ITEM 1B.
Unresolved Staff Comments
None.
Our headquarters are located in our Buffalo regional market center at 726 Exchange Street, Suite 618, Buffalo, New York where we lease 115,000 square feet of space. At December 31, 2012, we conducted our business through 205 full-service branches located across Upstate New York, 129 full-service branches in Pennsylvania, 85 branches in Connecticut, and 11 branches in Western Massachusetts, including several financial services offices. One hundred fifty-two of our branches are owned and 278 are leased.
In addition to our branch network and Buffalo regional market center, we occupy office space in our six other regional market centers located in Rochester, Albany, and Syracuse, New York and Pittsburgh and Philadelphia, Pennsylvania and New Haven, Connecticut where we provide financial services and perform certain back office operations. We also lease or own other facilities which are used as training centers and storage. Some of our facilities contain tenant leases that are subleases. These properties include 38 leased offices and 21 buildings which we own with a total occupancy of approximately 1,556,000 square feet, including our administrative center in Lockport, New York which has 76,000 square feet. At December 31, 2012, our premises and equipment had a net book value of $411 million. See Note 5 of the “Notes to Consolidated Financial Statements” filed herewith in Part II, Item 8, “Financial Statements and Supplementary Data” for further detail on our premises and equipment. All of these properties are generally in good condition and are appropriate for their intended use.
ITEM 3.
ITEM 3.
Legal Proceedings
In the ordinary course of business, we are involved in various threatened and pending legal proceedings. We believe that we are not a party to any pending legal, arbitration, or regulatory proceedings that would have a material adverse impact on our financial results or liquidity.
ITEM 4.
ITEM 4.
Mine Safety Disclosures
Not applicable.
PART II
ITEM 5.
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded under the symbol ‘FNFG’ on the NASDAQ Global Select Market. At December 31, 2012, we had approximately 26,000 stockholders of record. During 2012, the high sales price of our common stock was $10.35 and the low sales price of our common stock was $7.08. We paid dividends of $0.32 per common share during 2012. See additional information regarding the market price and dividends paid in Item 6, “Selected Financial Data.”
During 2011, we repurchased 9 million shares of our common stock, but we did not repurchase any shares of our common stock during 2012. Under the current stock repurchase plan, approved by our Board of Directors on July 27, 2010, we are authorized to repurchase up to an additional 12 million shares of our common stock. This plan does not have an expiration date.
Stock Performance Graph
Below is a stock performance graph comparing (i) the cumulative total return on our common stock for the period beginning December 31, 2007 as reported by the NASDAQ Global Select Market, through December 31, 2012, (ii) the cumulative total return on stocks included in the NASDAQ Composite Index over the same period, and (iii) the cumulative total return of publicly traded regional banks and thrifts over the same period. Cumulative return assumes the reinvestment of dividends, and is expressed in dollars based on an assumed investment of $100.
FIRST NIAGARA FINANCIAL GROUP, INC.
ITEM 6.
ITEM 6.
Selected Financial Data
(1)
Includes the impact of the HSBC Branch Acquisition on May 18, 2012.
(2)
Includes the impact of the merger with NewAlliance Bancshares, Inc. on April 15, 2011.
(3)
Includes the impact of the merger with Harleysville National Corporation on April 9, 2010.
(4)
Includes the impact of the acquisition of 57 National City Bank branch locations on September 4, 2009.
(5)
Includes $21 million gain on sale of mortgage-backed securities portfolio repositioning in 2012.
(6)
Includes $8 million of discount accretion related to the redemption of preferred stock issued as part of the Troubled Asset Relief Program in 2009.
(7)
Excludes unallocated employee stock ownership plan shares and unvested restricted stock shares.
(8)
Tangible common equity is used to calculate tangible book value per common share and excludes goodwill and other intangibles of $2.6 billion, $1.8 billion, $1.1 billion, $935 million, and $785 million at December 31, 2012, 2011, 2010, 2009, and 2008, respectively. Tangible common equity also excludes preferred stock of $338 million at December 31, 2012 and 2011 and $177 million at December 31, 2008. This is a non-GAAP financial measure that we believe provides management and investors with information that is useful in understanding our financial performance and condition.
(1)
Includes the impact of the HSBC Branch Acquisition on May 18, 2012.
(2)
Includes the impact of the merger with NewAlliance Bancshares, Inc. on April 15, 2011.
(3)
Includes the impact of the merger with Harleysville National Corporation on April 9, 2010.
(4)
Includes the impact of the acquisition of 57 National City Bank branch locations on September 4, 2009.
(5)
Computed using daily averages.
(6)
Average tangible common equity excludes average goodwill, other intangibles, and preferred stock of $2.7 billion, $1.6 billion, $1.1 billion, $900 million, and $815 million for 2012, 2011, 2010, 2009, and 2008, respectively. This is a non-GAAP financial measure that we believe provides management and investors with information that is useful in understanding our financial performance and condition.
(7)
Average tangible equity excludes average goodwill and other intangibles of $2.3 billion, $1.6 billion, $1.1 billion, $829 million, and $795 million for 2012, 2011, 2010, 2009, and 2008, respectively. This is a non-GAAP financial measure that we believe provides management and investors with information that is useful in understanding our financial performance and condition.
(8)
Computed by dividing noninterest expense by the sum of net interest income and noninterest income.
(9)
Computed by subtracting the sum of preferred stock and the junior subordinated debentures associated with trust preferred securities from Tier 1 capital, divided by risk weighted assets. This is a non-GAAP financial measure that we believe provides management and investors with information that is useful in understanding our financial performance and position.
(10)
Tangible capital ratio presented for periods ended prior to First Niagara Bank’s conversion to a national bank regulated by the OCC. Leverage ratio disclosed for periods ended subsequent to such conversion.
