recurring basis (Level 2).

FHLB Stock

The carrying value of FHLB stock equals cost. The fair value of FHLB stock is based on redemption at par value (Level 1).

Loans

The fair value of one- to four-family mortgages and home equity loans are generally estimated using the present value of expected future cash flows, assuming future prepayments and using market rates for new loans with comparable credit risk. Published pricing in the secondary and securitization markets was also utilized to assist in the fair value of the loan portfolio (Level 3). The valuation of our loan portfolio is consistent with accounting guidance but does not fully incorporate the exit price approach.

Deposits

For deposit liabilities payable on demand, the fair value is the carrying value at the reporting date (Level 1). For time deposits the fair value is estimated by discounting estimated future cash flows using currently offered rates (Level 2).

Borrowed Funds

The fair value of fixed-maturity borrowed funds is estimated by discounting estimated future cash flows using current market rates (Level 2). Structured borrowed funds are valued using an option valuation model which uses assumptions for anticipated calls of borrowings based on market interest rates and weighted-average life (Level 2).

Off-balance Sheet Financial Instruments

There is no material difference between the fair value and the carrying amounts recognized with respect to our off-balance sheet loan commitments (Level 3). The fair value of our loan commitments is immaterial to our financial condition.

Other important elements that are not deemed to be financial assets or liabilities and, therefore, not considered in these estimates include the value of Hudson City Savings’ retail branch delivery system, its existing core deposit base and banking premises and equipment.

 

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Notes to Unaudited Consolidated Financial Statements

 

The estimated fair values of financial instruments are summarized as follows:

 

		June 30, 2015								December 31, 2014
		Carrying				Estimated				Carrying				Estimated
		Amount				Fair Value				Amount				Fair Value
		(In thousands)
Assets:
Cash and due from banks		$	102,957			$	102,957			$	122,484			$	122,484
Federal funds sold and other overnight deposits			6,599,793				6,599,793				6,163,082				6,163,082
Investment securities held to maturity			—				—				39,011				41,593
Investment securities available for sale			5,360,431				5,360,431				3,611,045				3,611,045
Federal Home Loan Bank of New York stock			309,892				309,892				320,753				320,753
Mortgage-backed securities held to maturity			—				—				1,272,137				1,356,160
Mortgage-backed securities available for sale			2,730,493				2,730,493				2,963,304				2,963,304
Loans			19,646,757				20,667,152				21,428,812				22,641,662
Liabilities:
Deposits			18,174,139				18,198,982				19,376,544				19,437,546
Borrowed funds			12,175,000				13,357,401				12,175,000				13,525,813

10. Postretirement Benefit Plans

We maintain non-contributory retirement and post-retirement plans to cover employees hired prior to August 1, 2005, including retired employees, who have met the eligibility requirements of the plans. Benefits under the qualified and non-qualified defined benefit retirement plans are based primarily on years of service and compensation. Funding of the qualified retirement plan is actuarially determined on an annual basis. It is our policy to fund the qualified retirement plan sufficiently to meet the minimum requirements set forth in the Employee Retirement Income Security Act of 1974. The non-qualified retirement plan, which is maintained for certain employees, is unfunded.

In 2005, we limited participation in the non-contributory retirement plan and the post-retirement benefit plan to those employees hired on or before July 31, 2005. We also placed a cap on paid medical expenses at the 2007 rate, beginning in 2008, for those eligible employees who retire after December 31, 2005. As part of our acquisition of Sound Federal in 2006, participation in the Sound Federal retirement plans and the accrual of benefits for such plans were frozen as of the acquisition date.

 

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The components of the net periodic expense for the plans were as follows:

 

		For the Three Months Ended June 30,
		Retirement Plans								Other Benefits
		2015				2014				2015				2014
		(In thousands)
Service cost		$	1,357			$	1,130			$	278			$	246
Interest cost			2,483				2,326				593				554
Expected return on assets			(3,794	)			(3,609	)			—				—
Amortization of:
Net loss			1,745				617				428				187
Unrecognized prior service cost			35				58				(391	)			(391	)
Net periodic benefit cost		$	1,826			$	522			$	908			$	596
		For the Six Months Ended June 30,
		Retirement Plans								Other Benefits
		2015				2014				2015				2014
		(In thousands)
Service cost		$	2,714			$	2,260			$	556			$	492
Interest cost			4,966				4,652				1,186				1,108
Expected return on assets			(7,588	)			(7,218	)			—				—
Amortization of:
Net loss			3,490				1,234				856				374
Unrecognized prior service cost			70				116				(782	)			(782	)
Net periodic benefit cost		$	3,652			$	1,044			$	1,816			$	1,192

We made no contributions to the pension plans during the first six months of 2015 or 2014.

11. Other Comprehensive Income (Loss)

The changes in accumulated other comprehensive income (loss) by component, net of tax, is as follows:

 

		Unrealized gains
		(losses) on securities				Postretirement
		available for sale				Benefit Plans				Total
		(In thousands)
Balance at December 31, 2014		$	18,382			$	(68,756	)		$	(50,374	)
Other comprehensive income before reclassifications			50,901				—				50,901
Amounts reclassified from accumulated other comprehensive income (loss)			(42,906	)			2,149				(40,757	)
Other comprehensive income			7,995				2,149				10,144
Balance at June 30, 2015		$	26,377			$	(66,607	)		$	(40,230	)
Balance at December 31, 2013		$	33,944			$	(27,608	)		$	6,336
Other comprehensive income before reclassifications			35,827				—				35,827
Amounts reclassified from accumulated other comprehensive income (loss)			(17,141	)			557				(16,584	)
Other comprehensive income			18,686				557				19,243
Balance at June 30, 2014		$	52,630			$	(27,051	)		$	25,579

 

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Notes to Unaudited Consolidated Financial Statements

 

The following table presents the reclassification adjustment out of accumulated other comprehensive income (loss) included in net income and the corresponding line item on the consolidated statements of operations for the periods indicated:

 

		Amounts Reclassified																Line Item in
Details about Accumlated Other		from Accumulated Other																the Statement of
Comprehensive Income Components		Comprehensive Income																Income
(In thousands)		For the Three Months Ended June 30,								For the Six Months Ended June 30,
		2015				2014				2015				2014
Securities available for sale:
Net realized gain on securities available for sale		$	(67,064	)		$	(18,260	)		$	(72,538	)		$	(28,882	)			Gain on securities transaction, net
Income tax expense			27,396				7,459				29,632				11,741				Income tax expense
Net of income tax expense			(39,668	)			(10,801	)			(42,906	)			(17,141	)
Amortization of postretirement benefit pension plans:
Net actuarial loss		$	2,173			$	804			$	4,346			$	1,608				(a	)
Prior service cost			(356	)			(333	)			(712	)			(666	)			(a	)
Total before income tax expense			1,817				471				3,634				942
Income tax expense			(743	)			(192	)			(1,485	)			(385	)			Income tax expense
Net of income tax expense			1,074				279				2,149				557
Total reclassifications		$	(38,594	)		$	(10,522	)		$	(40,757	)		$	(16,584	)

 

(a)	These items are included in the computation of net period pension cost. See Postretirement Benefit Plans footnote for additional disclosure.

 

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Notes to Unaudited Consolidated Financial Statements

 

12. Stock-Based Compensation

Stock Option Plans

A summary of the changes in outstanding stock options is as follows:

 

		For the Six Months Ended June 30,
		2015								2014
		Number of				Weighted				Number of				Weighted
		Stock				Average				Stock				Average
		Options				Exercise Price				Options				Exercise Price
Outstanding at beginning of period			22,359,456			$	13.16				25,402,955			$	13.02
Exercised			—				—				(11,900	)			9.50
Forfeited			(403,024	)			11.14				(2,804,799	)			11.92
Outstanding at end of period			21,956,432			$	13.20				22,586,256			$	13.16

In June 2006, our shareholders approved the Hudson City Bancorp, Inc. 2006 Stock Incentive Plan (the “2006 SIP”) authorizing us to grant up to 30,000,000 shares of common stock. In July 2006, the Compensation Committee of the Board of Directors of Hudson City Bancorp (the “Committee”), authorized grants to each non-employee director, executive officers and other employees to purchase shares of the Company’s common stock, pursuant to the 2006 SIP. Grants of stock options made through December 31, 2010 pursuant to the 2006 SIP amounted to 23,120,000 options at an exercise price equal to the fair value of our common stock on the grant date of the respective options, based on quoted market prices. These options had vesting periods ranging from one to five years and, if vested, may be exercised for up to ten years after grant.

In April 2011, our shareholders approved the Hudson City Bancorp, Inc. Amended and Restated 2011 Stock Incentive Plan (the “2011 SIP”) authorizing us to grant up to 28,750,000 shares of common stock including 2,070,000 shares remaining under the 2006 SIP. During 2011, the Committee authorized stock option grants (the “2011 option grants”) pursuant to the 2011 SIP for 1,618,932 options at an exercise price equal to the fair value of our common stock on the grant date, based on quoted market prices. Of these options, 1,308,513 had vesting periods of three years and were subject to our attainment of certain financial performance goals (the “2011 Performance Options”). The remaining 310,419 options vested in April 2012. The 2011 option grants may be exercised after vesting for up to ten years after grant. The performance measures for the 2011 Performance Options have been met and we have recorded compensation expense for those grants accordingly.

There was no compensation expense related to our outstanding stock options for the three and six months ended June 30, 2015. Compensation expense related to our outstanding stock options amounted to $10,000 for the three months ended June 30, 2014 and $272,000 for the six months ended June 30, 2014.

Stock Unit Awards

Beginning in 2011, Hudson City Bancorp has granted annual stock unit awards to each of its officers and outside directors.

Each stock unit award granted since 2011 to our outside directors has been scheduled to vest on continued service through the first anniversary of the award, and to be settled in shares of our common stock following the director’s departure from the Board of Directors. These include 53,739 stock units granted

 

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in 2013 that vested on continued service through April 2014, 53,851 stock units granted in 2014 that vested on continued service through March 2015, and 56,757 stock units granted in 2015 that are scheduled to vest on continued service through January 2016, for a total value of $525,000 granted in each of these years.

Hudson City Bancorp granted stock unit awards to employees in 2011 pursuant to the 2011 SIP for a total value of $9.4 million, or stock units of 963,700 shares. These awards vested on continued service through the third anniversary of the awards, based on our attainment of certain financial performance measures as certified by the Committee. A portion of these vested awards was settled in shares of our common stock upon vesting, and the remainder will be settled in shares of our common stock on the sixth anniversary of the awards.

Stock unit awards were made to employees in 2012 (the “2012 stock unit awards”) pursuant to the 2011 SIP for a total of $12.2 million, or stock units of 1,693,354 shares. The 2012 stock unit awards include stock units of 974,528 shares that vested on continued service through the third anniversary of the awards, based on our attainment of certain financial performance measures as certified by the Committee. A portion of these vested awards was settled in shares of our common stock upon vesting, and the remainder will be settled in shares of our common stock on the sixth anniversary of the awards. The 2012 stock unit awards also include variable performance stock units (“VPUs”) of 718,826 shares that vested on continued service through the third anniversary of the awards, and were settled in shares of our common stock upon vesting. Half of each VPU award was conditioned on the ranking of the total shareholder return of the Company’s common stock over the calendar years 2012 to 2014 against the total shareholder return of a peer group of 50 companies and the other half was conditioned on the Company’s attainment of return on tangible equity measures for the calendar year 2012. Based on the level of performance of each award, between 0% and 150% of the VPUs could have vested. The market condition requirements were reflected in the grant date fair value of the award, and the compensation expense for the award was recognized regardless of whether the market conditions were met. Based on performance through December 31, 2014, the Company determined that 128% of the VPUs subject to the total shareholder return condition vested upon continued service through their vesting dates. Based on performance through December 31, 2012, the Company determined that 60.25% of the VPUs subject to the return on tangible equity condition vest upon continued service through their vesting dates.

Stock unit awards were made to employees in 2013 (the “2013 stock unit awards”) pursuant to the 2011 SIP for a total value of $13.2 million, or stock units of 1,618,900 shares. The 2013 stock unit awards include 1,480,100 stock units granted to employees in June 2013 that will be settled, if vested, in shares of our common stock on the third and sixth anniversaries of the awards. Vesting of these stock units is based on the attainment of certain financial performance measures and continued service through a particular date. The attainment of the financial performance measures has been certified by the Committee and a portion of these stock units have vested based on continued service through January 1, 2014 and 2015, with the remainder subject to continued service through January 1, 2016. The Committee specifically reserved its rights to reduce the number of shares covered by the 2013 stock unit awards to senior executives on or before certification of the performance goals if the Committee determined, in its discretion, that prevailing circumstances warrant such a reduction. The Committee exercised this discretion in the first quarter of 2014 resulting in the forfeiture of stock units representing 323,550 shares. The 2013 stock unit awards also include 138,800 stock units granted in March 2013 that are settled in shares of our common stock on each vesting date. These awards have vested in part on continued service through March 19, 2014 and 2015, with the remainder subject to continued service through March 19, 2016.

 

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Notes to Unaudited Consolidated Financial Statements

 

Stock unit awards were made to employees in March 2014 pursuant to the 2011 SIP for a total of $12.7 million, or stock units of 1,363,470 shares. These awards are settled, if vested, in shares of our common stock on the third and sixth anniversaries of the awards. Vesting of these stock units is based on the attainment of certain financial performance measures and continued service through a particular date. The attainment of the financial performance measures has been certified by the Committee and a portion of these awards vested in part based on continued service through January 1, 2015, with the remainder subject to continued service through January 1, 2016 and 2017.

Stock unit awards were made in January 2015 pursuant to the 2011 SIP for a total of $4.3 million, or stock units of 485,600 shares. These awards will be settled, if vested, in shares of our common stock on the third and sixth anniversaries of the awards. These awards are subject to continued service through January 1, 2016 and our achievement of certain financial performance measures.

Expense for the stock unit awards is recognized over their vesting period and is based on the fair value of our common stock on each stock unit grant date, based on quoted market prices. Total compensation expense for stock unit awards amounted to $3.1 million and $3.2 million for the three months ended June 30, 2015 and 2014, respectively, and $6.8 million and $5.8 million for the six months ended June 30, 2015 and 2014, respectively.

13. Recent Accounting Pronouncements

In August 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-14, “Receivables – Troubled Debt Restructurings by Creditors”. The amendment requires that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met: (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The amendments in ASU 2014-14 are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2014. Early adoption is permitted. This guidance did not have a material impact on our financial condition or results of operations.

In June 2014, the FASB issued ASU 2014-12, “Compensation—Stock Compensation – Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could Be Achieved after the Requisite Service Period”. The amendment applies to reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target can be achieved after the requisite service period. A reporting entity should apply existing guidance in ASC Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still

 

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Notes to Unaudited Consolidated Financial Statements

 

be eligible to vest in the award if the performance target is achieved. As indicated in the definition of vest, the stated vesting period (which includes the period in which the performance target could be achieved) may differ from the requisite service period. The amendments in ASU 2014-12 are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2014. Early adoption is permitted. This guidance did not have a material impact on our financial condition or results of operations.

In June 2014, the FASB issued ASU 2014-11, “Transfers and Servicing – Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures”. The amendments in this update require that repurchase-to-maturity transactions be accounted for as secured borrowings consistent with the accounting for other repurchase agreements. In addition, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty (a repurchase financing), which will result in secured borrowing accounting for the repurchase agreement. The amendments require an entity to disclose information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements, in which the transferor retains substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. In addition the amendments require disclosure of the types of collateral pledged in repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions and the tenor of those transactions. The amendments in ASU 2014-11 are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. This guidance did not have a material impact on our financial condition or results of operations.

14. Legal Matters

Since the announcement of the Merger, eighteen putative class action complaints have been filed in the Court of Chancery, Delaware against Hudson City Bancorp, its directors, M&T, and WTC challenging the Merger. Six putative class actions challenging the Merger have also been filed in the Superior Court for Bergen County, Chancery Division, of New Jersey (the “New Jersey Court”). The lawsuits generally allege, among other things, that the Hudson City Bancorp directors breached their fiduciary duties to Hudson City Bancorp’s public shareholders by approving the Merger at an unfair price, that the Merger was the product of a flawed sales process, and that Hudson City Bancorp and M&T filed a misleading and incomplete Form S-4 with the SEC in connection with the proposed transaction. All 24 lawsuits seek, among other things, to enjoin completion of the Merger and an award of costs and attorneys’ fees. Certain of the actions also seek an accounting of damages sustained as a result of the alleged breaches of fiduciary duty and punitive damages.

On April 12, 2013, the defendants entered into a memorandum of understanding (the “MOU”) with the plaintiffs regarding the settlement of all of the actions described above (collectively, the “Actions”).

Under the terms of the MOU, Hudson City Bancorp, M&T, the other named defendants, and all the plaintiffs have reached an agreement in principle to settle the Actions and release the defendants from all claims relating to the Merger, subject to approval of the New Jersey Court. Pursuant to the MOU, Hudson City Bancorp and M&T agreed to make available additional information to Hudson City Bancorp shareholders. The additional information was contained in a Supplement to the Joint Proxy Statement filed with the SEC as an exhibit to a Current Report on Form 8-K dated April 12, 2013. In addition, under the terms of the MOU, plaintiffs’ counsel also has reserved the right to seek an award of attorneys’

 

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Notes to Unaudited Consolidated Financial Statements

 

fees and expenses. If the New Jersey Court approves the settlement contemplated by the MOU, the Actions will be dismissed with prejudice. The settlement will not affect the Merger consideration to be paid to Hudson City Bancorp’s shareholders in connection with the proposed Merger. In the event the New Jersey Court approves an award of attorneys’ fees and expenses in connection with the settlement, such fees and expenses shall be paid by Hudson City Bancorp, its successor in interest, or its insurers.