(11)
Tangible common equity and tangible assets exclude goodwill and other intangibles of $2.6 billion, $1.8 billion, $1.1 billion, $935 million, and $785 million at December 31, 2012, 2011, 2010, 2009, and 2008, respectively. Tangible common equity also excludes preferred stock of $338 million at December 31, 2012 and 2011 and $177 million at December 31, 2008. This is a non-GAAP financial measure that we believe provides management and investors with information that is useful in understanding our financial performance and condition.
(12)
Includes consumer loans, which are considered classified when they are 90 days or more past due. Classified loans include substandard, doubtful, and loss, which are consistent with regulatory definitions, and as described in Item 1, “Business”, under the heading “Asset Quality Review”.
(13)
Beginning in 2011, criticized loans include consumer loans when they are 90 days or more past due. Prior to 2011, criticized loans include consumer loans when they are 60 days or more past due. Criticized loans include special mention, substandard, doubtful, and loss.
(14)
The Texas ratio is computed by dividing the sum of nonperforming assets and loans 90 days past due still accruing by the sum of tangible equity and the allowance for loan losses. This is a non-GAAP measure that we believe provides management and investors with information that is useful in understanding our financial performance and position.
(15)
Originated loans represent total loans excluding acquired loans.
ITEM 7.
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is an analysis of our financial condition and results of operations. You should read this item in conjunction with our Consolidated Financial Statements and related notes filed with this report in Part II, Item 8, “Financial Statements and Supplementary Data” and the description of our business filed here within Part I, Item I, “Business.”
OVERVIEW
First Niagara Financial Group, Inc. is a Delaware corporation and a bank holding company, subject to supervision and regulation by the Federal Reserve, serving both retail and commercial customers through our bank subsidiary, First Niagara Bank, N.A., a national bank subject to supervision and regulation by the OCC. We are a multi-faceted regional bank, with a community banking model, in Upstate New York, Pennsylvania, Connecticut, and Western Massachusetts with $36.8 billion of assets, $27.7 billion of deposits, and 430 branch locations as of December 31, 2012.
We were organized in April 1998 in connection with the conversion of First Niagara Bank, N.A. from a mutual savings bank to a stock savings bank. Since that time we have strategically deployed capital through the acquisition of community banks and financial services companies throughout Upstate New York, and most recently through our September 2009 acquisition of 57 National City Bank branch locations in Western Pennsylvania; our April 2010 merger with Harleysville in Eastern Pennsylvania; our April 2011 merger with NewAlliance, which allowed us to further build our organization by adding operations in Connecticut and Western Massachusetts; and our May 18, 2012 acquisition of 137 full-service branches from HSBC in the Buffalo, Rochester, Syracuse, Albany, Downstate New York and Connecticut banking markets. We provide our customers with a full range of products and services delivered through our customer focused operations, which include retail and commercial banking; financial services and risk management (insurance); and commercial business services. These include commercial real estate loans, commercial business loans and leases, residential real estate, home equity and other consumer loans, as well as retail and commercial deposit products and insurance services. We also provide wealth management products and services.
Our goal is to organically grow both loans and deposits, as these relationships are the primary drivers of our financial success. We have continued to open de novo branch locations, albeit at a slower pace, especially in areas where acquisition opportunities have been more limited. We have also significantly expanded our commercial lending and business services to include a full complement of cash management and merchant banking services. Over the past three year period, we supplemented our organic growth strategy with the opportunistic acquisitions of whole banks, bank branches, and financial services organizations.
Following the acquisition of four franchises over the past three year period, our strategy today has evolved to an “Operate Operate Operate” strategy from the prior “Aggregate, Integrate, Operate” strategy. We fully expect to leverage our expanded market presence, improved competencies, our capacity in newer and existing markets, and our enhanced products and services to continue the acquisition of core deposit and lending relationships with current and prospective customers within our footprint. In our retail banking unit, we expect to further enhance our Simple Fast Easy value proposition through the addition of features and functionalities including an enhanced digital platform, remote deposit capture, and our recently launched mobile banking application as well as cross-selling products and services such as credit cards, mortgage, and automobile loans offered by our Consumer Finance division.
On May 18, 2012, the Bank acquired 137 full-service branches from HSBC in the Buffalo, Rochester, Syracuse, Albany, Downstate New York and Connecticut banking markets and paid a net deposit premium of $772 million. The Bank acquired cash of $7.4 billion, performing loans with a fair value of approximately $1.6 billion, core deposit and other intangibles of $85 million, and deposits with a fair value of approximately $9.9 billion (shortly after acquisition, we allowed $0.5 billion in municipal deposits to one large customer run-off), resulting in goodwill of $780 million. The cash received was used to pay down wholesale borrowings, including those used to purchase securities in advance of the HSBC Branch Acquisition. In addition, we acquired certain wealth management relationships and approximately $2.5 billion of assets under management of such relationships. At closing, the Bank did not receive any loans greater than 60 days delinquent. Concurrent with the HSBC Branch Acquisition, we consolidated 15 existing First Niagara branches into acquired HSBC branches and in the third quarter of 2012, we consolidated 19 of the HSBC branches into First Niagara branches, resulting in 103 net new full-service branches from the HSBC Branch Acquisition.
We incurred $183 million in pre-tax merger and acquisition expenses related to the HSBC Branch Acquisition since we entered into the Purchase and Assumption Agreement on July 30, 2011. These expenses include $65 million in prepayment penalties
on borrowings and swap termination fees; redundant facilities and employee severance costs; technology costs related to system conversions; and professional fees.
In connection with the regulatory process for the HSBC Branch Acquisition, we agreed with the DOJ to assign our purchase rights related to 26 HSBC branches in the Buffalo area. In January 2012, we entered into an agreement with Key Bank ("Key") assigning our right to purchase the 26 HSBC Buffalo branches as well as 11 additional HSBC branches in the Rochester area. On July 13, 2012, Key acquired these 37 branches with a total of $2.0 billion in deposits and approximately $256.5 million in loans, and paid us a deposit premium of $91.5 million.
In January 2012, we also entered into separate agreements with Five Star Bank ("Five Star") and Community Bank System, Inc. ("Community Bank") for them to purchase seven First Niagara branches and 20 HSBC branches, for which we had assigned our purchase rights. On June 22, 2012, Five Star acquired four First Niagara branches with $58.6 million in loans, assumed approximately $129.3 million in deposits, and paid us a deposit premium of $5.3 million. On August 17, 2012, Five Star acquired four of the HSBC branches, assumed approximately $18 million in loans, $157.2 million in deposits, and paid us a deposit premium of $6.5 million. On July 20, 2012, Community Bank acquired 16 HSBC branches, with a total of $107.0 million in loans, $696.6 million in deposits, and paid us a deposit premium of $23.8 million. On September 7, 2012, Community Bank acquired three First Niagara branches, assumed approximately $55.4 million in loans, $100.8 million in deposits, and paid us a deposit premium of $3.1 million.
The HSBC Branch Acquisition represented a unique opportunity to acquire low cost deposits and valuable customer relationships. We believe that the HSBC Branch Acquisition will result in earnings growth and strengthen our franchise. The size of the HSBC Branch Acquisition, in terms of loans acquired, deposit liabilities assumed, and the number of banking offices acquired, presents us with an attractive opportunity to significantly enhance our position in the Albany, Buffalo, Rochester and Syracuse, New York banking markets as well as in the New York-New Jersey-Connecticut banking market. Furthermore, the HSBC Branch Acquisition provides us with the opportunity to grow our share of the consumer banking, business banking and wealth management businesses in Upstate New York.
In the second quarter of 2012, we sold mortgage-backed securities in our available for sale portfolio with a total carrying value of $3.1 billion and recognized a $21 million pre-tax gain. The securities sold were selected based on an assessment of their potential prepayment risk at that time and the proceeds were used to pay down short-term borrowings. The sale of the securities served to reduce future volatility in our net interest margin by reducing the impact of prepayments on the mortgage-backed securities portfolio yield. In addition, the sale of these securities with the greatest levels of prepayment risk coupled with the pay down of short-term borrowings improves our asset sensitivity, allowing us to be better positioned to benefit when interest rates rise while at the same time managing the near term volatility created by the current sustained low interest rate environment.
As a result of the substantial prepayments received after June and the expected levels of cash flows to be received for the foreseeable future, we recognized a pre-tax retroactive adjustment of $16 million, or $0.03 per share, to accelerate premium amortization on our remaining CMO portfolio in the fourth quarter of 2012. The adjustment reduces the amount of unamortized premium on our CMO portfolio to reflect the impacts of the substantial level of prepayments received in recent months, particularly in the fourth quarter, and the expected elevated levels of cash flows to be received for the foreseeable future.
FINANCIAL OVERVIEW
Our 2012 results reflect the benefits of our HSBC Branch Acquisition, our strong core business fundamentals, and core customer acquisition across our regional banking footprint. Our performance was driven by sustained market share gains through new customer acquisition as well as deepening relationships with existing customers.
Our GAAP net income for 2012 was $168 million compared to $174 million for 2011 and diluted earnings per share in 2012 was $0.40, compared to $0.64 in 2011, reflecting:
•
Our May 2012 HSBC Branch Acquisition as reflected in the merger and acquisition integration expenses and higher average net interest-earning assets and interest-bearing liabilities.
•
The $21 million gain resulting from the sale of investment securities partially offset by the forgone interest income on these securities.
•
$25 million in retroactive premium amortization on our CMO portfolio, including $16 million in the fourth quarter of 2012 as a result of the substantial level of prepayments in recent months and those expected to continue for the foreseeable future.
•
Continued pressure on asset pricing from the low interest rate environment.
•
The full year impact of our April 2011 acquisition of NewAlliance and 94 million shares issued to its stockholders.
•
Our December 2011 issuance of 57 million common shares.
•
$28 million in dividends on the 14 million preferred shares we issued in December 2011.
Our operating (non-GAAP) net income amounted to $292 million, or $0.75 per diluted share, for 2012, compared to $267 million, or $0.98 per diluted share, for 2011. Our operating results for 2012 exclude the $25 million retroactive premium amortization on our CMO portfolio, $21 million gain on securities portfolio repositioning, $178 million in merger and acquisition integration expenses, and $6 million in restructuring charges. Our operating results for 2011 exclude $98 million in merger and acquisition integration expenses and $43 million in restructuring charges. Operating income is a non-GAAP financial measure which we believe provides a meaningful comparison of our underlying operational performance and facilitates management's and investors’ assessments of business and performance trends in comparison to others in the financial services industry and period over period analysis of our fundamental results. In addition, we believe the exclusion of the nonoperating items from our performance enables management and investors to perform a more effective evaluation and comparison of our results and to assess performance in relation to our ongoing operations.
Net interest income increased to $1.0 billion in 2012, from $881 million in 2011. This increase was driven by a number of factors, including higher interest-earning assets resulting from our May 2012 HSBC Branch Acquisition, the full year impact of our NewAlliance merger, and double digit commercial loan growth. However, our taxable equivalent net interest margin decreased from 3.58% for 2011 to 3.34% in 2012 as the accelerated premium amortization on our investment securities portfolio and downward repricing pressure on our interest earning assets negatively impacted our yields. Compression of loan yields from prepayments and lower spreads were partially offset by a 26 basis point decline in the cost of interest-bearing liabilities. Noninterest income increased $114 million due primarily to the partial year impact of the HSBC Branch Acquisition, the gain on securities portfolio restructuring, and full year impact of our April 2011 merger with NewAlliance. Mortgage banking revenues benefited from higher purchase and refinance volumes as well as higher margins on sold loans. Growth in derivatives sales to existing and new commercial customers continued to push our capital markets revenues higher.