Hudson City Bancorp, M&T, and the other defendants deny all of the allegations in the Actions and believe the disclosures in the Joint Proxy Statement are adequate under the law. Nevertheless, Hudson City Bancorp, M&T, and the other defendants have agreed to settle the Actions in order to avoid the costs, disruption, and distraction of further litigation.

 

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Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Summary

Our results of operations depend primarily on net interest income, which, in part, is a direct result of the market interest rate environment. Net interest income is the difference between the interest income we earn on our interest-earning assets, primarily mortgage loans, mortgage-backed securities and investment securities, and the interest we pay on our interest-bearing liabilities, primarily time deposits, interest-bearing transaction accounts and borrowed funds. Net interest income is affected by the shape of the market yield curve, the timing of the placement and repricing of interest-earning assets and interest-bearing liabilities on our balance sheet, the prepayment rate on our mortgage-related assets and the puts of our borrowings. Our results of operations may also be affected significantly by general and local economic and competitive conditions, particularly those with respect to changes in market interest rates, credit quality, government policies and actions of regulatory authorities. Our results of operations are also affected by the market price of our stock, as the expense of our employee stock ownership plan is related to the current price of our common stock.

On August 27, 2012, the Company entered into the Merger Agreement with M&T and WTC, pursuant to which the Company will merge with and into WTC, with WTC continuing as the surviving entity.

Subject to the terms and conditions of the Merger Agreement, in the Merger, Hudson City Bancorp shareholders will have the right to receive with respect to each of their shares of common stock of the Company, at their election (but subject to proration and adjustment procedures), 0.08403 of a share of common stock, or cash having a value equal to the product of 0.08403 multiplied by the average closing price of the M&T common stock for the ten days immediately prior to the completion of the Merger. The Merger Agreement also provides that at the closing of the Merger, 40% of the outstanding shares of Hudson City Bancorp common stock will be converted into the right to receive cash and the remainder of the outstanding shares of Hudson City Bancorp common stock will be converted into the right to receive shares of M&T common stock.

On four occasions, Hudson City Bancorp and M&T have agreed to extend the date after which either party may elect to terminate the Merger Agreement. Each extension was documented with an amendment to the Merger Agreement and the most recent amendment, Amendment No. 4, provides that the Company may terminate the Merger Agreement at any time if it reasonably determines that M&T is unlikely to be able to obtain the requisite regulatory approvals in time to permit the closing to occur on or prior to October 31, 2015. Amendment No. 4, and applicable provisions from the prior amendments, permit the Company to take certain interim actions without the prior approval of M&T, including with respect to the Bank’s conduct of business, implementation of its Strategic Plan, retention incentives and certain other matters with respect to Bank personnel, prior to the completion of the Merger. There can be no assurances that the Merger will be completed by October 31, 2015 or that the Company will not exercise its right to terminate the Merger Agreement in accordance with its terms.

Over the last several quarters, we have managed our balance sheet on a dual-track strategy, which includes the implementation of our Strategic Plan initiatives and preparing for the completion of the Merger with M&T. The operational core of the Strategic Plan includes the expansion of our loan and deposit product offerings over time and the diversification of our revenue sources. The Strategic Plan also includes a future balance sheet restructuring transaction that would significantly increase our net

 

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interest margin and net income by extinguishing approximately $12 billion of borrowings that have a weighted average cost of 4.59%. We anticipate extinguishing these borrowings primarily with the short-term liquid assets that are currently on our balance sheet as well as new borrowings with significantly lower rates. At June 30, 2015, short-term liquid assets, consisting of Federal funds sold and other overnight funds and U.S. Treasury securities, amounted to $11.6 billion with a weighted average yield of 0.26%. While we expect that the restructuring transaction would result in a material charge to earnings, we believe that the restructuring would increase our net interest margin by as much as 185 basis points depending on the timing of the execution, the net interest margin immediately prior to the restructuring transaction and the prevailing rates at that time. The delay in the execution of the balance sheet restructuring and our continuing to carry an excess liquidity position is primarily due to the delay in obtaining the requisite regulatory approvals for the Merger, though a variety of factors are involved in the decision regarding any such restructuring.

Market interest rates remained at low levels during the first six months of 2015, which provided limited opportunities for the reinvestment of repayments received on our mortgage-related assets. As a result, we continued to reduce the size of our balance sheet and we continue to carry an elevated level of short-term liquid assets. Federal funds sold and other overnight deposits amounted to $6.60 billion, or 18.6%, of total assets at June 30, 2015. In addition, we have $5.00 billion of U.S. Treasury securities with a weighted average remaining term of 9 months and an average yield of 0.28%. We believe that while carrying this level of short-term liquid assets adversely impacts our current earnings, it better positions our balance sheet for a future balance sheet restructuring. Our total assets decreased $1.15 billion, or 3.1%, to $35.42 billion at June 30, 2015 from $36.57 billion at December 31, 2014.

Net income for the first six months of 2015 reflected the continued decrease in the Company’s net interest margin that is the result of our elevated level of low-yielding short-term liquid assets combined with our high-cost borrowings. During 2014, we supplemented our earnings with gains on the sales of securities. This strategy was key to maintaining earnings despite a decreasing net interest margin as rates remained low and we continued to carry excess liquidity with very little appetite for reinvesting this liquidity into longer-term investments or fixed-rate residential mortgage loans. In addition, the market demand and prices provided a strong opportunity for us to sell these securities. However, in anticipation of the closing of the Merger, which was expected to close on May 1, 2015, we significantly reduced the sale of securities during the first quarter of 2015. The unexpected news in early April that there would be a further delay in completing the Merger came too late for us to resume the sale of securities before the end of the first quarter and, as a result, our net income for the first six months of 2015 was adversely affected. We resumed the sale of securities during the second quarter. To facilitate these securities sales, in the second quarter of 2015 we transferred to available for sale all securities that were held to maturity.

The Federal Open Market Committee of the Board of Governors of the Federal Reserve System (the “FOMC”) noted that economic activity expanded moderately during the second quarter of 2015. The FOMC noted that the labor market continued to improve, with solid job gains and declining unemployment. A range of labor market indicators suggests that underutilization of labor resources has diminished. Growth in household spending has been moderate and the housing sector has shown additional improvement. The national unemployment rate decreased to 5.3% in June 2015 from 5.6% in December 2014 and from 6.1% in June 2014. The FOMC decided to maintain the overnight lending target rate at zero to 0.25% during the second quarter of 2015.

Net interest income decreased to $56.6 million for the second quarter of 2015 as compared to $ $117.7 million for the second quarter of 2014 reflecting the overall decrease in the average balance of interest-earning assets and interest-bearing liabilities, the continued low interest rate environment and a continued

 

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increase in the average balance of short-term liquid assets, including U.S. Treasury securities and Federal funds sold and other overnight deposits. Our interest rate spread decreased to 0.33% for the second quarter of 2015 as compared to 0.53% for the linked first quarter of 2015 and 1.00% for the second quarter of 2014. Our net interest margin was 0.66% for the second quarter of 2015 as compared to 0.85% for the linked first quarter of 2015 and 1.29% for the second quarter of 2014.

Net interest income decreased $117.8 million, or 47.1%, to $132.2 million for the first six months of 2015 as compared to $250.0 million for the first six months of 2014. Our interest rate spread decreased 63 basis points to 0.44% for the six months ended June 30, 2015 as compared to 1.07% for the six months ended June 30, 2014. Our net interest margin decreased 59 basis points to 0.76% for the six months ended June 30, 2015 as compared to 1.35% for the six months ended June 30, 2014.

The decrease in our interest rate spread and net interest margin for the three and six month periods ended June 30, 2015 is primarily due to repayments of higher yielding assets due to the low interest rate environment. The decrease is also due to an increase in the average balance of Federal funds sold and other overnight deposits and U.S. Treasury securities with a weighted average yield of 0.26% and 0.28%, respectively.

Market interest rates on mortgage-related assets remained at low levels primarily due to the FRB’s program to purchase mortgage-backed securities to provide stimulus to the housing markets. Given the current market environment and our concerns about taking on additional interest rate risk, we expect to continue to reduce the size of our balance sheet in the near term.

There was no provision for loan losses for both the three and six month periods ended June 30, 2015 and 2014. No provision was needed due to improving home prices and economic conditions, a continued decrease in total delinquent loans and a continued decrease in the size of the loan portfolio. Early stage loan delinquencies (defined as loans that are 30 to 89 days delinquent) decreased $65.2 million to $342.4 million at June 30, 2015 from $407.6 million at December 31, 2014. Non-performing loans, defined as non-accruing loans and accruing loans delinquent 90 days or more, amounted to $801.8 million at June 30, 2015 as compared to $852.0 million at December 31, 2014, and $1.01 billion at June 30, 2014. The ratio of non-performing loans to total loans was 4.05% at June 30, 2015 as compared to 3.95% at December 31, 2014, and 4.35% at June 30, 2014. This increase in the ratio of non-performing loans to total loans was due to the decrease in the size of our loan portfolio. The foreclosure process and the time to complete a foreclosure continue to be prolonged, especially in New York and New Jersey where approximately 71% of our non-performing loans are located. This protracted foreclosure process delays our ability to resolve non-performing loans through the sale of the underlying collateral and our ability to maximize any recoveries.

Total non-interest income was $68.6 million for the second quarter of 2015 as compared to $21.2 million for the second quarter of 2014. Included in non-interest income for the second quarter of 2015 were $67.1 million in gains from the sale of $988.2 million of mortgage-backed securities. Included in non-interest income for the second quarter of 2014 were $19.5 million in gains from the sale of $565.6 million of mortgage-backed securities. The remainder of non-interest income is primarily made up of service fees and charges on deposit and loan accounts.

Total non-interest income was $77.3 million for the first six months of 2015 as compared to $38.9 million for the same period in 2014. Included in non-interest income for the first six months 2015 were $74.4 million in gains from the sale of $1.21 billion of mortgage-backed securities. Gains on the sales of securities amounted to $35.5 million from the sale of $984.9 million of mortgage-backed securities for the six months ended June 30, 2014.

 

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Total non-interest expense decreased $6.6 million to $66.5 million for the second quarter of 2015 as compared to $73.1 million for the second quarter of 2014. This decrease was due primarily to a $5.2 million decrease in the FDIC assessment and a $2.5 million decrease in other non-interest expense. These decreases were partially offset by a $1.8 million increase in compensation and employee benefit costs.

Total non-interest expense amounted to $141.2 million for the six months ended June 30, 2015 as compared to $152.8 million for the six months ended June 30, 2014. This decrease was due to decreases of $8.1 million in Federal deposit insurance expense and $5.2 million in other non-interest expense, partially offset by a $2.6 million increase in compensation and employee benefit expenses.

Net loans decreased to $19.65 billion at June 30, 2015 as compared to $21.43 billion at December 31, 2014 due primarily to a decrease in loan production. During the first six months of 2015, our loan production (originations and purchases) amounted to $416.7 million as compared to $813.4 million for the same period of 2014. Loan production was offset by principal repayments of $2.16 billion in the first six months of 2015, as compared to principal repayments of $1.72 billion for the first six months of 2014.

The Strategic Plan includes the implementation of our commercial real estate (“CRE”) lending initiative. During 2014, the Bank began to purchase CRE and multi-family loans and interests in such loans. The Bank funded $86.0 million of such loans and interests in the fourth quarter of 2014 and $57.6 million during the first six months of 2015, for an aggregate of $143.6 million.

Total mortgage-backed securities decreased $1.51 billion to $2.73 billion at June 30, 2015 from $4.24 billion at December 31, 2014. The decrease was due primarily to securities sales of $1.21 billion and repayments of $365.8 million of mortgage-backed securities during the first six months of 2015. We sold mortgage-backed securities to take advantage of market demand and prices. The proceeds from the sales have been invested primarily in short-term liquid assets. While this further increases our levels of low-yielding liquid assets, we believe this positions our balance sheet for a future balance sheet restructuring transaction.

Total investment securities increased $1.71 billion to $5.36 billion at June 30, 2015 as compared to $3.65 billion at December 31, 2014. The increase was due primarily to purchases of $1.70 billion of U.S. Treasury securities with a remaining average life of 9 months, which are used as collateral for our outstanding borrowings.

Total liabilities decreased $1.19 billion, or 3.7%, to $30.60 billion at June 30, 2015 from $31.79 billion at December 31, 2014. The decrease in total liabilities reflected a decrease in total deposits while total borrowed funds remained unchanged.

During 2013 and 2014 the Bank was subject to the Bank MOU. In accordance with the Bank MOU, the Bank adopted and implemented enhanced operating policies and procedures that are intended to continue to (a) reduce our level of interest rate risk, (b) reduce our funding concentration, (c) diversify our funding sources, (d) enhance our liquidity position, (e) monitor and manage loan modifications and (f) maintain our capital position in accordance with our existing capital plan. On February 26, 2015 the OCC terminated the Bank MOU.

 

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The Company is currently subject to the Company MOU. In accordance with the Company MOU, the Company is required to: (a) obtain approval from the FRB prior to receiving a capital distribution from the Bank or declaring a dividend to shareholders and (b) obtain approval from the FRB prior to repurchasing or redeeming any Company stock or incurring any debt with a maturity of greater than one year.

While the Company believes it is in compliance in all material respects with the terms of the Company MOU, it will remain in effect until modified or terminated by the FRB.

Comparison of Financial Condition at June 30, 2015 and December 31, 2014

Total assets decreased $1.15 billion, or 3.1%, to $35.42 billion at June 30, 2015 from $36.57 billion at December 31, 2014. The decrease in total assets reflected a $1.78 billion decrease in net loans and a $1.51 billion decrease in total mortgage-backed securities, partially offset by a $1.71 billion increase in investment securities and a $417.2 million increase in cash and cash equivalents.

Total cash and cash equivalents increased $417.2 million to $6.70 billion at June 30, 2015 as compared to $6.29 billion at December 31, 2014. The high level of cash and cash equivalents is primarily due to repayments on mortgage-related assets and our continued limited appetite for reinvesting these funds in low-yielding longer-term assets. We have maintained lower deposit rates to allow a reduction in our deposits to help manage deposit levels at a time when there are limited investment opportunities and to prepare for a future balance sheet restructuring during 2015. We have used a portion of our excess cash inflows to fund these deposit reductions.

Net loans decreased to $19.65 billion at June 30, 2015 as compared to $21.43 billion at December 31, 2014 due primarily to a decrease in loan production and the acceleration of loan repayments. During the first six months of 2015, our loan production (originations and purchases) amounted to $416.7 million as compared to $813.4 million for the same period of 2014. Loan production was offset by principal repayments of $2.16 billion in the first six months of 2015, as compared to principal repayments of $1.72 billion for the first six months of 2014.

The decline in loan production during the first six months of 2015 as compared to the first six months of 2014 reflects our continued limited appetite for adding long-term fixed-rate residential mortgage loans to our portfolio and our focus on originating variable-rate residential mortgage loans which are not as attractive to loan customers in the current low market interest rate environment. The low market interest rate environment also significantly influences the increase in principal repayments.

Our first mortgage loan production during the first six months of 2015 was primarily in one- to four-family mortgage loans. Fixed-rate mortgage loans accounted for 52.6% of our first mortgage loan portfolio at June 30, 2015 as compared to 53.4% at December 31, 2014. Beginning in the fourth quarter of 2014, the Bank began to purchase CRE loans and CRE loan participations, which is one of the initiatives in the Company’s Strategic Plan. During the first six months of 2015, the Bank funded $57.6 million of such loans and loan participations and funded $86.0 million during the fourth quarter of 2014, for an aggregate of $143.6 million.

Our ALL amounted to $225.6 million at June 30, 2015 and $235.3 million at December 31, 2014. Non-performing loans amounted to $801.8 million, or 4.05% of total loans, at June 30, 2015 as compared to $852.0 million, or 3.95% of total loans, at December 31, 2014.

 

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Total mortgage-backed securities decreased $1.51 billion to $2.73 billion at June 30, 2015 from $4.24 billion at December 31, 2014. The decrease was due primarily to securities sales of $1.21 billion and repayments of $365.8 million of mortgage-backed securities during the first six months of 2015. We sold mortgage-backed securities to take advantage of market demand and prices. The proceeds from the sales have been invested primarily in short-term liquid assets. While this further increases our levels of low-yielding liquid assets, we believe this positions our balance sheet for a future balance sheet restructuring transaction.

Total investment securities increased $1.71 billion to $5.36 billion at June 30, 2015 as compared to $3.65 billion at December 31, 2014. The increase was due primarily to purchases of $1.70 billion of U.S. Treasury securities with a remaining average life of 9 months, which are used as collateral for our outstanding borrowings.

Total liabilities decreased $1.19 billion, or 3.7%, to $30.60 billion at June 30, 2015 from $31.79 billion at December 31, 2014. The decrease in total liabilities reflected a decrease in total deposits while total borrowed funds remained unchanged.

Total deposits decreased $1.21 billion, or 6.2%, to $18.17 billion at June 30, 2015 from $19.38 billion at December 31, 2014. The decrease in total deposits reflected an $848.9 million decrease in our time deposit accounts, a $369.1 million decrease in our money market accounts and a $56.2 decrease in our NOW accounts, partially offset by an increase in savings accounts of $33.5 million. The decrease in our money market and time deposit accounts was due to our decision to maintain lower deposit rates that allow us to manage deposit levels at a time when there are limited investment opportunities with attractive yields to reinvest the funds received from payment activity on mortgage-related assets. We had 135 banking offices at both June 30, 2015 and December 31, 2014.

Borrowings amounted to $12.18 billion at June 30, 2015 with an average cost of 4.59%, unchanged from December 31, 2014. Borrowings scheduled to mature in the next 12 months amount to $1.83 billion with an average cost of 4.94%.

At June 30, 2015, we had $3.33 billion of borrowed funds with put dates within one year, all of which can be put back to the Company quarterly. If interest rates were to decrease, or remain consistent with current rates, we believe these borrowings would likely not be put back and our average cost of existing borrowings would not decrease even as market interest rates decrease. Conversely, if interest rates increase we believe these borrowings would likely be put back at their next put date and our cost to replace these borrowings would increase. However, we believe, given current market conditions, that the likelihood that a significant portion of these borrowings would be put back will not increase substantially unless interest rates were to increase by at least 250 basis points.

Total shareholders’ equity increased $40.3 million to $4.82 billion at June 30, 2015 as compared to $4.78 billion at December 31, 2014. The increase was due to net income of $41.5 million and a change in accumulated other comprehensive loss of $10.2 million, partially offset by $20.0 million in cash dividends paid to common shareholders during the first six months of 2015. At June 30, 2015, our consolidated shareholders’ equity to asset ratio was 13.61% and our tangible book value per share was $9.32.

Accumulated other comprehensive loss amounted to $40.2 million at June 30, 2015 as compared to $50.4 million at December 31, 2014. Accumulated other comprehensive loss at June 30, 2015 included a $66.6 million after-tax accumulated other comprehensive loss related to the funded status of our employee benefit plans partially offset by a $26.4 million after-tax net unrealized gain on securities available for

 

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sale ($44.5 million pre-tax). Accumulated other comprehensive loss at December 31, 2014 included a $68.7 million after-tax accumulated other comprehensive loss related to the funded status of our employee benefit plans partially offset by a $18.3 million after-tax net unrealized gain on securities available for sale ($30.9 million pre-tax). The change in accumulated other comprehensive loss of $10.2 million reflects the transfer to available for sale of all of our securities that were classified as held to maturity with a carrying value of $1.22 billion and a fair value of $1.30 billion, which occurred in the second quarter of 2015. The resulting after-tax net unrealized built-in gain of $48.3 million ($81.6 million pre-tax) was recorded as a component of accumulated other comprehensive loss. In addition, during the six months ended June 30, 2015 we reclassified $42.9 million ($72.5 million pre-tax) of realized gains out of accumulated other comprehensive loss.

As of June 30, 2015, there remained 50,123,550 shares that may be purchased under our existing stock repurchase programs. We did not repurchase any shares of our common stock during the first six months of 2015. Pursuant to the Company MOU, any future share repurchases must be approved by the FRB. In addition, pursuant to the terms of the Merger Agreement, we may not repurchase shares of Hudson City Bancorp common stock without the consent of M&T. At June 30, 2015, our capital ratios were in excess of the applicable regulatory requirements to be considered well-capitalized. See “Liquidity and Capital Resources.”

At June 30, 2015, our shareholders’ equity to asset ratio was 13.61% compared with 13.08% at December 31, 2014. Our book value per share, using the period-end number of outstanding shares, less purchased but unallocated employee stock ownership plan shares and less purchased but unvested recognition and retention plan shares, was $9.62 at June 30, 2015 and $9.57 at December 31, 2014. Our tangible book value per share, calculated by deducting goodwill and the core deposit intangible from shareholders’ equity, was $9.32 as of June 30, 2015 and $9.27 at December 31, 2014.

 

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Comparison of Operating Results for the Three-Month Periods Ended June 30, 2015 and 2014

Average Balance Sheet. The following table presents the average balance sheets, average yields and costs and certain other information for the three months ended June 30, 2015 and 2014. The table presents the annualized average yield on interest-earning assets and the annualized average cost of interest-bearing liabilities. We derived the yields and costs by dividing annualized income or expense by the average balance of interest-earning assets and interest-bearing liabilities, respectively, for the periods shown. We derived average balances from daily balances over the periods indicated. Interest income includes fees that we considered to be adjustments to yields. Yields on tax-exempt obligations were not computed on a tax equivalent basis. Nonaccrual loans were included in the computation of average balances and therefore have a zero yield. The yields set forth below include the effect of deferred loan origination fees and costs, and purchase discounts and premiums that are amortized or accreted to interest income.

 

		For the Three Months Ended June 30,
		2015												2014
		Average Balance				Interest				Average Yield/ Cost				Average Balance				Interest				Average Yield/ Cost
		(Dollars in thousands)
Assets:
Interest-earnings assets:
First mortgage loans, net (1)		$	19,960,416			$	201,401				4.04	%		$	23,083,914			$	247,124				4.28	%
Consumer and other loans			185,327				1,890				4.08				207,456				2,199				4.24
Federal funds sold and other overnight deposits			6,144,459				3,922				0.26				5,252,541				3,316				0.25
Mortgage-backed securities at amortized cost			3,282,724				16,109				1.96				7,646,018				41,723				2.18
Federal Home Loan Bank stock			310,489				3,243				4.18				337,942				3,338				3.95
Investment securities, at amortized cost			5,089,160				4,644				0.37				539,141				1,505				1.12
Total interest-earning assets			34,972,575				231,209				2.64				37,067,012				299,205				3.23
Noninterest-earnings assets			880,597												901,004
Total Assets		$	35,853,172											$	37,968,016
Liabilities and Shareholders’ Equity:
Interest-bearing liabilities:
Savings accounts		$	1,080,922				408				0.15				1,045,799				392				0.15
Interest-bearing transaction accounts			2,079,086				1,395				0.27				2,163,365				1,558				0.29
Money market accounts			3,883,437				1,918				0.20				4,788,273				2,366				0.20
Time deposits			10,829,676				29,650				1.10				12,112,789				35,857				1.19
Total interest-bearing deposits			17,873,121				33,371				0.75				20,110,226				40,173				0.80
Repurchase agreements			6,150,000				69,055				4.44				6,150,000				69,083				4.44
Federal Home Loan Bank of New York advances			6,025,000				72,227				4.74				6,025,000				72,267				4.75
Total borrowed funds			12,175,000				141,282				4.59				12,175,000				141,350				4.59
Total interest-bearing liabilities			30,048,121				174,653				2.31				32,285,226				181,523				2.23
Noninterest-bearing liabilities:
Noninterest-bearing deposits			696,527												659,994
Other noninterest-bearing liabilities			247,903												204,034
Total noninterest-bearing liabilities			944,430												864,028
Total liabilities			30,992,551												33,149,254
Shareholders’ equity			4,860,621												4,818,762
Total Liabilities and Shareholders’ Equity		$	35,853,172											$	37,968,016
Net interest income/net interest rate spread (2)						$	56,556				0.33							$	117,682				1.00
Net interest-earning assets/net interest margin (3)		$	4,924,454								0.66	%		$	4,781,786								1.29	%
Ratio of interest-earning assets to interest-bearing liabilities											1.16	x											1.15	x

 

(1)	Amount includes deferred loan costs and non-performing loans and is net of the allowance for loan losses.

(2)	Determined by subtracting the annualized weighted average cost of total interest-bearing liabilities from the annualized weighted average yield on total interest-earning assets.

(3)	Determined by dividing annualized net interest income by total average interest-earning assets.

 

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General. Net income was $35.7 million for the second quarter of 2015 as compared to $39.2 million for the second quarter of 2014. Both basic and diluted earnings per common share were $0.07 for the second quarter of 2015 as compared to both basic and diluted earnings per share of $0.08 for the second quarter of 2014. For the second quarter of 2015, our annualized return on average shareholders’ equity was 2.93% as compared to 3.25% for the corresponding period in 2014. Our annualized return on average assets for the second quarter of 2015 was 0.40% as compared to 0.41% for the second quarter of 2014. The decrease in the annualized return on average equity and assets is primarily due to the decrease in net income during the second quarter of 2015.

Interest and Dividend Income. Total interest and dividend income for the second quarter of 2015 decreased $68.0 million, or 22.7%, to $231.2 million from $299.2 million for the second quarter of 2014. The decrease in total interest and dividend income was due to a $2.10 billion decrease in the average balance of total interest-earning assets during the second quarter of 2015 to $34.97 billion from $37.07 billion for the second quarter of 2014 as well as a decrease in the annualized weighted-average yield on total interest earning assets. The decrease in the average balance of total interest-earning assets for the second quarter of 2015 as compared to the second quarter of 2014 was due primarily to repayments and sales of mortgage-related assets as a result of the low interest rate environment and our decision not to reinvest in low yielding, long term assets. As such, we maintained lower deposit rates and used the proceeds from the repayments and sales of mortgage related assets to fund the decrease in deposits.

The annualized weighted-average yield on total interest-earning assets was 2.64% for the second quarter of 2015 as compared to 3.23% for the second quarter of 2014. The decrease in the annualized weighted-average yield was due to a $4.55 billion increase in investment securities, which substantially consist of U.S. Treasury securities, with an annualized weighted-average yield of 0.37% and an increase of $891.9 million in the average balance of Federal funds sold and other overnight deposits with an average yield of 0.26% for the quarter ended June 30, 2015. The decrease was also due to continued low market interest rates earned on mortgage-related assets.

Interest on first mortgage loans decreased $45.7 million, or 18.5%, to $201.4 million for the second quarter of 2015 from $247.1 million for the second quarter of 2014. The decrease in interest on first mortgage loans was primarily due to a $3.12 billion decrease in the average balance of first mortgage loans to $19.96 billion for the second quarter of 2015 from $23.08 billion for the second quarter in 2014. The decrease in interest on first mortgage loans was also due to a 24 basis point decrease in the annualized weighted-average yield to 4.04% for the second quarter of 2015 from 4.28% for the second quarter of 2014.

The decrease in the annualized weighted-average yield earned on first mortgage loans during the second quarter of 2015 was due primarily to repayments of higher-yielding loans coupled with lower yields on new loan originations. The decrease in the average balance of first mortgage loans was due to a decrease in our loan production reflecting our continued limited appetite for adding long-term mortgage loans to our portfolio and our focus on originating variable-rate residential mortgage loans which are not as attractive to loan customers in the current low interest rate environment. During the first six months of 2015, our loan production (originations and purchases) amounted to $416.7 million as compared to $813.4 million for the same period of 2014. Loan production was offset by principal repayments of $2.16 billion in the first six months of 2015, as compared to principal repayments of $1.72 billion for the first six months of 2014.

Interest on consumer and other loans decreased $309,000 to $1.9 million for the second quarter of 2015 from $2.2 million for the second quarter of 2014 due to a decrease in the average balance of consumer and other loans. The average balance of consumer and other loans decreased $22.2 million to $185.3 million for the second quarter of 2015 from $207.5 million for the second quarter of 2014 and the annualized

 

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weighted-average yield earned decreased 16 basis points to 4.08% from 4.24% for those same respective periods. The average balance of consumer loans decreased as consumer loans is not a business that we actively pursue. The decrease in the annualized weighted-average yield is a result of current market interest rates.

Interest on mortgage-backed securities decreased $25.6 million to $16.1 million for the second quarter of 2015 from $41.7 million for the second quarter of 2014. This decrease was due primarily to a $4.37 billion decrease in the average balance of mortgage-backed securities to $3.28 billion for the second quarter of 2015 from $7.65 billion for the second quarter of 2014.

The decrease in the average balance of mortgage-backed securities during the second quarter of 2015 was due to sales of mortgage-backed securities and principal repayments continuing our strategy from 2014. During the second quarter of 2015, we sold $988.2 million of mortgage-backed securities to realize gains that otherwise would have decreased as repayments reduced the outstanding principal balance on these securities. The decrease in interest on mortgage-backed securities was also due to a decrease of 22 basis points in the annualized weighted-average yield of mortgage-backed securities to 1.96% for the second quarter of 2015 as compared to 2.18% for second quarter of 2014.

Interest on investment securities increased $3.1 million to $4.6 million for the second quarter of 2015 as compared to $1.5 million for the second quarter of 2014. This increase was due primarily to a $4.55 billion increase in the average balance of investment securities to $5.09 billion for the second quarter of 2015 from $539.1 million for the second quarter of 2014. The increase in the average balance of investment securities was due primarily to the purchase of $3.30 billion of U.S. Treasury securities in 2014 and $1.70 billion of U.S. Treasury securities during the first six months of 2015 as we invested cash from the mortgage-backed securities sales and loan repayments. This increase was partially offset by a decrease in the annualized weighted-average yield to 0.37% for the second quarter of 2015 from 1.12% for the second quarter of 2014. The decrease in the annualized weighted-average yield earned on investment securities is primarily due to the increase in the average balance of U.S. Treasury securities of $4.54 billion for the second quarter of 2015, which have an average yield of 0.28%.

Interest on Federal funds sold and other overnight deposits amounted to $3.9 million for the second quarter of 2015 as compared to $3.3 million for the second quarter of 2014. The increase in interest income on Federal funds sold and other overnight deposits was due to an increase in the average balance of Federal funds sold and other overnight deposits. The average balance of Federal funds sold and other overnight deposits amounted to $6.14 billion for the second quarter of 2015 as compared to $5.25 billion for the second quarter of 2014. The increase in the average balance was due primarily to repayments and sales of mortgage-related assets and our low appetite for adding long-term fixed-rate mortgage loans to our portfolio in the current low interest rate environment. The yield earned on Federal funds sold and other overnight deposits was 0.26% for the second quarter of 2015 as compared to 0.25% for the second quarter of 2014.

Interest Expense. Total interest expense for the quarter ended June 30, 2015 decreased $6.8 million, or 3.7%, to $174.7 million from $181.5 million for the quarter ended June 30, 2014. This decrease was primarily due to a $2.24 billion decrease in the average balance of total interest-bearing liabilities to $30.05 billion for the quarter ended June 30, 2015 from $32.29 billion for the quarter ended June 30, 2014. This was partially offset by an increase in the annualized weighted-average cost of total interest-bearing liabilities to 2.31% for the quarter ended June 30, 2015 as compared to 2.23% for the quarter ended June 30, 2014. The decrease in the average balance of total interest-bearing liabilities was due entirely to a decrease in the average balance of total deposits.

 

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The increase in the average cost of interest-bearing liabilities during the second quarter of 2015 was due to a decrease in the average balance of interest-bearing deposits, which have a lower weighted-average cost than our borrowed funds, the average balances of which remained unchanged. Interest-bearing deposits accounted for 59% of interest-bearing liabilities for the quarter ended June 30, 2015 as compared to 62% for the quarter ended June 30, 2014.

Interest expense on deposits decreased $6.8 million, or 16.9%, to $33.4 million for the second quarter of 2015 from $40.2 million for the second quarter of 2014. The decrease was primarily due to a $2.24 billion decrease in the average balance of interest-bearing deposits to $17.87 billion for the second quarter of 2015 from $20.11 billion for the second quarter of 2014. The decrease is also due to a decrease in the average cost of interest-bearing deposits of 5 basis points to 0.75% for the second quarter of 2015 from 0.80% for the second quarter of 2014. The decrease in the average cost of deposits for the second quarter of 2015 reflected the low market interest rates and our decision to maintain lower deposit rates to continue our balance sheet reduction.

Interest expense on our time deposit accounts decreased $6.2 million to $29.7 million for the second quarter of 2015 from $35.9 million for the second quarter of 2014. This decrease was due to a $1.28 billion decrease in the average balance of time deposit accounts to $10.83 billion for the second quarter of 2015 from $12.11 billion for the same period in 2014. The decrease was also due to a 9 basis point decrease in the annualized weighted-average cost to 1.10% for the second quarter of 2015 compared with 1.19% for the second quarter of 2014 as maturing time deposits were renewed or replaced by new time deposits at lower rates. The decline in the average balance of our time deposits reflects our decision to maintain lower deposit rates to continue our balance sheet reduction.

Interest expense on money market accounts decreased $448,000 to $1.9 million for the second quarter of 2015 from $2.4 million for the second quarter of 2014. This was due primarily to a $904.8 million decrease in the average balance of money market accounts to $3.88 billion for the second quarter of 2015 from $4.79 billion for the second quarter of 2014. The decline in the average balance of our money market accounts reflects our decision to maintain lower deposit rates to continue our balance sheet reduction. The annualized weighted-average cost of money market accounts was 0.20% for both the second quarter of 2015 and the second quarter of 2014.

Interest expense on borrowed funds amounted to $141.3 million for the second quarter of 2015 as compared to $141.4 million for the second quarter of 2014. The average cost of borrowed funds was 4.59% for both the quarters ended June 30, 2015 and 2014. The average balance of borrowings was unchanged for both comparative periods.

Net Interest Income. Net interest income decreased to $56.6 million for the second quarter of 2015 as compared to $117.7 million for the second quarter of 2014 reflecting the overall decrease in the average balance of interest-earning assets and interest-bearing liabilities, the continued low interest rate environment and a continued increase in the average balance of short-term liquid assets, including U.S. Treasury securities and Federal funds sold and other overnight deposits. Our interest rate spread decreased to 0.33% for the second quarter of 2015 as compared to 1.00% for the second quarter of 2014. Our net interest margin was 0.66% for the second quarter of 2015 as compared to 1.29% for the second quarter of 2014.

 

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The decreases in our interest rate spread and net interest margin for the second quarter of 2015 as compared to the second quarter of 2014 are primarily due to repayments and sales of higher yielding assets due to the low interest rate environment. The decrease was also due to an increase of $4.55 billion in investment securities with an annualized weighted-average yield of 0.37% and an increase of $891.9 million in the average balance of Federal funds sold and other overnight deposits to $6.14 billion with an average yield of 0.26% during this same period, all of which caused our average yield on interest earning assets to decline while the average cost of interest-bearing liabilities rose slightly. The compression of our net interest margin and the reduction in the size of our balance sheet may result in a decline in our net interest income in future periods.