Our HSBC Branch Acquisition resulted in higher loan and deposit balances. In addition, our commercial loan portfolio, which comprised 61% of total loans at December 31, 2012, increased 17%, excluding loans acquired from HSBC, due to sustained growth driven by our focus on our commercial lending efforts. Our investment securities balances increased $338 million as the purchases we made in anticipation of asset needs related to the HSBC Branch Acquisition were offset by our sale of $3.1 billion in mortgage-backed securities at the end of the second quarter of 2012. We used the proceeds from the sale to pay down short-term borrowings, improving our funding profile and capital ratios. Excluding deposits acquired from HSBC, our total deposit balances decreased, driven by our pricing initiatives to reduce higher cost certificates of deposit and money market accounts, which pay a higher interest rate and have higher acquisition costs. However, our strategic focus on customer acquisition and increasing consumer and business checking deposit balances resulted in higher interest-bearing checking account balances.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We evaluate those accounting policies and estimates that we judge to be critical: those most important to the presentation of our financial condition and results of operations, and that require our most subjective and complex judgments. Accordingly, our accounting estimates relating to the investment securities accounting (valuation, other than temporary impairment analysis, and prepayment assumptions on our CMOs and MBS), the accounting treatment and valuation of our acquired loans, adequacy of our allowance for loan losses, and the analysis of the carrying value of goodwill for impairment are deemed to be critical, as our judgments could have a material effect on our results of operations.
Investment Securities
As of December 31, 2012, our available for sale and held to maturity investment securities totaled $12.3 billion, or 33% of our total assets. We use third party pricing services to value our investment securities portfolio, which is comprised almost entirely of Level 2 fair value measured securities. Fair value of our investment securities is based upon quoted market prices of identical securities, where available. If such quoted prices are not available, fair value is determined using valuation models that consider cash flow, security structure, and other observable information. For the vast majority of the portfolio, we validate the prices received from these third parties, on a quarterly basis, by comparing them to prices provided by a different independent pricing service. For the remaining securities that are priced by these third parties where we are unable to obtain a secondary independent price, we review material price changes for reasonableness based upon changes in interest rates, credit outlook based upon spreads for similar securities, and the weighted average life of the debt securities. We have also reviewed detailed valuation methodologies provided to us by our pricing services. We did not adjust any of the prices provided to us by the independent pricing services at December 31, 2012 or 2011. Where sufficient information is not available from the pricing services to produce a reliable valuation, we estimate fair value based on broker quotes, which are reviewed using the same
process that is applied to our securities priced by pricing services where we are unable to obtain a secondary independent price, or based on internally developed models consider estimated prepayment speeds, losses, recoveries, default rates that are implied by the underlying performance of collateral in the structure or similar structures, and discount rates that are implied by market prices for similar securities and collateral structure types.
We conduct a quarterly review and evaluation of our investment securities portfolio to determine if any declines in fair value below amortized cost are other than temporary. In making this determination, we consider some or all of the following factors: the period of time the securities have been in an unrealized loss position, the percentage decline in fair value in comparison to the securities’ amortized cost, credit rating, the financial condition of the issuer and guarantor, where applicable, the delinquency or default rates of underlying collateral, credit enhancement, projected losses, level of credit loss, and projected cash flows. If we intend to sell a security with a fair value below amortized cost or if it is more likely than not that we will be required to sell such a security, we would record an other than temporary impairment charge through current period earnings for the full decline in fair value below amortized cost. For debt securities that we do not intend to sell or it is more likely than not that we will not be required to sell before recovery, we would record an other than temporary impairment charge through current period earnings for the amount of the valuation decline below amortized cost that is attributable to credit losses. The remaining difference between the debt security’s fair value and amortized cost (i.e. decline in fair value not attributable to credit losses) is recognized in other comprehensive income.
Our investment securities portfolio includes residential mortgage backed securities and collateralized mortgage obligations. As the underlying collateral of each of these securities is comprised of a large number of similar residential mortgage loans for which prepayments are probable and the timing and amount of such prepayments can be reasonably estimated, we estimate future principal prepayments of the underlying residential mortgage loans to determine a constant effective yield used to apply the interest method, with retroactive adjustments made as warranted.
Acquired Loans
Loans that we acquire in acquisitions subsequent to January 1, 2009 are recorded at fair value with no carryover of the related allowance for loan losses. Determining the fair value of the loans involves estimating the amount and timing of principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest.
We have acquired loans in four separate acquisitions after January 1, 2009. For each acquisition, we reviewed all loans greater than $1 million and considered the following factors as indicators that such an acquired loan had evidence of deterioration in credit quality and was therefore in the scope of Accounting Standards Codification (“ASC”) 310-30 (Loans and Debt Securities Acquired with Deteriorated Credit Quality):
•
Loans that were 90 days or more past due;
•
Loans that had an internal risk rating of substandard or worse. Substandard is consistent with regulatory definitions and is defined as having a well defined weakness that jeopardizes liquidation of the loan;
•
Loans that were classified as nonaccrual by the acquired bank at the time of acquisition; or
•
Loans that had been previously modified in a troubled debt restructuring.
Any acquired loans that were not individually in the scope of ASC 310-30 because they did not meet the criteria above were either (i) pooled into groups of similar loans based on the borrower type, loan purpose, and collateral type and accounted for under ASC 310-30 by analogy or (ii) accounted for under ASC 310-20 (Nonrefundable Fees and Other Costs.)
Acquired loans accounted for under ASC 310-30 by analogy
We performed a fair valuation of each of the pools and each pool was recorded at a discount. We determined that at least part of the discount on the acquired pools of loans was attributable to credit quality by reference to the valuation model used to estimate the fair value of these pools of loans. The valuation model incorporated lifetime expected credit losses into the loans’ fair valuation in consideration of factors such as evidence of credit deterioration since origination and the amounts of contractually required principal and interest that we did not expect to collect as of the acquisition date. Based on the guidance included in the December 18, 2009 letter from the AICPA Depository Institutions Panel to the Office of the Chief Accountant of the SEC, we have made an accounting policy election to apply ASC 310-30 by analogy to qualifying acquired pools of loans that (i) were acquired in a business combination or asset purchase, (ii) resulted in recognition of a discount attributable, at least in part, to credit quality; and (iii) were not subsequently accounted for at fair value.