Provision for Loan Losses. There was no provision for loan losses recorded for the second quarters of 2015 and 2014 due to improving home prices and economic conditions, a decrease in total delinquent loans and a decrease in the size of the loan portfolio. The decline in non-performing loans was primarily due to improving economic conditions, particularly in the housing and labor markets. The ALL amounted to $225.6 million at June 30, 2015 as compared to $235.3 million at December 31, 2014. See “Critical Accounting Policies – Allowance for Loan Losses.”

Our primary lending emphasis is the origination and purchase of one to four-family first mortgage loans on residential properties and, to a lesser extent, second mortgage loans on one-to four-family residential properties. Our loan growth is primarily concentrated in one-to four-family mortgage loans with original loan-to-value (“LTV”) ratios of less than 80%. At June 30, 2015, the average LTV ratio of our 2015 first mortgage loan originations and our total first mortgage loan portfolio were 64.9% and 60.4%, respectively, using appraised values at the time of origination. The value of the property used as collateral for our loans is dependent upon local market conditions. As part of our estimation of the ALL, we monitor changes in the values of homes in each market using indices published by various organizations. Based on our analysis of the data for the second quarter of 2015, we concluded that home values in our primary lending markets have increased approximately 2.8% since the second quarter of 2014.

Economic conditions in our primary market area continued to improve modestly during the first six months of 2015 as evidenced by increased levels of home sale activity, higher real estate valuations and a decrease in the unemployment rate. We continue to closely monitor the local and national real estate markets and other factors related to risks inherent in our loan portfolio.

Non-performing loans amounted to $801.8 million at June 30, 2015 as compared to $852.0 million at December 31, 2014 and $1.01 billion at June 30, 2014. Non-performing loans at June 30, 2015 included $789.1 million of one- to four-family first mortgage loans as compared to $841.7 million at December 31, 2014 and $999.6 million at June 30, 2014. The ratio of non-performing loans to total loans was 4.05% at June 30, 2015 as compared to 3.95% at December 31, 2014 and 4.35% at June 30, 2014. Loans delinquent 30 to 59 days amounted to $235.1 million at June 30, 2015 as compared to $278.5 million at December 31, 2014 and $274.9 million at June 30, 2014. Loans delinquent 60 to 89 days amounted to $107.3 million at June 30, 2015 as compared to $129.1 million at December 31, 2014 and $136.5 million at June 30, 2014. Accordingly, total early stage delinquencies (loans 30 to 89 days past due) decreased $65.2 million to $342.4 million at June 30, 2015 from $407.6 million at December 31, 2014 and decreased $69.0 million from $411.4 million at June 30, 2014. Foreclosed real estate amounted to $100.2 million at June 30, 2015 as compared to $80.0 million at December 31, 2014 and $77.8 million at June 30, 2014.

 

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At June 30, 2015, the ratio of the ALL to non-performing loans was 28.13% as compared to 27.62% at December 31, 2014 and 25.29% at June 30, 2014. The ratio of the ALL to total loans was 1.14% at June 30, 2015 as compared to 1.09% at December 31, 2014 and 1.10% at June 30, 2014. Changes in the ratio of the ALL to non-performing loans are not, absent other factors, an indication of the adequacy of the ALL since there is not necessarily a direct relationship between changes in various asset quality ratios and changes in the ALL, non-performing loans and losses we may incur on our loan portfolio. A loan generally becomes non-performing when the borrower experiences financial difficulty. In many cases, the borrower also has a second mortgage or home equity loan on the property. In substantially all of these cases, we do not hold the second mortgage or home equity loan as that is not a business we have actively pursued.

We obtain updated collateral values by the time a loan becomes 180 days past due and annually thereafter. If the estimated fair value of the collateral (less estimated selling costs) is less than the recorded investment in the loan, we charge-off an amount to reduce the loan to the fair value of the collateral less estimated selling costs. As a result, certain losses inherent in our non-performing loans are being recognized as charge-offs which may result in a lower ratio of the ALL to non-performing loans. Charge-offs, net of recoveries, amounted to $4.9 million for the second quarter of 2015 as compared to $10.7 million for the second quarter of 2014. The decrease in charge-offs primarily reflects improving home prices in our market area that are reflected in the proceeds received from our foreclosure sales. Net charge-offs as a percentage of average loans was 0.10% for the quarter ended June 30, 2015 and 0.18% for the quarter ended June 30, 2014. Foreclosed real estate transactions (sales and write-downs) resulted in a net gain of $2.5 million for the second quarter of 2015 as compared to a net gain of $592,000 for the second quarter of 2014. The results of our reappraisal process, our recent charge-off history and our loss experience related to the sale of foreclosed real estate are considered in the determination of the ALL. Our loss experience (excluding previous charge-offs) on the sale of foreclosed real estate was 14% for both the second quarter of 2015 and 2014.

As part of our estimation of the ALL, we monitor changes in the values of homes in each market using indices published by various organizations including the FHFA and Case Shiller. Our Asset Quality Committee (“AQC”) uses these indices and a stratification of our loan portfolio by state as part of its quarterly determination of the ALL. We do not apply different loss factors based on geographic locations since, at June 30, 2015, 85.1% of our loan portfolio and 79.2% of our non-performing loans are located in the New York metropolitan area. We obtain updated collateral values by the time a loan becomes 180 days past due and annually thereafter, which we believe identifies potential charge-offs more accurately than a house price index that is based on a wide geographic area and includes many different types of houses. However, we use house price indices to identify geographic trends in housing markets to determine if an overall adjustment to the ALL is required based on loans we have in those geographic areas and to determine if changes in the loss factors used in the ALL quantitative analysis are necessary. Our quantitative analysis of the ALL accounts for increases in non-performing loans by applying progressively higher risk factors to loans as they become more delinquent.

Due to the nature of our loan portfolio, our evaluation of the adequacy of our ALL is performed primarily on a “pooled” basis. Each quarter we prepare an analysis which categorizes the entire loan portfolio by certain risk characteristics such as loan type (fixed and variable one-to four-family, interest-only, reduced documentation, multi-family, commercial, construction, etc.), loan source (originated or purchased) and payment status (i.e., current or number of days delinquent). Loans with known losses are categorized separately. We assign estimated loss factors to the payment status categories on the basis of our assessment of the potential risk inherent in each loan type. These factors are periodically reviewed for appropriateness giving consideration to our loss experience, delinquency trends, portfolio growth and environmental factors such as the status of the regional economy and housing market, in order to ascertain

 

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that the loss factors cover probable and estimable losses inherent in the portfolio. We define our loss experience on non-performing loans as the ratio of the excess of the loan balance (including selling costs) over the updated collateral value to the principal balance of loans for which we have updated valuations. We obtain updated collateral values by the time a loan becomes 180 days past due and on an annual basis thereafter for as long as the loan remains non-performing. Based on our analysis, our loss experience on our non-performing one-to four-family first mortgage loans was approximately 10.9% at June 30, 2015 compared to 13.1% at June 30, 2014, reflecting improving home prices.

In addition to our loss experience, we also use environmental factors and qualitative analyses to determine the adequacy of our ALL. This analysis includes further evaluation of economic factors, such as trends in the unemployment rate, as well as a ratio analysis to evaluate the overall measurement of the ALL, a review of delinquency ratios, net charge-off ratios and the ratio of the ALL to both non-performing loans and total loans. The qualitative review is used to reassess the overall determination of the ALL and to ensure that directional changes in the ALL and the provision for loan losses are supported by relevant internal and external data.

As a result of our underwriting policies, our borrowers typically have a significant amount of equity, at the time of origination, in the underlying real estate that we use as collateral for our loans. Due to the ability of real estate values to fluctuate, the LTV ratios based on appraisals obtained at time of origination do not necessarily indicate the extent to which we may incur a loss on any given loan that may go into foreclosure. We consider the average LTV of our non-performing loans and our total portfolio in relation to the overall changes in house prices in our lending markets when determining the ALL. This provides us with a “macro” indication of the severity of potential losses that might be expected. Since substantially all our portfolio consists of first mortgage loans on residential properties, the LTV ratio is particularly important to us when a loan becomes non-performing. The weighted average LTV ratio in our one- to four-family mortgage loan portfolio at June 30, 2015 was approximately 60.4%, using appraised values at the time of origination. The average LTV ratio of our non-performing loans was approximately 70.0% at June 30, 2015. Based on the valuation indices, house prices declined in the New York metropolitan area, where 79.2% of our non-performing loans were located at June 30, 2015, by approximately 17% from the peak of the market in 2006 through April 2015 and by 13% nationwide during that period. During 2015, home prices increased 2% in the New York metropolitan area and increased 5% nationwide. Changes in house values may affect our loss experience which may require that we change the loss factors used in our quantitative analysis of the ALL. There can be no assurance whether significant further declines in house values may occur and result in higher loss experience and increased levels of charge-offs and loan loss provisions.

Due to the unprecedented level of foreclosures and the desire by many states to slow the foreclosure process, we continue to experience a time frame to repayment or foreclosure of up to 48 months from the initial non-performing period. These delays have impacted our level of non-performing loans as these loans take longer to migrate to real estate owned and ultimate disposition. In addition, the highly publicized foreclosure issues that have affected the nation’s largest mortgage loan servicers has resulted in greater court and state attorney general scrutiny. Our foreclosure process and the time to complete a foreclosure continue to be prolonged, especially in New York and New Jersey where 71.3% of our non-performing loans are located. However, since 2013, we have experienced an increased volume of completed foreclosures for loans that have been in the foreclosure process for over 48 months. If real estate prices do not continue to improve or begin to decline, this extended time may result in further charge-offs. In addition, current conditions in the housing market have made it more difficult for borrowers to sell homes to satisfy the mortgage and second lien holders are less likely to repay our loan if the value of the property is not enough to satisfy their loan. We continue to closely monitor the property values underlying our non-performing loans during this timeframe and take appropriate charge-offs when the loan balances exceed the underlying estimated property values.

 

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Although we believe that we have established and maintained the ALL at adequate levels, additions may be necessary if future economic and other conditions differ substantially from the current operating environment. Changes in our loss experience on non-performing loans, the loss factors used in our quantitative analysis of the ALL and continued increases in overall loan delinquencies can have a significant impact on our need for increased levels of loan loss provisions in the future. Although we use the best information available, the level of the ALL remains an estimate that is subject to significant judgment and short-term change. See “Critical Accounting Policies.”

Non-Interest Income. Total non-interest income was $68.6 million for the second quarter of 2015 as compared to $21.2 million for the second quarter of 2014. Included in non-interest income for the second quarter of 2015 were $67.1 million in gains from the sale of $988.2 million of mortgage-backed securities. Included in non-interest income for the second quarter of 2014 were $19.5 million in gains from the sale of $565.6 million of mortgage-backed securities. The remainder of non-interest income is primarily made up of service fees and charges on deposit and loan accounts.

Non-Interest Expense. Total non-interest expense decreased $6.6 million to $66.5 million for the second quarter of 2015 as compared to $73.1 million for the second quarter of 2014. This decrease was due primarily to a $5.2 million decrease in the FDIC assessment and a $2.5 million decrease in other non-interest expense. These decreases were partially offset by a $1.8 million increase in compensation and employee benefit costs.

Compensation and employee benefit costs increased $1.8 million, or 5.6%, to $34.2 million for the second quarter of 2015 as compared to $32.4 million for the same period in 2014. The increase in compensation and employee benefit costs is primarily due to a $1.4 million increase in pension expense. The increase in pension expense is due primarily to a decrease in the discount rate used to calculate our pension obligations as well as the updated mortality tables published in October 2014 by the Society of Actuaries. See “Critical Accounting Policies – Pension and Other Post-Retirement Benefit Assumptions”. At June 30, 2015, we had 1,466 full-time equivalent employees as compared to 1,514 at June 30, 2014. While the reduction in full-time equivalent employees resulted in a reduction in compensation and employee benefit costs, this reduction was offset by costs incurred through the use of temporary employees and consultants to fill vacant positions during the pendency of the Merger.

For the second quarter of 2015 Federal deposit insurance expense decreased $5.2 million, or 39.7%, to $7.9 million compared to $13.1 million for the same period in 2014. This decrease was due primarily to a reduction in the size of our balance sheet and a decrease in our assessment rate.

Other non-interest expense decreased $2.5 million to $15.7 million for the quarter ended June 30, 2015 as compared to $18.2 million for the second quarter of 2014. This decrease was due primarily to a $1.9 million increase in net gains on the sale of foreclosed properties.

 

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Included in other non-interest expense were net gains of $2.5 million resulting from foreclosed real estate transactions for the second quarter of 2015 as compared to a net gain of $592,000 for the same period in 2014. We sold 61 properties during the second quarter of 2015 and had 313 properties in foreclosed real estate with a carrying value of $100.2 million, 65 of which were under contract to sell as of June 30, 2015. For the second quarter of 2014, we sold 70 properties and had 228 properties in foreclosed real estate with a carrying value of $77.8 million, 85 of which were under contract to sell as of June 30, 2014.

Income Taxes. Income tax expense amounted to $23.0 million for the second quarter of 2015 as compared to income tax expense of $26.6 million for the corresponding period in 2014. Our effective tax rate for the second quarter of 2015 was 39.26% compared with 40.41% for the second quarter of 2014.

 

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Comparison of Operating Results for the Six-Month Periods Ended June 30, 2015 and 2014

Average Balance Sheet. The following table presents the average balance sheets, average yields and costs and certain other information for the six months ended June 30, 2015 and 2014. The table presents the annualized average yield on interest-earning assets and the annualized average cost of interest-bearing liabilities. We derived the yields and costs by dividing annualized income or expense by the average balance of interest-earning assets and interest-bearing liabilities, respectively, for the periods shown. We derived average balances from daily balances over the periods indicated. Interest income includes fees that we considered to be adjustments to yields. Yields on tax-exempt obligations were not computed on a tax equivalent basis. Nonaccrual loans were included in the computation of average balances and therefore have a zero yield. The yields set forth below include the effect of deferred loan origination fees and costs, and purchase discounts and premiums that are amortized or accreted to interest income.

 

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		For the Six Months Ended June 30,
		2015												2014
		Average Balance				Interest				Average Yield/ Cost				Average Balance				Interest				Average Yield/ Cost
		(Dollars in thousands)
Assets:
Interest-earnings assets:
First mortgage loans, net (1)		$	20,418,516			$	418,689				4.10	%		$	23,309,914			$	500,263				4.29	%
Consumer and other loans			188,237				3,931				4.18				209,764				4,477				4.27
Federal funds sold and other overnight deposits			6,142,236				7,711				0.25				4,942,571				6,202				0.25
Mortgage-backed securities at amortized cost			3,685,292				36,245				1.97				8,034,614				90,424				2.25
Federal Home Loan Bank stock			315,592				6,962				4.41				342,496				7,494				4.38
Investment securities, at amortized cost			4,495,023				8,600				0.38				442,286				2,884				1.30
Total interest-earning assets			35,244,896				482,138				2.74				37,281,645				611,744				3.28
Noninterest-earnings assets			855,414												905,703
Total Assets		$	36,100,310											$	38,187,348
Liabilities and Shareholders’ Equity:
Interest-bearing liabilities:
Savings accounts			1,071,638				800				0.15				1,033,539				770				0.15
Interest-bearing transaction accounts			2,085,483				2,770				0.27				2,179,399				3,118				0.29
Money market accounts			4,042,334				3,909				0.20				4,985,144				4,839				0.20
Time deposits			11,029,153				61,431				1.12				12,212,864				72,084				1.19
Total interest-bearing deposits			18,228,608				68,910				0.76				20,410,946				80,811				0.80
Repurchase agreements			6,150,000				137,255				4.44				6,401,934				142,730				4.43
Federal Home Loan Bank of New York advances			6,025,000				143,789				4.75				5,773,066				138,185				4.76
Total borrowed funds			12,175,000				281,044				4.59				12,175,000				280,915				4.59
Total interest-bearing liabilities			30,403,608				349,954				2.30				32,585,946				361,726				2.21
Noninterest-bearing liabilities:
Noninterest-bearing deposits			612,793												591,218
Other noninterest-bearing liabilities			256,163												207,396
Total noninterest-bearing liabilities			868,956												798,614
Total liabilities			31,272,564												33,384,560
Shareholders’ equity			4,827,746												4,802,788
Total Liabilities and Shareholders’ Equity		$	36,100,310											$	38,187,348
Net interest income/net interest rate spread (2)						$	132,184				0.44							$	250,018				1.07
Net interest-earning assets/net interest margin (3)		$	4,841,288								0.76	%		$	4,695,699								1.35	%
Ratio of interest-earning assets to interest-bearing liabilities											1.16	x											1.14	x

 

(1)	Amount includes deferred loan costs and non-performing loans and is net of the allowance for loan losses.

(2)	Determined by subtracting the annualized weighted average cost of total interest-bearing liabilities from the annualized weighted average yield on total interest-earning assets.

(3)	Determined by dividing annualized net interest income by total average interest-earning assets.

General. Net income was $41.5 million for the six months ended June 30, 2015 as compared to net income of $81.7 million for the six months ended June 30, 2014. Both basic and diluted earnings per common share were $0.08 for the six months ended June 30, 2015 as compared to both basic and diluted earnings per share of $0.16 for the six months ended June 30, 2014. For the six months ended June 30, 2015, our annualized return on average shareholders’ equity was 1.72%, compared with 3.40% for the six months ended June 30, 2014. Our annualized return on average assets for the six months ended June 30, 2015 was 0.23% as compared to 0.43% for the six months ended June 30, 2014. The decrease in the annualized return on average equity and assets is primarily due to the decrease in net income during the first six months of 2015.