The excess of expected cash flows from acquired loans over the estimated fair value of acquired loans at acquisition is referred to as the accretable discount and is recognized into interest income over the remaining life of the acquired loans using the interest method. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable discount. The nonaccretable discount represents estimated future
credit losses expected to be incurred over the life of the acquired loans. Subsequent decreases to the expected cash flows require us to evaluate the need for an addition to the allowance for loan losses. Subsequent improvements in expected cash flows result in the reversal of a corresponding amount of the nonaccretable discount which we then reclassify as accretable discount that is recognized into interest income over the remaining life of the loan using the interest method. Our evaluation of the amount of future cash flows that we expect to collect takes into account actual credit performance of the acquired loans to date and our best estimates for the expected lifetime credit performance of the loans using currently available information. Charge-offs of the principal amount on acquired loans would be first applied to the nonaccretable discount portion of the fair value adjustment. To the extent that we experience a deterioration in credit quality in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses would be established based on our estimate of future credit losses over the remaining life of the loans.
In accordance with ASC 310-30, recognition of income is dependent on having a reasonable expectation about the timing and amount of cash flows expected to be collected. We perform such an evaluation on a quarterly basis on both our acquired loans individually accounted for under ASC 310-30 and those in pools accounted for under ASC 310-30 by analogy.
Cash flows for acquired loans individually accounted for under ASC 310-30 are estimated on a quarterly basis. Based on this evaluation, a determination is made as to whether or not we have a reasonable expectation about the timing and amount of cash flows. Such an expectation includes cash flows from normal customer repayment, foreclosure or other collection efforts. Cash flows for acquired loans accounted for on a pooled basis under ASC 310-30 by analogy are also estimated on a quarterly basis. For residential real estate, home equity and other consumer loans, cash flow loss estimates are calculated by a vintage and FICO based model which incorporates a projected forward loss curve. For commercial loans, lifetime loss rates are assigned to each pool with consideration given for pool make-up, including risk rating profile. Lifetime loss rates are developed from internally generated loss data and are applied to each pool.
To the extent that we cannot reasonably estimate cash flows, interest income recognition is discontinued. The unit of account for loans in pools accounted for under ASC 310-30 by analogy is the pool of loans. Accordingly, as long as we can reasonably estimate cash flows for the pool as a whole, accretable yield on the pool is recognized and all individual loans within the pool - even those more than 90 days past due - would be considered to be accruing interest in our financial statement disclosures, regardless of whether or not we expected to collect any principal or interest cash flows on an individual loan 90 days or more past due.
Allowance for Loan Losses
We determined our allowance for loan losses by portfolio segment, which consist of commercial loans and consumer loans. Our commercial loan portfolio segment includes both business and commercial real estate loans. Our consumer portfolio segment includes residential real estate, home equity, and other consumer loans. We further segregate these segments between loans which are accounted for under the amortized cost method (referred to as “originated” loans) and loans acquired (referred to as “acquired” loans), as acquired loans were originally recorded at fair value, which includes an estimate of lifetime credit losses, resulting in no carryover of the related allowance for loan losses.
Originated loans
We establish our allowance for loan losses through a provision for credit losses based on our evaluation of the credit quality of our loan portfolio. This evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers, among other matters, the estimated fair value of the underlying collateral, economic conditions, historical net loan loss experience, and other factors that warrant recognition in determining our allowance for loan losses. We continue to monitor and modify the level of our allowance for loan losses to ensure it is adequate to cover losses inherent in our loan portfolio. In addition, regulatory agencies, as an integral part of their examination process, review our allowance for loan losses.
For our originated loans, our allowance for loan losses consists of the following elements: (i) specific valuation allowances based on probable losses on specifically identified impaired loans; and (ii) valuation allowances based on net historical loan loss experience for similar loans with similar inherent risk characteristics and performance trends, adjusted, as appropriate, for qualitative risk factors specific to respective loan types.
For our originated loans, when current information and events indicate that it is probable that we will be unable to collect all amounts of principal and interest due under the original terms of a business or commercial real estate loan greater than $200 thousand, such loan will be classified as impaired. Additionally, all loans modified in a TDR are considered impaired. The need for specific valuation allowances are determined for impaired loans and recorded as necessary. For impaired loans, we consider the fair value of the underlying collateral, less estimated costs to sell, if the loan is collateral dependent, or we use the present value of estimated future cash flows in determining the estimates of impairment and any related allowance for loan losses for
these loans. Confirmed losses are charged off immediately. Prior to a loan becoming impaired, we typically would obtain an appraisal through our internal loan grading process to use as the basis for the fair value of the underlying collateral.
Commercial loan portfolio segment
We estimate the allowance for our commercial loan portfolio segment by considering their type and loan grade. We first apply a historic loss rate to loans based on their type and loan grade. This amount is then adjusted, as necessary, for qualitative considerations to reflect changes in underwriting, market or industry conditions, or based on changes in trends in the composition of the portfolio, including risk composition, seasoning, and underlying collateral. Our loan grading system is described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Credit Risk.”
Consumer loan portfolio segment
We estimate the allowance for loan losses for our consumer loan portfolio segment by first estimating the amount of loans that will eventually default based on delinquency severity. We then apply a loss rate to the amount of loans that we predict will default based on our historical net loss experience. This amount is then adjusted, as necessary, for qualitative considerations to reflect changes in underwriting, market or industry conditions or based on changes in trends in the composition of the portfolio, including risk composition, seasoning, and underlying collateral. We obtain and review refreshed FICO scores on a quarterly basis, and trends are evaluated for consideration as a qualitative adjustment to the allowance. Other qualitative considerations include, but are not limited to, the evaluation of trends in property values, building permits and unemployment.
Acquired Loans
Acquired loans accounted for under ASC 310-30 (including those accounted for under ASC 310-30 by analogy)
For our acquired loans accounted for under ASC 310-30, our allowance for loan losses is estimated based upon our expected cash flows for these loans. To the extent that we experience a deterioration in borrower credit quality resulting in a decrease in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses would be established based on our estimate of future credit losses over the remaining life of the loans.
Acquired loans accounted for under ASC 310-20
We establish our allowance for loan losses through a provision for credit losses based upon an evaluation process that is similar to our evaluation process used for originated loans. This evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers, among other matters, the estimated fair value of the underlying collateral, economic conditions, historical net loan loss experience, carrying value of the loans, which includes the remaining net purchase discount or premium, and other factors that warrant recognition in determining our allowance for loan losses.
Goodwill
We record the excess of the cost of acquired entities over the fair value of identifiable tangible and intangible assets acquired less the fair value of liabilities assumed as goodwill. We do not amortize goodwill and we review it for impairment at our reporting unit level on an annual basis, and when events or changes in circumstances indicate that the carrying amounts may be impaired. We define a reporting unit as a distinct, separately identifiable component of one of our operating segments for which complete, discrete financial information is available and reviewed regularly by that segment's management. We have two reporting units: Banking and Financial Services. At December 31, 2012, our goodwill totaled $2.5 billion. Of this $2.5 billion, $2.4 billion, or 97%, was allocated to our Banking unit.
Under Step 1 of the goodwill impairment review, we compare each reporting unit's fair value to carrying value to identify potential impairment. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired. Determining the fair value of a reporting unit as part of the Step 1 analysis involves significant judgment. Inputs and assumptions, such as future cash flows and earnings, discount rates, the assessment of relevant market transactions for comparability and the resulting control premium assumption, and multiples of relevant financial statement metrics, such as tangible book value and estimated earnings are all estimates involving significant judgment. We are also required to assess the reasonableness of the overall combined fair value of our reporting units by reference to our market capitalization over time.
If the carrying amount of the reporting unit were to exceed its estimated fair value, a second step (Step 2) would be performed that would compare the implied fair value of the reporting unit's goodwill with the carrying amount of the goodwill for the reporting unit. The implied fair value of goodwill is determined in the same manner as goodwill that is recognized in a business combination. Significant judgment and estimates are also involved in estimating the fair value of the assets and liabilities of the reporting units, and therefore the implied fair value of goodwill, as part of this Step 2 analysis. The most significant
estimates involved related to our Banking unit would be the fair valuation of our loans and core deposit intangible asset. We would determine fair value of our loan portfolio by reference to market observable transactions for loan portfolios with similar characteristics, while we would estimate the value of the core deposit intangible asset using a discounted cash flow approach and market comparable transactions. Both of these estimates are highly subjective and involve many estimates.
During 2012, the banking industry has been challenged by numerous factors, including actions by the Federal Reserve intended to keep long term interest rates low, uncertainty surrounding the resolution of the "fiscal cliff", and regulatory actions emanating from Dodd-Frank. These factors have put negative pressure on our profitability and market capitalization. Further declines in overall interest rates, increased regulatory costs or resulting lost revenue, or worsening credit losses as a result of adverse economic conditions could reduce the profitability of one or both of our reporting units and therefore result in us having a lower stock price and market capitalization, both of which are important elements of the overall evaluation of goodwill impairment, and therefore could also lead to a goodwill impairment charge. A substantial goodwill impairment charge would not have a significant impact on our regulatory capital ratios, but could have an adverse impact on our results of operations and financial condition. However, such a charge would not be expected to decrease our level of income producing assets such as loans or investments. Due to regulatory restrictions, our banking subsidiary could be restricted from distributing available cash to the bank holding company, thus adversely affecting the liquidity of the bank holding company.
We perform our annual impairment review of goodwill on November 1 of each year utilizing valuation methods we believe appropriate, given the availability and applicability of market-based inputs for those methods. After giving appropriate consideration to all available information, we determined that the fair value of each reporting unit exceeded its carrying value (Step 1) and, therefore, there was no impairment of goodwill in 2012. As both of our reporting units' fair values exceeded their carrying amount, we were not required to perform Step 2 of the goodwill impairment review. For Step 1, we used both an income approach and a market approach to determine the fair values of our reporting units.
For our banking reporting unit, our application of the income approach was based upon assumptions of both balance sheet and income statement activity. A long-term internal forecast was developed through consideration of current year financial performance and near term expectations regarding key business drivers such as anticipated loan and deposit growth. A long-term growth rate of 5% was then applied in determining the terminal value. These cash flows were discounted at an 11% discount rate based upon consideration of the risk free rate, leverage factors, equity risk premium, and Company specific risk factors.
In our application of the market approach for our banking reporting unit, we utilized a 50% control premium assumption based on our review of transactions observable in the market place that we determined were comparable and applied market based multiples to the tangible book value and projected earnings of our banking reporting unit. The projected earnings multiple used was 10.9x and was based on our stock price at the assessment date and consensus analyst earnings, and was applied to our projected 2013 earnings. The tangible book value multiple used was 1.5x and was based on our stock price and tangible book value at the assessment date.
The market and income approaches were weighted equally. Both approaches have their inherent strengths and weaknesses; we use both and weight each equally as we believe that the approaches are complimentary. Additionally, the results of each approach were congruent with the other approach. The fair value of our Banking unit exceeded its carrying value by approximately $300 million (7%). Adverse changes to the significant estimates used in computing fair value of our Banking unit could have a significant adverse impact on its value. A reduction in the control premium assumption from 50% to 45% decreases the overall fair value of our Banking unit by approximately $80 million. A 100 basis point increase in the discount rate decreases the fair value of the Banking unit by approximately $160 million. In both of these stress scenarios, we would pass Step 1 of the goodwill impairment review.