 

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Interest and Dividend Income. Total interest and dividend income for the six months ended June 30, 2015 decreased $129.6 million, or 21.2%, to $482.1 million from $611.7 million for the six months ended June 30, 2014. The decrease in total interest and dividend income was primarily due to a decrease in the average balance of total interest-earning assets of $2.04 billion, or 5.5%, to $35.24 billion for the six months ended June 30, 2015 from $37.28 billion for the six months ended June 30, 2014. The decrease in total interest and dividend income was also due to a decrease of 54 basis points in the annualized weighted-average yield on total interest-earning assets to 2.74% for the six months ended June 30, 2015 from 3.28% for the six months ended June 30, 2014. The decrease in the average balance of total interest-earning assets was due primarily to repayments and sales of mortgage-related assets during the first six months of 2015 as a result of the low interest rate environment and our decision not to reinvest in low yielding, long term assets. The decrease in the annualized weighted-average yield was due to a $4.35 billion increase in the average balance of Federal funds sold and other overnight deposits, which had an average yield of 0.25% during the six months ended June 30, 2015 and a $4.05 million increase in the average balance of investment securities, which substantially consist of U.S. Treasury securities, with an annualized weighted-average yield of 0.38% for the six months ended June 30, 2015. The decrease was also due to lower market interest rates earned on mortgage-related assets.

For the six months ended June 30, 2015, interest on first mortgage loans decreased $81.6 million, or 16.3%, to $418.7 million from $500.3 million for the six months ended June 30, 2014. This was primarily due to a $2.89 billion decrease in the average balance of first mortgage loans to $20.42 billion for the six months ended June 30, 2015 from $23.31 billion for the six months ended June 30, 2014. The decrease in interest income on mortgage loans was also due to a 19 basis point decrease in the annualized weighted-average yield to 4.10% for the six months ended June 30, 2015 from 4.29% for the six months ended June 30, 2014.

The decrease in the average yield earned on first mortgage loans during the six months ended June 30, 2015 was due primarily to repayments of higher-yielding loans coupled with lower yields on new loan originations. Consequently, the average yield on our loan portfolio continued to decline during 2015.

Interest on consumer and other loans decreased $546,000 to $3.9 million for the six months ended June 30, 2015 from $4.5 million for the six months ended June 30, 2014. The average balance of consumer and other loans decreased $21.6 million to $188.2 million for the first six months of 2015 from $209.8 million for the first six months of 2014 and the annualized weighted-average yield earned decreased 9 basis points to 4.18% from 4.27% for those same respective periods. The average balance of consumer loans decreased as consumer loans is not a business that we actively pursue. The decrease in the annualized weighted-average yield is a result of current market interest rates.

Interest on mortgage-backed securities decreased $54.2 million to $36.2 million for the six months ended June 30, 2015 from $90.4 million for the six months ended June 30, 2014. This decrease was due primarily to a $4.34 billion decrease in the average balance of mortgage-backed securities to $3.69 billion during the first six months of 2015 from $8.03 billion for the first six months of 2014. The annualized weighted-average yield of mortgage-backed securities was 1.97% for the first six months of 2015 as compared to 2.25% for the first six months of 2014.

The decrease in the average balance of mortgage-backed securities during the six months ended June 30, 2015 was due to sales of mortgage-backed securities and principal repayments continuing our strategy from 2014. During the first six months of 2015, we sold $1.21 billion of mortgage-backed securities to realize gains that otherwise would have decreased as repayments reduced the outstanding principal balance on these securities.

 

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For the six months ended June 30, 2015, interest on investment securities increased $5.7 million to $8.6 million as compared to $2.9 million for the six months ended June 30, 2014. This increase was due to a $4.05 billion increase in the average balance of investment securities to $4.50 billion for the first six months of 2015 as compared to $442.3 million for the first six months of 2014. This increase was partially offset by a decrease of 92 basis points in the annualized weighted-average yield to 0.38% for the first six months of 2015 from 1.30% for the same period in 2014.

The increase in the average balance of investment securities during the six months ended June 30, 2015 was due primarily to the purchase of $3.30 billion of U.S. Treasury securities in 2014 and $1.70 billion of U.S. Treasury securities during the first six months of 2015 as we invested cash from the mortgage-backed securities sales and loan repayments. This increase was partially offset by a decrease in the annualized weighted-average yield to 0.38% for the six months ended June 30, 2015 from 1.30% for the six months ended June 30, 2014. The decrease in the annualized weighted-average yield earned on investment securities during the first six months of 2015 is primarily due to the increase in the average balance of U.S. Treasury securities of $4.04 billion for the first six months of 2015, which have an average yield of 0.28%.

Dividends on FHLB stock decreased $532,000 or 7.1%, to $7.0 million for the six months ended June 30, 2015 from $7.5 million for the six months ended June 30, 2014. The decrease was due to a $26.9 million decrease in the average balance of FHLB stock to $315.6 million for the first six months of 2015 as compared to $342.5 million for the first six months of 2014. The annualized weighted-average dividend yield earned on FHLB stock was 4.41% for the six months ended June 30, 2015 as compared to 4.38% for the same period in 2014.

Interest on Federal funds sold and other overnight deposits amounted to $7.7 million for the six months ended June 30, 2015 as compared to $6.2 million for the six months ended June 30, 2014 due primarily to an increase in the average balance of Federal funds sold and other overnight deposits. The average balance of Federal funds sold and other overnight deposits amounted to $6.14 billion for the first six months of 2015 as compared to $4.94 billion for the same period in 2014. The yield earned on Federal funds sold and other overnight deposits was 0.25% for both the six months ended June 30, 2015 and 2014.

The increase in the average balance of Federal funds sold and other overnight deposits for the six months ended June 30, 2015 was due primarily to repayments and sales of mortgage-related assets and our low appetite for adding long-term fixed-rate mortgage loans to our portfolio in the current low interest rate environment.

Interest Expense. For the six months ended June 30, 2015, total interest expense decreased $11.7 million, or 3.2%, to $350.0 million from $361.7 million for the six months ended June 30, 2014. This decrease was primarily due to a $2.19 billion, or 6.7%, decrease in the average balance of total interest-bearing liabilities to $30.40 billion for the six months ended June 30, 2015 compared with $32.59 billion for the six months ended June 30, 2014. This was partially offset by an increase in the annualized weighted-average cost of total interest-bearing liabilities to 2.30% for the six months ended June 30, 2015 as compared to 2.21% for the six months ended June 30, 2014.

The increase in the average cost of interest-bearing liabilities during the six months ended June 30, 2015 was due to a decrease in the average balance of interest-bearing deposits, which have a lower weighted-average cost than our borrowed funds, the average balances of which remained unchanged. Interest-bearing deposits accounted for 60% of interest-bearing liabilities for the six months ended June 30, 2015, as compared to 63% for the six months ended June 30, 2014.

 

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Interest expense on deposits decreased $11.9 million, or 14.7%, to $68.9 million from $80.8 million for the six months ended June 30, 2014. This decrease was due primarily to a decrease of $2.18 billion in the average balance of interest-bearing deposits to $18.23 billion during the first six months of 2015 from $20.41 billion for the first six months of 2014. The decrease is also due to a decrease in the average cost of interest-bearing deposits of 4 basis points to 0.76% for the first six months of 2015 from 0.80% for the first six months of 2014.

Interest expense on our time deposit accounts decreased $10.7 million to $61.4 million for the six months ended June 30, 2015 as compared to $72.1 million for the six months ended June 30, 2014. This decrease was due to a $1.18 billion decrease in the average balance of time deposit accounts to $11.03 billion for the six months ended June 30, 2015 from $12.21 billion for the same period in 2014. The decrease was also due to a 7 basis point decrease in the annualized weighted-average cost to 1.12% for the six months ended June 30, 2015 compared with 1.19% for the six months ended June 30, 2014 as maturing time deposits were renewed or replaced by new time deposits at lower rates. The decline in the average balance of our time deposits reflects our decision to maintain lower deposit rates to continue our balance sheet reduction.

Interest expense on money market accounts decreased $930,000 to $3.9 million for the six months ended June 30, 2015 from $4.8 million for the six months ended June 30, 2014. This decrease was the result of a $942.8 million decrease in the average balance of money market accounts to $4.04 billion for the six months ended June 30, 2015 from $4.99 billion for the six months ended June 30, 2014. The decline in the average balance of our money market accounts reflects our decision to maintain lower deposit rates to continue our balance sheet reduction. The annualized weighted-average cost remained the same at 0.20% for both the six months ended June 30, 2015 and 2014.

Interest expense on our interest-bearing transaction accounts decreased $348,000 to $2.8 million for the six months ended June 30, 2015 from $3.1 million for the same period in 2014. The decrease is due to a 2 basis point decrease in the annualized weighted-average cost to 0.27% for the six months ended June 30, 2015 as compared to 0.29% for the same period in 2014. The decrease was also the result of a $93.9 million decrease in the average balance to $2.09 billion for the six months ended June 30, 2015 as compared to $2.18 billion for the same period in 2014.

The decrease in the average cost of deposits for the first six months of 2015 reflected lower market interest rates and our decision to maintain lower deposit rates to continue our balance sheet reduction.

For the six months ended June 30, 2015 interest expense on borrowed funds was $281.0 million as compared to $280.9 million for the six months ended June 30, 2014. The average cost of borrowed funds was 4.59% for both the six months ended June 30, 2015 and 2014. The average balance of borrowings was unchanged for both comparative periods.

Borrowings amounted to $12.18 billion at June 30, 2015 with an average cost of 4.59%. Borrowings scheduled to mature within 12 months of June 30, 2015 amounted to $1.83 billion with an average cost of 4.94%.

 

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Net Interest Income. Net interest income decreased $117.8 million, or 47.1%, to $132.2 million for the first six months of 2015 as compared to $250.0 million for the first six months of 2014. Our interest rate spread decreased 63 basis points to 0.44% for the six months ended June 30, 2015 as compared to 1.07% for the six months ended June 30, 2014. Our net interest margin decreased 59 basis points to 0.76% for the six months ended June 30, 2015 as compared to 1.35% for the six months ended June 30, 2014. The decrease in our interest rate spread and net interest margin for the six months ended June 30, 2015 was primarily due to repayments and sales of higher yielding assets due to the low interest rate environment and an increase in the average balance of short-term liquid assets, consisting of Federal funds sold and other overnight deposits and U.S. Treasury securities with a weighted average yield of 0.26%.

Provision for Loan Losses. There was no provision for loan losses for the six months ended June 30, 2015 and 2014. No provisions were recorded due to improving home prices and economic conditions, a decrease in total delinquent loans and a decrease in the size of the loan portfolio. The decline in non-performing loans was primarily due to improving economic conditions, particularly in the housing and labor markets. The ALL amounted to $225.6 million at June 30, 2015 as compared to $255.0 million at June 30, 2014. We recorded our provision for loan losses during the first six months of 2015 based on our ALL methodology that considers a number of quantitative and qualitative factors, including the amount of non-performing loans, the loss experience of our non-performing loans, recent collateral valuations, conditions in the real estate and housing markets, current economic conditions, particularly continued elevated levels of unemployment, and growth or shrinkage in the loan portfolio. See “Comparison of Operating Results for the Three Months Ended June 30, 2015 and 2014 – Provision for Loan Losses.”

Non-Interest Income. Total non-interest income was $77.3 million for the first six months of 2015 as compared to $38.9 million for the same period in 2014. Included in non-interest income for the first six months of 2015 were $74.4 million in gains from the sale of $1.21 billion of mortgage-backed securities. Gains on the sales of securities amounted to $35.5 million for the six months ended June 30, 2014.

Non-Interest Expense. Total non-interest expense amounted to $141.2 million for the six months ended June 30, 2015 as compared to $152.8 million for the six months ended June 30, 2014. This decrease was due to an $8.1 million decrease in Federal deposit insurance expense and a $5.2 million decrease in other non-interest expense, partially offset by a $2.6 million increase in compensation and employee benefit expense.

Compensation and employee benefit costs increased $2.6 million, or 3.9%, to $68.6 million for the first six months of 2015 as compared to $66.0 million for the same period in 2014. The increase in compensation costs is primarily due to an increase of $3.0 million in pension plan expense. The increase in pension expense is due primarily to a decrease in the discount rate used to calculate our pension obligations as well as the updated mortality tables published in October 2014 by the Society of Actuaries. See “Critical Accounting Policies – Pension and Other Post-Retirement Benefit Assumptions”. This increase was partially offset by a decrease of $455,000 in medical expenses.

For the six months ended June 30, 2015 Federal deposit insurance expense decreased $8.1 million, or 30.0%, to $18.9 million from $27.0 million for the six months ended June 30, 2014. This decrease was due primarily to a reduction in the size of our balance sheet and a decrease in our assessment rate.

For the six months ended June 30, 2015, other non-interest expense decreased $5.2 million to $35.5 million as compared to $40.7 million for the same period in 2014. This decrease was due to a $3.0 million write down in the receivable related to our claim against the Lehman Brothers, Inc. estate in the first quarter of 2014 and a $2.2 million increase in the net gain on the sale of foreclosed properties.

 

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Included in other non-interest expense were net gains of $2.8 million resulting from foreclosed real estate transactions for the six months ended June 30, 2015 as compared to a net gain of $670,000 for the comparable period in 2014. We sold 110 properties during the first six months of 2015 as compared to 116 properties for the same period in 2014. Expenses associated with foreclosed real estate were $9.5 million and $8.4 million for the six months ended June 30, 2015 and 2014, respectively.

Income Taxes. Income tax expense amounted to $26.8 million for the six months ended June 30, 2015 compared with income tax expense of $54.4 million for the six months ended June 30, 2014. Our effective tax rate for the six months ended June 30, 2015 was 39.18% compared with 39.99% for the six months ended June 30, 2014.

 

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Asset Quality

Credit Quality

Historically, our primary lending emphasis has been the origination and purchase of one- to four-family first mortgage loans on residential properties. Our lending market areas generally consist of those states that are east of the Mississippi River and as far south as South Carolina. Loans located outside of the New York metropolitan area were part of our loan purchases. Our loan purchase activity has declined significantly as sellers from whom we have historically purchased loans are either retaining these loans in their portfolios or selling them to the GSEs.

The following table presents the composition of our loan portfolio in dollar amounts and in percentages of the total portfolio at the dates indicated:

 

		June 30, 2015								December 31, 2014
						Percent								Percent
		Amount				of Total				Amount				of Total
		(Dollars in thousands)
First mortgage loans:
One- to four-family:
Amortizing		$	16,342,897				82.61	%		$	17,746,149				82.29	%
Interest-only			2,459,933				12.44				2,874,024				13.33
FHA/VA			638,835				3.23				648,070				3.01
Multi-family and commercial			157,838				0.80				102,323				0.47
Construction			177				—				177				—
Total first mortgage loans			19,599,680				99.08				21,370,743				99.10
Consumer and other loans
Fixed-rate second mortgages			65,736				0.33				72,309				0.34
Home equity credit lines			100,013				0.51				104,372				0.48
Other			16,293				0.08				17,550				0.08
Total consumer and other loans			182,042				0.92				194,231				0.90
Total loans			19,781,722				100.00	%			21,564,974				100.00	%
Deferred loan costs			90,608								99,155
Allowance for loan losses			(225,573	)							(235,317	)
Net loans		$	19,646,757							$	21,428,812

At June 30, 2015, first mortgage loans secured by one-to four-family properties accounted for 98.3% of total loans. Fixed-rate mortgage loans represent 52.6% of our first mortgage loans. Compared to adjustable-rate loans, fixed-rate loans possess less inherent credit risk since loan payments do not change in response to changes in interest rates. In addition, we do not originate or purchase loans with payment options or negative amortization loans. We believe our loans, when made, were amply collateralized and otherwise conformed to our lending standards.

Included in our loan portfolio at June 30, 2015 are interest-only loans of approximately $2.46 billion, or 12.4% of total loans, as compared to $2.87 billion, or 13.3% of total loans, at December 31, 2014. These loans are originated as adjustable rate mortgage loans with initial terms of five, seven or ten years with the interest-only portion of the payment based upon the initial loan term, or offered on a 30-year fixed-rate loan, with interest-only payments for the first 10 years of the obligation. At the end of the initial 5-, 7- or 10-year interest-only period, the loan payment will adjust to include both principal and interest and will

 

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amortize over the remaining term so the loan will be repaid at the end of its original life. These loans are underwritten using the fully- amortizing payment amount. Interest-only loans of $288.6 million will become fully-amortizing within the next 12 months. Non-performing interest-only loans amounted to $90.3 million, or 11.3% of non-performing loans, at June 30, 2015 as compared to non-performing interest-only loans of $99.8 million, or 11.7% of non-performing loans, at December 31, 2014.

Prior to January 2014, we originated loans to certain eligible borrowers as reduced documentation loans. Loans that were eligible for reduced documentation processing were ARM loans, interest-only first mortgage loans and 10-, 15-, 20- and 30-year fixed-rate loans to owner-occupied primary and second home applicants. These loans were available in amounts up to 65% of the lower of the appraised value or purchase price of the property. Generally the maximum loan amount for reduced documentation loans was $750,000 and these loans were subject to higher interest rates than our full documentation loan products. Reduced documentation loans have an inherently higher level of risk compared to loans with full documentation. Reduced documentation loans represent 21.9% of our one- to four-family first mortgage loans at June 30, 2015. Included in our loan portfolio at June 30, 2015 are $3.73 billion of amortizing reduced documentation loans and $532.7 million of reduced documentation interest-only loans as compared to $3.99 billion and $620.0 million, respectively, at December 31, 2014. Non-performing loans at June 30, 2015 include $151.2 million of amortizing reduced documentation loans and $33.5 million of interest-only reduced documentation loans as compared to $168.2 million and $39.8 million, respectively, at December 31, 2014.