For our financial services reporting unit, our income approach was based upon assumptions of income statement activity. An internal forecast was developed through consideration of current year financial performance and near term expectations regarding key business drivers. Long-term growth rates of 3% were then applied in determining the terminal value. A discount rate of 14% was used based upon consideration of the risk free rate, leverage factors, equity risk premium, and Company specific risk factors. In our market approach for our financial services reporting unit, we utilized a 30% control premium assumption based on our review of transactions observable in the market place that we determined were comparable to earnings for our financial services reporting unit. The market and income approaches were weighted equally.
The aggregate fair values of both of our reporting units (Banking and Financial Services) were compared to market capitalization as an assessment of the appropriateness of the fair value measurements. The comparison between the aggregate fair values and market capitalization indicated an implied control premium of 57%. A control premium analysis indicated that the implied premium was within range of the overall premiums observed in the market place.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2012 AND DECEMBER 31, 2011
The following table summarizes our results of operations for the periods indicated on a GAAP basis and on an operating (non-GAAP) basis. Our results for 2012 reflect the partial year impact of our May 2012 HSBC Branch Acquisition, the full year impact of our merger with NewAlliance in April 2011, and the full year impact of our December 2011 common stock and preferred stock issuances. Our results for 2011 reflect the full year impact of our April 2010 merger with Harleysville, partial year impact of our merger with NewAlliance, and partial year impact of our common stock issuance.
Our operating (non-GAAP) results exclude the retroactive premium amortization on investment securities portfolio, gain on securities portfolio restructuring, merger and acquisition integration expenses, and restructuring charges. We believe this non-GAAP measure provides a meaningful comparison of our underlying operational performance and facilitates management’s and investors’ assessments of business and performance trends in comparison to others in the financial services industry and period over period analysis of our fundamental results. In addition, we believe the exclusion of the nonoperating items from our performance enables management and investors to perform a more effective evaluation and comparison of our results and to assess performance in relation to our ongoing operations (amounts in thousands).
Net Interest Income
Our net interest income increased 16% to $1.0 billion in 2012 from $881 million in 2011. The year over year increase primarily reflected our $6.0 billion increase in average interest earning assets to $31.2 billion, which was largely attributable to the HSBC Branch Acquisition and full year impact of the NewAlliance merger. The increase in average interest earning assets outpaced the growth in average interest bearing liabilities, which increased $4.2 billion year over year, resulting in a $1.7 billion increase in net earning assets to $5.4 billion in 2012. The increase, on a taxable equivalent basis, in net interest income due to the increase in our average net earning assets was approximately $133 million.
As previously discussed, the Federal Reserve implements national monetary policies through its open-market operations. The FOMC has taken actions to grow the economy through maximum employment and price stability, through programs such as "Operation Twist" and purchasing of agency mortgage-backed securities. We expect these actions to further exacerbate longer-term pressures on the industry net interest margin by (i) continuing to reduce the yields on earning assets relative to the cost of funding; (ii) causing borrowers to repay their higher-yielding fixed rate loans at a faster rate; and (iii) reducing the rates at which cash flows from these repayments could be reinvested.
Despite a 24 basis points reduction in our net interest margin, our net interest income, on a taxable equivalent basis, increased $4 million due to interest rates. This was due to the impact of deposit pricing initiatives implemented by the Company throughout the year, partially offset by lower yielding assets and higher investment security premium amortization.
In light of the interest rate environment in 2012, we took targeted measures that partially mitigated this impact. Deposit pricing actions taken in the third and fourth quarter, focused primarily on our money market and online savings accounts, lowered funding costs with minimal impact to core balances. The actions related to money market deposit accounts contributed to an increase in our net interest income of $131 million. In addition, our net interest income benefited from approximately $11 million in accretable yield attributable to better than expected credit performance of certain loans acquired from Harleysville and NewAlliance.
In the second quarter of 2012, we executed our securities portfolio repositioning transaction. Since then, as a result of the substantial prepayments received and the expected levels of cash flows to be received for the foreseeable future, we recognized a pre-tax retroactive adjustment of $25 million during 2012 to accelerate premium amortization on our CMO portfolio. Including these retroactive premium adjustments, we recognized $100 million of premium amortization related to our residential mortgage-backed securities portfolio. As of December 31, 2012, the amount of net premiums on our residential mortgage-backed securities to be recognized in future periods amounted to approximately $96 million, which equates to a weighted average premium above par of approximately 1.7%. Subsequent changes to the interest rate environment will continue to impact our yield earned on these securities.
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Our average balance of investment securities increased year over year by approximately $2.3 billion due to the investment of the proceeds received from the HSBC Branch Acquisition, partially offset by the securities portfolio repositioning discussed above. The increase in average balance was offset by a decrease in yield of 68 basis points during 2012. The decrease in yield was primarily due to increased premium amortization on residential mortgage-backed securities and lower yielding assets.
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Our average balance of loans increased by $3.6 billion, of which $1.0 billion was attributable to the impact of loans acquired from HSBC. The remaining increase was attributable to organic growth in our commercial loans portfolio and $228 million in our indirect auto portfolio, offset by a decrease in our residential loan category. Loan yields declined 36 basis points as commercial loan yields decreased by 52 basis points, while our total consumer loan portfolio decreased by 11 basis points.
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Excluding the HSBC Branch Acquisition impact, our average balances of interest bearing deposits increased by $306 million and our average rate paid declined by two basis points due to our deposit pricing actions. The increase in our average balances was driven by the full year impact of the NewAlliance acquisition being offset by our interest rate and treasury management strategies as we continue to move down deposit pricing.
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Our average borrowings decreased year over year by approximately $1.3 billion as a result of paying down borrowings upon closing of the HSBC Branch Acquisition. This also increased the rate paid on borrowings by 9 basis points as the pay down of wholesale borrowings resulted in a higher concentration of our borrowings in longer term corporate debt.