The following table presents the geographic distribution of our total loan portfolio, as well as the geographic distribution of our non-performing loans:

 

		At June 30, 2015								At December 31, 2014
						Non-performing								Non-performing
		Total loans				Loans				Total loans				Loans
New Jersey			42.4	%			41.9	%			42.4	%			42.6	%
New York			28.1				29.4				27.8				27.8
Connecticut			14.6				7.9				14.6				7.8
Total New York metropolitan area			85.1				79.2				84.8				78.2
Pennsylvania			4.8				1.8				4.8				1.5
Massachusetts			2.0				1.8				2.0				1.8
Virginia			1.6				2.0				1.6				1.9
Maryland			1.6				4.6				1.6				5.2
Illinois			1.5				4.3				1.5				4.7
All others			3.4				6.3				3.7				6.7
Total outside New York metropolitan area			14.9				20.8				15.2				21.8
			100.0	%			100.0	%			100.0	%			100.0	%

 

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Non-Performing Assets

The following table presents information regarding non-performing assets as of the dates indicated.

 

		June 30, 2015				December 31, 2014
		(Dollars in thousands)
Non-accrual loans:
One-to four-family amortizing loans		$	659,459			$	708,518
One-to four-family interest-only loans			90,289				99,779
Multi-family and commercial mortgages			6,058				1,543
Construction loans			177				177
Consumer and other loans			6,472				8,613
Total non-accrual loans			762,455				818,630
Accruing loans delinquent 90 days or more (1)			39,378				33,383
Total non-performing loans			801,833				852,013
Foreclosed real estate, net			100,193				79,952
Total non-performing assets		$	902,026			$	931,965
Non-performing loans to total loans			4.05	%			3.95	%
Non-performing assets to total assets			2.55				2.55

 

(1)	Loans that are past due 90 days or more and still accruing interest are loans that are insured by the FHA.

Non-performing loans exclude loans which have been restructured and are accruing and performing in accordance with the terms of their restructure agreement for at least six months. We discontinue accruing interest and we reverse any accrued, but unpaid interest on troubled debt restructurings that are past due 90 days or more or if we believe we will not collect all amounts contractually due. Approximately $11.9 million of troubled debt restructurings that were previously accruing interest became 90 days or more past due during the first six months of 2015 for which we discontinued accruing interest and we reversed accrued, but unpaid interest.

 

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The following table is a comparison of our delinquent loans at June 30, 2015 and December 31, 2014:

 

		30-59 Days								60-89 Days								90 Days or More
		Number				Principal				Number				Principal				Number				Principal
		of				Balance				of				Balance				of				Balance
		Loans				of Loans				Loans				of Loans				Loans				of Loans
		(Dollars in thousands)
At June 30, 2015
One- to four- family first mortgages:
Amortizing			561			$	188,751				240			$	81,963				1,931			$	659,459
Interest-only			26				18,730				24				15,402				154				90,289
FHA/VA first mortgages			146				26,332				52				8,668				202				39,378
Multi-family and commercial mortgages			—				—				1				688				6				6,058
Construction loans			—				—				—				—				1				177
Consumer and other loans			29				1,308				16				593				59				6,472
Total			762			$	235,121				333			$	107,314				2,353			$	801,833
Delinquent loans to total loans							1.19	%							0.54	%							4.05	%
At December 31, 2014
One- to four- family first mortgages:
Amortizing			650			$	213,957				281			$	100,618				2,119			$	708,518
Interest-only			43				30,256				21				12,507				180				99,779
FHA/VA first mortgages			171				29,603				59				10,802				175				33,383
Multi-family and commercial mortgages			17				2,782				2				4,743				4				1,543
Construction loans			—				—				—				—				1				177
Consumer and other loans			16				1,938				11				441				69				8,613
Total			897			$	278,536				374			$	129,111				2,548			$	852,013
Delinquent loans to total loans							1.29	%							0.60	%							3.95	%

Potential problem loans consist of early-stage delinquencies, as set forth in the table above, and troubled debt restructurings that are not included in non-accrual loans. Potential problem loans amounted to $486.9 million at June 30, 2015 as compared to $544.9 million at December 31, 2014. The following table presents information regarding loans modified in a troubled debt restructuring at the dates indicated:

 

		June 30, 2015				December 31, 2014
		(In thousands)
Troubled debt restructurings:
Current		$	144,502			$	137,249
30-59 days			23,571				20,344
60-89 days			10,790				17,079
90 days or more			153,974				157,744
Total troubled debt restructurings		$	332,837			$	332,416

Loans that were modified in a troubled debt restructuring primarily represent loans that have been in a deferred principal payment plan for an extended period of time, generally in excess of nine months, loans that have had past due amounts capitalized as part of the loan balance, loans that have a confirmed Chapter 13 bankruptcy status, loans that have been discharged in a Chapter 7 bankruptcy and other repayment plans. These loans are individually evaluated for impairment to determine if the carrying value of the loan is in excess of the fair value of the collateral or the present value of the loan’s expected future cash flows.

 

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The following table presents loan portfolio by class that were modified as troubled debt restructurings. The pre-restructuring and post-restructuring outstanding recorded investments disclosed in the table below represent the loan carrying amounts immediately prior to the restructuring and the carrying amounts as of the dates indicated:

 

		June 30, 2015												December 31, 2014
						Pre-restructuring				Post-restructuring								Pre-restructuring				Post-restructuring
		Number				Outstanding				Outstanding				Number				Outstanding				Outstanding
		of				Recorded				Recorded				of				Recorded				Recorded
		Contracts				Investment				Investment				Contracts				Investment				Investment
		(Dollars in thousands)
Troubled debt restructurings:
One-to-four family first mortgages:
Amortizing			978			$	341,432			$	292,327				980			$	341,398			$	291,404
Interest-only			55				33,425				30,021				59				35,025				31,257
Multi-family and commercial mortgages			3				8,650				5,432				3				8,650				5,441
Consumer and other loans			42				5,381				5,057				36				4,594				4,314
Total			1,078			$	388,888			$	332,837				1,078			$	389,667			$	332,416

Foreclosed real estate amounted to $100.2 million and $80.0 million at June 30, 2015 and December 31, 2014, respectively. During the first six months of 2015 we transferred $74.1 million of loans to foreclosed real estate as compared to $60.3 million during the first six months of 2014. During the first six months of 2015 we sold 110 properties for $32.0 million as compared to 116 properties for $36.1 million during the first six months of 2014. Write-downs and net gains on the sale of foreclosed real estate amounted to a net gain of $2.8 million for the first six months of 2015 as compared to a net gain of $670,000 for the comparable period in 2014. Holding costs associated with foreclosed real estate amounted to $9.5 million and $8.4 million for the six months ended June 30, 2015 and 2014, respectively.

As part of our Strategic Plan, we are continuing to explore ways to reduce our interest rate risk while strengthening our balance sheet, which includes the implementation of our CRE lending initiative. Under this initiative, during 2014, the Bank began to purchase CRE and multi-family mortgage loans and interests in such loans. The Bank funded $86.0 million of such loans and interests in the fourth quarter of 2014 and $57.6 million during the first six months of 2015.

 

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Allowance for Loan Losses

The following table presents the activity in our allowance for loan losses at or for the dates indicated:

 

		For the Three Months								For the Six Months
		Ended June 30,								Ended June 30,
		2015				2014				2015				2014
		(Dollars in thousands)
Balance at beginning of period		$	230,489			$	265,732			$	235,317			$	276,097
Provision for loan losses			—				—				—				—
Charge-offs:
First mortgage loans			(10,788	)			(15,489	)			(19,979	)			(31,850	)
Consumer and other loans			(490	)			(220	)			(577	)			(391	)
Total charge-offs			(11,278	)			(15,709	)			(20,556	)			(32,241	)
Recoveries			6,362				4,988				10,812				11,155
Net charge-offs			(4,916	)			(10,721	)			(9,744	)			(21,086	)
Balance at end of period		$	225,573			$	255,011			$	225,573			$	255,011
Allowance for loan losses to total loans			1.14	%			1.10	%			1.14	%			1.10
Allowance for loan losses to non-performing loans			28.13				25.29				28.13				25.29
Net charge-offs as a percentage of average loans (1)			0.10				0.18				0.09				0.18

 

(1)	Ratio is annualized

The following table presents our allocation of the ALL by loan category and the percentage of loans in each category to total loans at the dates indicated:

 

		At June 30, 2015								At December 31, 2014
						Percentage								Percentage
						of Loans in								of Loans in
						Category to								Category to
		Amount				Total Loans				Amount				Total Loans
		(Dollars in thousands)
First mortgage loans:
One- to four-family		$	222,269				98.28	%		$	230,862				98.62	%
Other first mortgages			477				0.80				571				0.48
Total first mortgage loans			222,746				99.08				231,433				99.10
Consumer and other loans			2,827				0.92				3,884				0.90
Total allowance for loan losses		$	225,573				100.00	%		$	235,317				100.00	%

 

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Liquidity and Capital Resources

The term “liquidity” refers to our ability to generate adequate amounts of cash to fund loan originations, loan and security purchases, deposit withdrawals, repayment of borrowings and operating expenses. Our primary sources of funds are deposits, borrowings, the proceeds from principal and interest payments on loans and mortgage-backed securities, the maturities and calls of investment securities and funds provided by our operations. Deposit flows, calls of investment securities and borrowed funds, and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, national and local economic conditions and competition in the marketplace. These factors reduce the predictability of the receipt of these sources of funds. Our membership in the FHLB provides us access to additional sources of borrowed funds. We also have the ability to access the capital markets, depending on market conditions.

Historically, our primary investing activities have been the origination and purchase of one-to four-family real estate loans and consumer and other loans, the purchase of mortgage-backed securities, and the purchase of investment securities. These activities are funded primarily by borrowings, deposits and the proceeds from principal and interest payments on loans, mortgage-backed securities and investment securities. Our loan production (originations and purchases) was $416.7 million during the first six months of 2015 as compared to $813.4 million during the first six months of 2014. Principal repayments on loans amounted to $2.16 billion and $1.72 billion for those same respective periods. At June 30, 2015, commitments to originate and purchase mortgage loans amounted to $60.2 million and $140,000 respectively, as compared to $97.9 million and $140,000 respectively, at June 30, 2014.

Purchases of mortgage-backed securities during the first six months of 2015 amounted to $72.9 million as compared to $94.4 million for the six months ended June 30, 2014. Principal repayments on mortgage-backed securities amounted to $365.8 million for the first six months of 2015 as compared to $769.0 million for the first six months of 2014. Proceeds from sales of mortgage-backed securities during the six months ended June 30, 2015 were $1.28 billion as compared to $1.02 billion for the six months ended June 30, 2014.

At June 30, 2015, mortgage-backed securities and investment securities with an amortized cost of $7.26 billion were used as collateral for securities sold under agreements to repurchase and at that date we had $789.6 million of unencumbered securities.

As part of the membership requirements of the FHLB, we are required to hold a certain dollar amount of FHLB common stock based on our mortgage-related assets and borrowings from the FHLB. During the first six months of 2015, we had redemptions of FHLB common stock which amounted to $10.9 million.

As of June 30, 2015, total cash and cash equivalents amounted to $6.70 billion as compared to $5.45 billion as of June 30, 2014. This elevated level of cash and cash equivalents is primarily due to repayments on mortgage-related assets and the lack of attractive reinvestment opportunities in the current low interest rate environment as available short term reinvestment opportunities continue to carry low yields, and medium and longer term opportunities available to us carry significant duration risk at relatively low yields. We have maintained lower deposit rates, which helps us to manage our excess liquidity while we position our balance sheet for a possible restructuring. We have used a portion of our cash inflows to fund these deposit reductions. We believe that while carrying this level of cash and cash equivalents adversely impacts our current earnings, it better positions our balance sheet for future strategic initiatives such as a balance sheet restructuring.

 

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Our primary financing activities consist of gathering deposits, engaging in wholesale borrowings, repurchases of our common stock and the payment of dividends.

Total deposits decreased $1.20 billion during the first six months of 2015 as compared to a decrease of $958.5 million for the first six months of 2014. Deposit flows are typically affected by the level of market interest rates, the interest rates and products offered by competitors, the volatility of equity markets and other factors. We maintained our deposit rates at low levels during the first six months of 2015 to continue our balance sheet reduction. At June 30, 2015, time deposits scheduled to mature within one year totaled $7.32 billion with an average cost of 0.94%. These time deposits are scheduled to mature as follows: $2.52 billion with an average cost of 0.79% in the third quarter of 2015, $2.03 billion with an average cost of 0.91% in the fourth quarter of 2015, $1.60 billion with an average cost of 1.09% in the first quarter of 2016 and $1.17 billion with an average cost of 1.11% in the second quarter of 2016.

We have, in the past, primarily used wholesale borrowings to fund our investing activities. Structured putable borrowings amounted to $3.33 billion with a weighted average rate of 4.41% at June 30, 2015 and are putable quarterly. We anticipate that none of these borrowings will be put back assuming current market interest rates remain stable. We believe, given current market conditions, that the likelihood that a significant portion of these borrowings would be put back will not increase substantially unless interest rates were to increase by at least 250 basis points. Our remaining borrowings are fixed-rate, fixed maturity borrowings of $8.85 billion with a weighted-average rate of 4.66%. Borrowings scheduled to mature in the next 12 months amount to $1.83 billion with an average cost of 4.94%.

As part of our Strategic Plan, we are continuing to explore ways to reduce our interest rate risk while strengthening our balance sheet, which may include a further restructuring of our balance sheet during 2015. The Company previously completed a series of restructuring transactions in 2011 that reduced higher-cost structured borrowings on the Company’s balance sheet. Management is continuing to consider a variety of different restructuring alternatives, including whether to restructure all or various portions of our borrowed funds and various alternatives for replacement funding. No decision has been made at this time regarding the timing, structure and scope of any restructuring transaction. Decisions regarding any restructuring transaction are dependent upon, among other things, market interest rates, overall economic conditions and the status of the Merger. We expect a restructuring to result in a net loss and reduction of shareholder equity, though we also expect an improvement in net interest margin and future earnings prospects. Any restructuring will focus on the prospects for long-term overall earnings stability and growth. Any restructuring will likely reduce our excess cash position, but will not adversely affect the liquidity we need to operate in a safe and sound manner. The delay in the execution of the balance sheet restructuring and our continuing to carry an elevated liquidity position is primarily due to the delay in obtaining the requisite regulatory approvals for the Merger, though a variety of factors are involved in the decision regarding any such restructuring.

At June 30, 2015 we had a concentration of borrowings with a single counterparty with $6.03 billion of borrowings with the FHLB. We do not believe this concentration creates a material liquidity risk to us.

Our liquidity management process is structured to meet our daily funding needs and to cover both expected and unexpected deviations from normal daily operations. The primary tools we use for measuring and managing liquidity risk include cash flow projections, diversified funding sources, balance sheet concentration and liquidity limits, stress testing, a cushion of liquid assets and a formal, well developed contingency funding plan.

 

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Cash dividends paid during the six months ended June 30, 2015 were $20.0 million as compared to $40.1 million for the same period of 2014. The Board of Directors did not declare a dividend for the first quarter of 2015 after considering the level of earnings for the first quarter, the importance of paying dividends out of current earnings and the regulatory evaluation of any dividend request. The Board has declared a dividend for the second quarter of 2015. We did not purchase any of our common shares during the first six months ended June 30, 2015 pursuant to our repurchase programs. Pursuant to the Company MOU, any future share repurchases must be approved by the FRB. Pursuant to the Merger Agreement, we may not repurchase any shares without the consent of M&T. At June 30, 2015, there remained 50,123,550 shares available for purchase under existing stock repurchase programs.

The primary source of liquidity for the Company is capital distributions from its subsidiary, Hudson City Savings. At June 30, 2015, Hudson City Bancorp had total cash and due from banks of $135.4 million. The primary use of these funds is the payment of dividends to our shareholders and, when appropriate as part of our capital management strategy, the repurchase of our outstanding common stock. Hudson City Bancorp’s ability to continue these activities is dependent upon capital distributions from Hudson City Savings. Applicable federal law, regulations and regulatory actions may limit the amount of capital distributions Hudson City Savings may make. Currently, Hudson City Savings must seek approval from the OCC and the FRB for future capital distributions.

In accordance with the Company MOU, the Company is required to: (a) obtain approval from the FRB prior to receiving a capital distribution from the Bank or declaring a dividend to shareholders and (b) obtain approval from the FRB prior to repurchasing or redeeming any Company stock or incurring any debt with a maturity date of greater than one year.

While the Company believes it is in compliance in all material respects with the terms of the Company MOU, it will remain in effect until modified or terminated by the FRB.

At June 30, 2015, Hudson City Savings exceeded all regulatory capital requirements and is in compliance with our capital plan. Hudson City Savings’ Tier 1 leverage capital ratio, Tier 1 risk-based capital ratio, Common Equity Tier 1 risk-based capital ratio and Total risk-based capital ratio were 12.14%, 32.14%, 32.14% and 33.40%, respectively. Hudson City Bancorp’s Tier 1 leverage capital ratio, Tier 1 risk-based capital ratio, Common Equity Tier 1 risk-based capital ratio and Total risk-based capital ratio were 13.14%, 34.77%, 34.77% and 36.03%, respectively.

 

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Off-Balance Sheet Arrangements and Contractual Obligations

The Bank is a party to certain off-balance sheet arrangements, which occur in the normal course of our business, to meet the credit needs of our customers and the growth initiatives of the Bank. These arrangements are primarily commitments to originate and purchase residential mortgage loans, and to purchase mortgage-backed securities. We are also obligated under a number of non-cancellable operating leases.

The following table reports the amounts of our contractual obligations as of June 30, 2015.

 

		Payments Due By Period
						Less Than				One Year to				Three Years to				More Than
Contractual Obligation		Total				One Year				Three Years				Five Years				Five Years
		(In thousands)
Residential:
Mortgage loan originations		$	60,173			$	60,173			$	—			$	—			$	—
Mortgage loan purchases			140				140				—				—				—
Commercial mortgage loan originations			7,363				7,363				—				—				—
Repayment of borrowed funds			12,175,000				1,825,000				5,000,000				5,150,000				200,000
Operating leases			129,851				10,928				21,072				20,052				77,799
Total		$	12,372,527			$	1,903,604			$	5,021,072			$	5,170,052			$	277,799

Commitments to extend credit are agreements to lend money to a customer as long as there is no violation of any condition established in the contract. Commitments to fund first mortgage loans generally have fixed expiration dates of approximately 90 days and other termination clauses. Since some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Hudson City Savings evaluates each customer’s credit-worthiness on a case-by-case basis. Additionally, we have available home equity, commercial/construction lines of credit and overdraft lines of credit, which do not have fixed expiration dates, of approximately $145.3 million, $3.4 million, and $2.2 million, respectively. We are not obligated to advance further amounts on credit lines if the customer is delinquent, or otherwise in violation of the agreement. The commitments to purchase first mortgage loans and mortgage-backed securities had a normal period from trade date to settlement date of approximately 60 days.

Critical Accounting Policies

Note 2 to our Audited Consolidated Financial Statements, included in our 2014 Annual Report on Form 10-K, contains a summary of our significant accounting policies. We believe our policies with respect to the methodology for our determination of the ALL, the measurement of stock-based compensation expense, the impairment of securities, the impairment of goodwill and the measurement of the funded status and cost of our pension and other post-retirement benefit plans involve a higher degree of complexity and require management to make difficult and subjective judgments that often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. These critical policies and their application are continually reviewed by management, and are periodically reviewed with the Audit Committee and our Board of Directors.

 

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Allowance for Loan Losses

The ALL has been determined in accordance with U.S. generally accepted accounting principles, under which we are required to maintain an adequate ALL at June 30, 2015. We are responsible for the timely and periodic determination of the amount of the allowance required. We believe that our ALL is adequate to cover specifically identifiable loan losses, as well as estimated losses inherent in our portfolio for which certain losses are probable but not specifically identifiable.

Our primary lending emphasis is the origination and purchase of one- to four-family first mortgage loans on residential properties and, to a lesser extent, second mortgage loans on one- to four-family residential properties resulting in a loan concentration in residential first mortgage loans at June 30, 2015. As a result of our lending practices, we also have a concentration of loans secured by real property located primarily in New Jersey, New York and Connecticut. At June 30, 2015, approximately 85% of our total loans are in the New York metropolitan area. Additionally, the states of Pennsylvania, Massachusetts, Virginia, Maryland, and Illinois accounted for 5%, 2%, 2%, 2% and 1%, respectively of total loans. The remaining 3% of the loan portfolio is secured by real estate primarily in the remainder of our lending markets. Based on the composition of our loan portfolio and the growth in our loan portfolio, we believe the primary risks inherent in our portfolio are the continued weakened economic conditions due to the recent U.S. recession, continued high levels of unemployment, rising interest rates in the markets we lend and the potential for future declines in real estate market values. Any one or a combination of these adverse trends may adversely affect our loan portfolio resulting in increased delinquencies, non-performing assets, loan losses and future levels of loan loss provisions. We consider these trends in market conditions in determining the ALL.

Due to the nature of our loan portfolio, our evaluation of the adequacy of our ALL is performed primarily on a “pooled” basis. Each quarter we prepare an analysis which categorizes the entire loan portfolio by certain risk characteristics such as loan type (fixed and variable one- to four-family, interest-only, reduced documentation, multi-family, commercial, construction, etc.), loan source (originated or purchased) and payment status (i.e., current or number of days delinquent). Loans with known losses are categorized separately. We assign loss factors to the payment status categories on the basis of our assessment of the risk inherent in each loan type. These factors are periodically reviewed for appropriateness giving consideration to charge-off history, delinquency trends, portfolio growth and the status of the regional economy and housing market, in order to ascertain that the loss factors cover probable and estimable losses inherent in the portfolio. Based on our recent loss experience on non-performing loans and our consideration of environmental factors, we changed certain loss factors used in our quantitative analysis of the ALL for one- to four- family first mortgage loans during the first six months of 2015. This adjustment in our loss factors did not have a material effect on the ultimate level of our ALL or on our provision for loan losses. We use this analysis, as a tool, together with principal balances and delinquency reports, to evaluate the adequacy of the ALL. Other key factors we consider in this process are current real estate market conditions in geographic areas where our loans are located, changes in the trend of non-performing loans, the results of our foreclosed property transactions, the current state of the local and national economy, changes in interest rates and loan portfolio growth. Any one or a combination of these adverse trends may adversely affect our loan portfolio resulting in increased delinquencies, loan losses and higher future levels of provisions.

 

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We maintain the ALL through provisions for loan losses that we charge to income. We charge losses on loans against the ALL when we believe the collection of loan principal is unlikely. We establish the provision for loan losses after considering the results of our review as described above. We apply this process and methodology in a consistent manner and we reassess and modify the estimation methods and assumptions used in response to changing conditions. Such changes, if any, are approved by our AQC each quarter.

Hudson City Savings defines the population of potential impaired loans to be all non-accrual construction, commercial real estate and multi-family loans as well as loans classified as troubled debt restructurings. Impaired loans are individually assessed to determine that the loan’s carrying value is not in excess of the fair value of the collateral or the present value of the loan’s expected future cash flows. Smaller balance homogeneous loans that are collectively evaluated for impairment, such as residential mortgage loans and consumer loans, are specifically excluded from the impaired loan analysis.

We believe that we have established and maintained the ALL at adequate levels. Additions may be necessary if future economic and other conditions differ substantially from the current operating environment. Although management uses the best information available, the level of the ALL remains an estimate that is subject to significant judgment and short-term change.

Stock-Based Compensation

We recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of such awards in accordance with ASC 718-10. We made annual grants of performance-based stock options and stock unit awards that vest if certain financial performance measures are met. In accordance with ASC 718-10-30-6, we assess the probability of achieving these financial performance measures and recognize the cost of these performance-based grants if it is probable that the financial performance measures will be met. This probability assessment is subjective in nature and may change over the assessment period for the performance measures. We made grants of stock units in 2012 for which the sizes of the awards depended in part on market conditions based on the performance of our common stock. In accordance with ASC 718-10-30-15, we include the impact of these market conditions when estimating the grant date fair value of the awards. In accordance with ASC 718-10-55-61, we recognize compensation cost for these awards if service conditions are satisfied, even if the market condition is not satisfied.

We estimate the per share fair value of option grants and stock unit awards on the date of grant using the Black-Scholes option pricing model using assumptions for the expected dividend yield, expected stock price volatility, risk-free interest rate and expected option term. These assumptions are based on our analysis of our historical option exercise experience and our judgments regarding future option exercise experience and market conditions. These assumptions are subjective in nature, involve uncertainties and, therefore, cannot be determined with precision. The Black-Scholes option pricing model also contains certain inherent limitations when applied to options that are not traded on public markets.

The per share fair value of these equity grants is highly sensitive to changes in assumptions. In general, the per share fair value of options will move in the same direction as changes in the expected stock price volatility, risk-free interest rate and expected option term, and in the opposite direction of changes in the expected dividend yield. For example, the per share fair value of options will generally increase as expected stock price volatility increases, risk-free interest rate increases, expected option term increases and expected dividend yield decreases. The use of different assumptions or different option pricing models could result in materially different per share fair values of options.

 

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Pension and Other Post-Retirement Benefit Assumptions

Non-contributory retirement and post-retirement defined benefit plans are maintained for certain employees, including retired employees hired on or before July 31, 2005 who have met other eligibility requirements of the plans. In accordance with ASC 715, Retirement Benefits, we: (a) recognize in the statement of financial condition an asset for a plan’s overfunded status or a liability for a plan’s underfunded status; (b) measure plan assets and obligations that determine the plan’s funded status as of the end of our fiscal year; and (c) recognize, in comprehensive income, changes in the funded status of our defined benefit post-retirement plan in the year in which the changes occur.

We provide our actuary with certain rate assumptions used in measuring our benefit obligation. We monitor these rates in relation to the current market interest rate environment and update our actuarial analysis accordingly. The most significant of these is the discount rate used to calculate the period-end present value of the benefit obligations, and the expense to be included in the following year’s financial statements. A lower discount rate will result in a higher benefit obligation and expense, while a higher discount rate will result in a lower benefit obligation and expense. The discount rate assumption was determined based on a cash flow/yield curve model specific to our pension and post-retirement plans. We compare this rate to certain market indices, such as long-term treasury bonds, or the Moody’s bond indices, for reasonableness. For our pension plan, a discount rate of 3.85% was selected for the December 31, 2014 measurement date and for the 2015 expense calculation.

For our pension plan, we also assumed an annual rate of salary increase of 3.50% for future periods. This rate is corresponding to actual salary increases experienced over prior years. We assumed a return on plan assets of 8.25% for future periods. We actuarially determine the return on plan assets based on actual plan experience over the previous ten years. The actual return on plan assets was 8.8% for 2014 and 14.7% for 2013. There can be no assurances with respect to actual return on plan assets in the future. We periodically review and evaluate all actuarial assumptions affecting the pension plan, including assumed return on assets.

For our post-retirement benefit plan, a discount rate of 3.90% was used for the December 31, 2014 measurement date and for the 2015 expense calculation. The assumed health care cost trend rate used to measure the expected cost of other benefits for 2014 was 8.0%. The rate was assumed to decrease gradually to 4.50% for 2022 and remain at that level thereafter. Changes to the assumed health care cost trend rate are expected to have an immaterial impact as we capped our obligations to contribute to the premium cost of coverage to the post-retirement health benefit plan at the 2007 premium level.

Securities Impairment

Our available-for-sale securities portfolio is carried at estimated fair value with any unrealized gains and losses, net of taxes, reported as accumulated other comprehensive income/loss in shareholders’ equity. Debt securities which we have the positive intent and ability to hold to maturity are classified as held to maturity and are carried at amortized cost. During the second quarter of 2015, we transferred all securities classified as held to maturity to available for sale. The fair values for our securities are obtained from an independent nationally recognized pricing service. On a monthly basis, we assess the reasonableness of the fair values obtained by reference to a second independent nationally recognized pricing service.

 

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Substantially all of our securities portfolio is comprised of mortgage-backed securities and debt securities issued by GSEs. The fair value of these securities is primarily impacted by changes in interest rates and prepayment speeds. We generally view changes in fair value caused by changes in interest rates as temporary, which is consistent with our experience.

Accounting guidance requires that an entity assess whether an impairment of a debt security is other-than-temporary and, as part of that assessment, determine its intent and ability to hold the security. If the entity intends to sell the debt security, an other-than-temporary impairment shall be considered to have occurred. In addition, an other-than-temporary impairment shall be considered to have occurred if it is more likely than not that it will be required to sell the security before recovery of its amortized cost.

We conduct a periodic review and evaluation of the securities portfolio to determine if a decline in the fair value of any security below its cost basis is other-than-temporary. Our evaluation of other-than-temporary impairment considers the duration and severity of the impairment, our intent and ability to hold the securities, whether it is more likely than not that we will be required to sell the security before recovery of the amortized cost and our assessments of the reason for the decline in value and the likelihood of a near-term recovery. The unrealized losses on securities in our portfolio were due primarily to changes in market interest rates subsequent to purchase. As a result, the unrealized losses on our securities were not considered to be other-than-temporary and, accordingly, no impairment loss was recognized during the first six months of 2015.

Impairment of Goodwill

Goodwill and intangible assets with indefinite useful lives are tested for impairment at least annually using a fair-value based two-step approach. Goodwill and other intangible assets amounted to $152.2 million and were recorded as a result of Hudson City Bancorp’s acquisition of Sound Federal Bancorp, Inc. in 2006.

The first step (“Step 1”) used to identify potential impairment involves comparing each reporting unit’s estimated fair value to its carrying amount, including goodwill. As a community-oriented bank, substantially all of the Company’s operations involve the delivery of loan and deposit products to customers and these operations constitute the Company’s only segment for financial reporting purposes. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill is not considered to be impaired. If the carrying amount exceeds the estimated fair value, there is an indication of potential impairment and the second step (“Step 2”) is performed to measure the amount. Step 2 involves calculating an implied fair value of goodwill for each reporting unit for which impairment was indicated in Step 1. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination by measuring the excess of the estimated fair value of the reporting unit, as determined in Step 1, over the aggregate estimated fair values of the individual assets, liabilities, and identifiable intangibles, as if the reporting unit was being acquired at the impairment test date. Subsequent reversal of goodwill impairment losses is not permitted.

 

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We performed our annual goodwill impairment analysis as of June 30, 2015 and concluded that goodwill was not impaired. Therefore, we did not recognize any impairment of goodwill or other intangible assets during 2015.

The estimation of the fair value of the Company requires the use of estimates and assumptions that results in a greater degree of uncertainty. In addition, the estimated fair value of the Company is based on, among other things, the market price of our common stock as calculated per the terms of the Merger. As a result of the current volatility in market and economic conditions, these estimates and assumptions are subject to change in the near-term and may result in the impairment in future periods of some or all of the goodwill on our balance sheet.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Quantitative and qualitative disclosure about market risk is presented as of December 31, 2014 in Hudson City Bancorp’s Annual Report on Form 10-K. The following is an update of the discussion provided therein, as of June 30, 2015.

General

As a financial institution, our primary component of market risk is interest rate volatility. Our net income is primarily based on net interest income, and fluctuations in interest rates will ultimately impact the level of both income and expense recorded on a large portion of our assets and liabilities. Fluctuations in interest rates will also affect the market value of our interest-earning assets and interest-bearing liabilities. Due to the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets. We did not engage in any hedging transactions that use derivative instruments (such as interest rate swaps and caps) during the first six months of 2015 and did not have any such hedging transactions in place at June 30, 2015. Our loan and securities portfolios, which comprise approximately 78% of our balance sheet, are subject to risks associated with the economy in the New York metropolitan area and the general economy of the United States, particularly the residential housing market. Our residential mortgage-related assets are also subject to prepayment risk due to mortgage refinancing and/or housing turnover. We continually analyze our asset quality and believe our allowance for loan losses is adequate to cover known or potential losses.

Historically, our lending activities have emphasized residential fixed-rate first mortgage loans, while purchasing adjustable-rate or hybrid mortgage-backed securities to diversify our predominantly fixed-rate loan portfolio. In the past several years, we have originated a larger percentage of adjustable-rate mortgage loans, increased our purchases of U.S. Treasury securities, and, in recent quarters, initiated a loan program to purchase participations in commercial real estate loans in order to better manage our interest rate risk. Adjustable-rate residential mortgage-related assets include those loans or securities with a contractual annual rate adjustment after an initial fixed-rate period of one to ten years. Growth in these types of mortgage-related assets would help moderate our exposure to interest rate fluctuations and are expected to benefit our long-term profitability, as the rate earned on these mortgage loans will increase, as prevailing market rates increase although the rates on adjustable-rate mortgage loans do not reset as quickly as market interest rates. However, this strategy to originate a higher percentage of adjustable-rate instruments may have an initial adverse impact on our net interest income and net interest margin in the short-term, as adjustable-rate interest-earning assets generally have initial interest rates lower than alternative fixed-rate investments.

 

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In the aggregate, 51% of our mortgage-related assets are adjustable-rate or hybrid instruments. Our percentage of fixed-rate mortgage-related assets to total mortgage-related assets was 49% as of June 30, 2015 compared with 48% as of March 31, 2015. Overall, our percentage of fixed-rate interest-earning assets to total interest-earning assets was 46% at June 30, 2015 compared with 47% as of March 31, 2015.

The level of prepayment activity on our interest-sensitive assets impacts our net interest income. The timing of the principal payments on mortgage loans and mortgage-backed securities can be significantly impacted by changes in market interest rates and prepayment rates of our mortgage-related assets. Mortgage prepayment rates can vary due to a number of factors but prepayment rates are, generally, inversely related to the prevailing market interest rate. Accordingly, as market interest rates increase, prepayment rates tend to decrease. Prepayment rates on our mortgage-related assets have remained elevated during the first six months of 2015. An elevated level of prepayment activity directly affects the yield earned on assets, as the payments received on the interest-earning assets will be reinvested at the prevailing lower market interest rate.

Our primary sources of funds have traditionally been deposits, consisting primarily of time deposits and interest-bearing demand accounts, and borrowings. Our deposits have substantially shorter terms to maturity than our mortgage loan portfolio and borrowed funds. The Bank currently has $6.93 billion of interest-bearing non-maturity deposits, and $7.32 billion of time deposits scheduled to mature within the next 12 months. Borrowings, advances from the FHLB and term repurchase agreements with major broker/dealers, are an additional principal source of funding. As of June 30, 2015, these borrowings totaled $12.18 billion, $3.33 billion of which are putable on a quarterly basis. The weighted average rate of our putable borrowings is 4.41%. Since market interest rates have remained low for an extended period of time, we have not had any lenders put borrowings back to us. We believe, given current market conditions, that the likelihood that a significant portion of these borrowings being put back to us will not increase substantially unless interest rates were to rise by at least 250 basis points. There are $8.85 billion of fixed-rate/fixed-maturity borrowings with a weighted average rate of 4.66% including $1.83 billion that are scheduled to mature within the next twelve months.

As a result of our investment and financing decisions, the steeper the slope of the yield curve, the more favorable the environment is for our ability to generate net interest income. Our interest-bearing liabilities generally reflect movements in short-term rates, while our interest-earning assets, a majority of which have initial terms to maturity or repricing greater than five years, generally reflect movements in intermediate- and long-term interest rates. A positive slope of the yield curve allows us to invest in interest-earning assets at a wider spread to the cost of interest-bearing liabilities. During the first six months of 2015, a more stable economic environment and market expectations regarding the continued pace of the Federal Reserve’s conduct of monetary policy has resulted in a flatter yield curve.

The FOMC noted that economic activity expanded moderately during the second quarter of 2015. The FOMC noted that the labor market continued to improve, with solid job gains and declining unemployment. A range of labor market indicators suggests that underutilization of labor resources has diminished. Growth in household spending has been moderate and the housing sector has shown additional improvement. The national unemployment rate decreased to 5.3% in June 2015 from 5.6% in December 2014 and from 6.1% in June 2014. The FOMC decided to maintain the overnight lending target rate at zero to 0.25% during the second quarter of 2015.

The FOMC stated that it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The FOMC believes this policy of keeping holdings of longer-term securities at sizable levels should help maintain accommodative financial conditions.

 

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With short-term market interest rates having remained at low levels for an extended period of time, the rates on our short-term time and non-maturity deposits had been decreasing in recent years but have remained stable during the first six months of 2015. With intermediate and longer term interest rates remaining soft, the yields on our primary investments in mortgage loans and investment securities continued to decline during the second quarter of 2015.

Interest Rate Risk Modeling

Simulation Model. We use our internal simulation models as our primary means to calculate and monitor the interest rate risk inherent in our portfolio. These models report changes to net interest income and the net present value of equity in different interest rate environments, assuming either an incremental or instantaneous and permanent parallel interest rate shock, as applicable, to all interest rate-sensitive assets and liabilities. We assume maturing or called instruments are reinvested into like product, with the rate earned or paid reset to our currently offered rate for loans and deposits, or the current market rate for securities and borrowed funds. We have not reported the minus 200 or minus 300 basis point interest rate shock scenarios in either of our simulation model analyses, as we believe, given the current interest rate environment, these scenarios would be highly unlikely and the resulting information would not be meaningful.

Net Interest Income. As a primary means of managing interest rate risk, we monitor the impact of interest rate changes on our net interest income over the next twelve-month period. This model does not purport to provide estimates of net interest income over the next twelve-month period, but attempts to assess the impact of interest rate changes on our net interest income. The following table reports the changes to our net interest income over the next 12 months from June 30, 2015 assuming both incremental and instantaneous changes in interest rates for the given rate shock scenarios. The incremental interest rate changes occur over a 12 month period.

 

		At June 30, 2015
Change in Interest		Percent Change in Net Interest Income
		Instantaneous Change				Incremental Change
(Basis points)
300			51.53	%			30.32	%
200			37.78				21.37
100			21.07				11.93
50			14.70				5.65
(50)			(12.61	)			(5.97	)
(100)			(21.61	)			(10.85	)

 

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Of note in the positive shock scenarios:

 

•

For instantaneous rate changes, interest income improves in rising rate environments due to our large overnight funds position and our sizable position in short-term investment securities. In addition, yields earned on mortgage-backed securities and mortgage loans improve with the repricing of adjustable rate interest-earning assets.

 

•

For incrementally changing rates, interest income improves with rising rates although at more modest rates than with instantaneous rate changes.

Of note in the negative shock scenarios:

 

•

In declining interest rate environments, net interest income suffers in both the incremental and instantaneous scenarios, with instantaneous rate moves proving more unfavorable. This results from both an acceleration of prepayments on the mortgage-related assets and the fact that our non-maturity and short term time deposits, already at low rates, cannot experience the full effect of rate scenarios of minus 50 and minus 100 basis points.

Net Present Value of Equity. We also monitor our interest rate risk by monitoring changes in the net present value of equity in the different rate environments. The net present value of equity is the difference between the estimated fair value of assets and liabilities. The changes in the fair value of assets and liabilities due to changes in interest rates reflect the interest sensitivity of those assets and liabilities. Their values are derived from the characteristics of the asset or liability (i.e., interest-type, optionality, maturity, re-pricing frequency, etc.) relative to the current interest rate environment. For example, in a rising interest rate environment, the fair market value of a fixed-rate asset will decline, whereas the fair market value of an adjustable-rate asset, depending on its re-pricing characteristics, will decline to a lesser extent. Increases in the fair value of assets relative to the fair value of liabilities will increase the present value of equity whereas decreases in the market value of assets relative to the fair value of liabilities will decrease the present value of equity.

The following table presents the estimated net present value of equity over a range of parallel interest rate change scenarios, as applicable, at June 30, 2015. The present value ratio shown in the table is the net present value of equity as a percent of the present value of total assets in each of the different rate environments. Our current policy sets a minimum ratio of the net present value of equity to the fair value of assets in the current interest rate environment (no rate shock) of 7.0% and a minimum present value ratio of 5.0% in the plus 300 basis point interest rate shock scenario.

 

		At June 30, 2015
Change in Interest Rates		Present Value Ratio				Basis Point Change
(basis points)
300			11.61	%			(259	)
200			12.83				(137	)
100			13.74				(46	)
50			14.04				(16	)
—			14.20				—
(50)			14.14				(6	)
(100)			13.88				(32	)

 

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Of note in the positive shock scenarios:

 

•

The net present value ratio decreases as interest rates increase. This is due to the fact that our assets are more sensitive to increases in interest rates than our liabilities. These sensitivity measures are referred to as duration; the duration of assets is greater than the duration of liabilities in the increasing rate scenarios. As such, the net present value of assets declines more than the net present value of liabilities in a rising interest rate environment.

Of note in the negative shock scenarios:

 

•

Prepayments on our mortgage loans accelerate and the duration of assets contracts to such an extent that the duration of liabilities exceeds the duration of assets in the declining rate scenarios presented. As a result, the net present value ratio decreases in this scenario.

The methods used in simulation modeling are inherently imprecise. This type of modeling requires that we make assumptions that may not reflect the manner in which actual yields and costs respond to changes in market interest rates. For example, we assume the composition of the interest rate-sensitive assets and liabilities will remain constant over the period being measured and that all interest rate shocks will be uniformly reflected across the yield curve. The analyses assume that we will take no action in response to the changes in interest rates. In addition, prepayment estimates and other assumptions within the model involve uncertainties, and, therefore, cannot be determined with precision. Accordingly, although the previous two tables may provide an estimate of our interest rate risk at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in interest rates on our net interest income or present value of equity.

Gap Analysis. The matching of the re-pricing characteristics of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate-sensitive” and by monitoring a financial institution’s interest rate sensitivity “gap.” An asset or liability is said to be “interest rate-sensitive” within a specific time period if it will mature or re-price within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or re-pricing within a specific time period and the amount of interest-bearing liabilities maturing or re-pricing within that same time period.

A gap is considered negative when the amount of interest-bearing liabilities maturing or re-pricing within a specific time period exceeds the amount of interest-earning assets maturing or re-pricing within that same period. A gap is considered positive when the amount of interest-earning assets maturing or re-pricing within a specific time period exceeds the amount of interest-bearing liabilities maturing or re-pricing within that same time period. During a period of rising interest rates, a financial institution with a negative gap position would be expected, absent the effects of other factors, to experience a greater increase in the costs of its interest-bearing liabilities relative to the yields of its interest-earning assets and thus a decrease in the institution’s net interest income. An institution with a positive gap position would be expected, absent the effect of other factors, to experience the opposite result. Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to reduce net interest income.

 

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The following table presents the amounts of our interest-earning assets and interest-bearing liabilities outstanding as of June 30, 2015 which we anticipate to reprice or mature in each of the future time periods shown. Except for prepayment or call activity and non-maturity deposit decay rates, we determined the amounts of assets and liabilities that reprice or mature during a particular period in accordance with the earlier of the term to rate reset or the contractual maturity of the asset or liability. Assumptions used for decay rates are based on the Bank’s experience with the particular deposit type. Prepayment speeds on our mortgage-related assets are based on recent experience. Callable investment securities and borrowed funds are reported at the anticipated call or put date, for those that are callable or putable within one year, or at their contractual maturity date or next interest rate step-up date, as applicable. We have reported no borrowings at their anticipated put date due to the low interest rate environment. We have excluded non-accrual mortgage loans of $756.0 million and non-accrual other loans of $6.5 million from the table.

 

		At June 30, 2015
		Six				More Than				More Than				More Than				More Than
		Months				Six Months				One Year				Two Years to				Three Years				More Than
		or Less				to One Year				to Two Years				Three Years				to Five Years				Five Years				Total
Interest-earning assets
First mortgage loans		$	2,397,515			$	1,988,018			$	2,397,885			$	2,620,211			$	3,610,138			$	5,829,930			$	18,843,697
Consumer and other loans			91,382				2,353				5,479				12,550				4,985				58,821				175,570
Federal funds sold			6,599,793				—				—				—				—				—				6,599,793
Mortgage-backed securities			745,718				351,403				768,371				182,119				213,930				468,952				2,730,493
FHLB stock			309,892				—				—				—				—				—				309,892
Investment securities			617,844				4,444,382				—				298,205				—				—				5,360,431
Total interest-earning assets			10,762,144				6,786,156				3,171,735				3,113,085				3,829,053				6,357,703				34,019,876
Interest-bearing liabilities
Savings accounts			65,325				65,325				115,408				101,254				167,669				573,776				1,088,757
Interest-bearing demand			196,788				196,788				287,898				237,334				357,518				783,875				2,060,201
Money market accounts			509,230				509,230				736,345				534,181				672,961				823,310				3,785,257
Time deposits			4,548,262				2,771,232				2,110,391				584,207				522,374				—				10,536,466
Borrowing			75,000				1,750,000				3,275,000				1,725,000				5,150,000				200,000				12,175,000
Total interest-bearing liabilities			5,394,605				5,292,575				6,525,042				3,181,976				6,870,522				2,380,961				29,645,681
Interest sensitivity gap		$	5,367,539			$	1,493,581			$	(3,353,307	)		$	(68,891	)		$	(3,041,469	)		$	3,976,742			$	4,374,195
Cumulative interest sensitivity gap		$	5,367,539			$	6,861,120			$	3,507,813			$	3,438,922			$	397,453			$	4,374,195
Cumulative interest sensitivity gap as a percentage of total assets			15.16	%			19.37	%			9.90	%			9.71	%			1.12	%			12.35	%
Cumulative interest-earnings assets as a percentage of interest-bearing liabilities			199.50	%			164.20	%			120.38	%			116.86	%			101.46	%			114.75	%

 

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Of note regarding the GAP analysis:

 

•

we have $6.60 billion of Federal funds sold;

 

•

we have $1.83 billion of borrowings maturing in the next 12 months and an additional $3.28 billion maturing in the next 24 months; and

 

•

we have experienced elevated, although moderating, levels of prepayment activity on our mortgage-related assets as interest rates have remained at relatively low levels.

Of note in comparison to December 31, 2014:

 

•

the cumulative one-year gap as a percent of total assets was positive 19.37% at June 30, 2015 as compared to 12.01% at December 31, 2014. The increase in the cumulative one-year gap reflects the shift of our U.S. Treasury securities from the More than One Year to Two Years category into the More than Six Months to One Year category as such securities have a remaining average maturity of 9 months at June 30, 2015;

 

•

net loans decreased $1.10 billion to $19.65 billion at June 30, 2015 as compared to $20.75 billion at December 31, 2014;

 

•

mortgage-backed securities decreased $1.51 billion to $2.73 billion at June 30, 2015 as compared to $4.24 billion at December 31, 2014;

 

•

investment securities increased to $5.36 billion as of June 30, 2015 from $3.65 billion at December 31, 2014; and

 

•

deposits declined by $734.9 million during the second quarter of 2015.

The methods used in the gap table are also inherently imprecise. For example, although certain assets and liabilities may have similar maturities or periods to re-pricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Certain assets, such as adjustable-rate loans and mortgage-backed securities, have features that limit changes in interest rates on a short-term basis and over the life of the loan. If interest rates change, prepayment and early withdrawal levels would likely deviate from those assumed in calculating the table. Finally, the ability of borrowers to make payments on their adjustable-rate loans may decrease if interest rates increase.

Item 4. - Controls and Procedures

Denis J. Salamone, our Chairman and Chief Executive Officer, and James C. Kranz, our Executive Vice President and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of June 30, 2015. Based upon their evaluation, they each found that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that we file and submit under the Exchange Act was recorded, processed, summarized and reported as and when required and that such information was accumulated and communicated to our management as appropriate to allow timely decisions regarding required disclosures.

There was no change in our internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II – OTHER INFORMATION

Item 1. – Legal Proceedings

Except as described below, we are not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. We believe that these routine legal proceedings, in the aggregate, are immaterial to our financial condition and results of operations.

Since the announcement of the Merger, eighteen putative class action complaints have been filed in the Court of Chancery, Delaware against Hudson City Bancorp, its directors, M&T, and WTC challenging the Merger. Six putative class actions challenging the Merger have also been filed in the Superior Court for Bergen County, Chancery Division, of New Jersey (the “New Jersey Court”). The lawsuits generally allege, among other things, that the Hudson City Bancorp directors breached their fiduciary duties to Hudson City Bancorp’s public shareholders by approving the Merger at an unfair price, that the Merger was the product of a flawed sales process, and that Hudson City Bancorp and M&T filed a misleading and incomplete Form S-4 with the SEC in connection with the proposed transaction. All 24 lawsuits seek, among other things, to enjoin completion of the Merger and an award of costs and attorneys’ fees. Certain of the actions also seek an accounting of damages sustained as a result of the alleged breaches of fiduciary duty and punitive damages.

On April 12, 2013, the defendants entered into a memorandum of understanding (the “MOU”) with the plaintiffs regarding the settlement of all of the actions described above (collectively, the “Actions”).

Under the terms of the MOU, Hudson City Bancorp, M&T, the other named defendants, and all the plaintiffs have reached an agreement in principle to settle the Actions and release the defendants from all claims relating to the Merger, subject to approval of the New Jersey Court. Pursuant to the MOU, Hudson City Bancorp and M&T agreed to make available additional information to Hudson City Bancorp shareholders. The additional information was contained in a Supplement to the Joint Proxy Statement filed with the SEC as an exhibit to a Current Report on Form 8-K dated April 12, 2013. In addition, under the terms of the MOU, plaintiffs’ counsel also has reserved the right to seek an award of attorneys’ fees and expenses. If the New Jersey Court approves the settlement contemplated by the MOU, the Actions will be dismissed with prejudice. The settlement will not affect the Merger consideration to be paid to Hudson City Bancorp’s shareholders in connection with the proposed Merger. In the event the New Jersey Court approves an award of attorneys’ fees and expenses in connection with the settlement, such fees and expenses shall be paid by Hudson City Bancorp, its successor in interest, or its insurers.

Hudson City Bancorp, M&T, and the other defendants deny all of the allegations in the Actions and believe the disclosures in the Joint Proxy Statement are adequate under the law. Nevertheless, Hudson City Bancorp, M&T, and the other defendants have agreed to settle the Actions in order to avoid the costs, disruption, and distraction of further litigation.

Item 1A. – Risk Factors

For a summary of risk factors relevant to our operations, please see Part I, Item 1A in our 2014 Annual Report on Form 10-K and Part II, Item 1A in our March 31, 2015 Form 10Q. There has been no material change in risk factors since March 31, 2015.

 

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Item 2. – Unregistered Sales of Equity Securities and Use of Proceeds

The following table reports information regarding repurchases of our common stock during the second quarter of 2015 and the stock repurchase plans approved by our Board of Directors.

 

														Maximum
										Total Number of				Number of Shares
		Total								Shares Purchased				that May Yet Be
		Number of				Average				as Part of Publicly				Purchased Under
		Shares				Price Paid				Announced Plans				the Plans or
Period		Purchased				per Share				or Programs				Programs (1)
April 1-April 30, 2015			—			$	—				—				50,123,550
May 1-May 31, 2015			—				—				—				50,123,550
June 1-June 30, 2015			—				—				—				50,123,550
Total			—				—				—

 

(1)	On July 25, 2007, Hudson City Bancorp announced the adoption of its eighth Stock Repurchase Program, which authorized the repurchase of up to 51,400,000 shares of common stock. This program has no expiration date.

Item 3. – Defaults Upon Senior Securities

Not applicable.

Item 4. – Mine Safety Disclosures

Not applicable.

Item 5. – Other Information

Not applicable.

Item 6. – Exhibits

 

Exhibit Number		Exhibit
31.1		Certification of Chief Executive Officer
31.2		Certification of Chief Financial Officer
32.1		Written Statement of Chief Executive Officer and Chief Financial Officer furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350. *
101		The following information from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015, filed with the SEC on August 7, 2015, has been formatted in eXtensible Business Reporting Language: (i) Consolidated Statements of Financial Condition at June 30, 2015 and December 31, 2014, (ii) Consolidated Statements of Income for the three and six months ended June 30, 2015 and 2014, (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2015 and 2014, (iv) Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2015 and 2014 and (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014 and (vi) Notes to the Unaudited Consolidated Financial Statements (detail tagged).

 

*	Pursuant to SEC rules, this exhibit will not be deemed filed for purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

		Hudson City Bancorp, Inc.
Date: August 7, 2015				By:		/s/ Denis J. Salamone
						Denis J. Salamone
						Chairman and Chief Executive Officer
						(Principal Executive Officer)
Date: August 7, 2015				By:		/s/ Francesco S. Rossi
						Francesco S. Rossi
						First Vice President
						(Principal Accounting Officer)

 

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