The following table presents our condensed average balance sheet as well as taxable-equivalent interest income and yields. We use a taxable equivalent basis in order to provide the most comparative yields among all types of interest-earning assets. Yields earned on interest-earning assets, rates paid on interest-bearing liabilities and average balances are based on average daily balances (amounts in thousands):
(1)
Average outstanding balances are net of deferred costs and unearned discounts and include nonperforming loans and for 2010, loans held for sale.
(2)
Average outstanding balances are at amortized cost.
(3)
Our operating (non-GAAP) results excluded $25 million of accelerated CMO adjustments from our net interest income. Had these adjustments been excluded from the table above, our yields for the year ended December 31, 2012 would have been:
(4)
Average outstanding balances include unrealized gains/losses on securities available for sale.
(5)
Average outstanding balances include allowance for loan losses and bank-owned life insurance, earnings from which are reflected in noninterest income.
Rate/Volume Analysis
The following table presents (on a taxable-equivalent basis) the extent to which changes in interest rates and changes in the volume of our interest-earning assets and interest-bearing liabilities have affected our net interest income during the years indicated. We have provided information in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate for the years ended December 31 (in thousands):
Provision for Credit Losses
Our provision for credit losses is comprised of three components: consideration of the adequacy of our allowance for originated loan losses; needs for allowance for acquired loan losses due to deterioration in credit quality subsequent to acquisition; and probable losses associated with our unfunded loan commitments. Our provision for credit losses related to our originated loans is based upon the inherent risk of our loans and considers such interrelated factors as the composition and other credit risk factors of our loan portfolio, growth in our loan portfolio, trends in asset quality including loan concentrations, and the level of our delinquent loans. Consideration is also given to collateral value, government guarantees, and regional and global economic considerations. Our provision for credit losses related to our acquired loans is based upon a deterioration in expected cash flows subsequent to the acquisition of the loans. These acquired loans were originally recorded at fair value on the date of acquisition. As the fair value at time of acquisition incorporated lifetime expected credit losses, there was no carryover of the related allowance for loan losses.
The following table details the composition of our provision for credit losses for the periods indicated (in thousands):
The provision for credit losses was $92.3 million in 2012, reflecting continued growth in our commercial lending portfolios, offset by credit quality improvements in our commercial real estate portfolio and, to a lesser extent, in our home equity portfolio. We also recorded a $1.3 million provision for unfunded loan commitments in 2012 as a result of the organic growth in our unfunded commitments and the associated liability. Our total unfunded commitments at December 31, 2012 were $8.7 billion, which included $3.0 billion of unfunded commitments acquired in the HSBC Branch Acquisition. The liability for unfunded commitments is included in Other Liabilities in our Consolidated Statements of Condition and amounted to $12 million and $7 million at December 31, 2012 and December 31, 2011, respectively. The remaining increase of $4 million was established to recognize probable losses inherent in the commitments assumed in the HSBC Branch Acquisition.
Our provision for loan losses related to our originated loans is based upon the inherent risk of our loans and considers such interrelated factors as the composition and other credit risk factors of our loan portfolio, trends in asset quality including loan concentrations, and the level of our delinquent loans. Consideration is also given to collateral value, government guarantees, and regional and global economic considerations. The provision for credit losses related to originated loans amounted to $83.7 million, or 0.73% of average originated loans, for 2012, compared to $51 million, or 0.58% of average originated loans, for 2011. This provision included approximately $43.3 million to support sequential originated loan growth of $3.5 billion and $40.4 million to cover net charge-offs.
Our provision for loan losses related to our acquired loans is based upon a deterioration in expected cash flows subsequent to the acquisition of the loans. These acquired loans were originally recorded at fair value on the date of acquisition. As the fair value at time of acquisition incorporated lifetime expected credit losses, there was no carryover of the related allowance for loan losses. Subsequent to acquisition, we periodically reforecast the expected cash flows for our acquired loans and compare this to our original estimates to evaluate the need for a loan loss provision. In 2012, we recorded $7.4 million of provision related to our acquired loans primarily due to the charge-off of several commercial loans acquired in the Harleysville acquisition. Due to a decrease in expected cash flows in 2011 related to a portfolio of other consumer loans acquired from Harleysville with an outstanding principal balance of approximately $59 million as of December 31, 2011, we recorded a provision for credit losses related to acquired other consumer loans for $2 million in 2011, representing our expected credit losses over the remaining life of the loans. In addition, we recognized $1 million in provision during 2011 related to commercial business and commercial real estate loans acquired from Harleysville due to a deterioration in credit performance.
Noninterest Income
The following table presents our noninterest income for the years ended December 31 (amounts in thousands):
Noninterest income increased $114 million for the year ended December 31, 2012, compared to the year ended December 31, 2011. The increase is primarily attributable to the partial year impact of the HSBC Branch Acquisition, gain on securities portfolio repositioning, and the full year impact of our April 2011 merger with NewAlliance. However, other factors contributing to changes in noninterest income are described below:
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Revenues from deposit service charges benefited not only from the HSBC Branch Acquisition but also from an increase in checking account openings and our ongoing fee income initiatives.
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Wealth management services revenues increased primarily due to the impact of acquiring wealth management relationships from HSBC. However, the increase is also a reflection of greater cross-selling of securities and insurance products through our branch network and the growth strategy of our Private Client Services group as we opened offices in Buffalo, Rochester and Pittsburgh in 2011 to add to offices we acquired in Philadelphia in 2010 and Connecticut in 2011. In addition, alternative investment products have become more marketable in the current low rate environment.
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Capital markets revenues more than doubled, reflecting growth in derivatives sales to commercial customers whereby we act as an interest rate swap counterparty.
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Mortgage banking revenues benefited from higher refinance volumes as well as higher margins on sold loans through the first three quarters of 2012 but we were negatively impacted late in the fourth quarter by lower application volumes and margins. We opened our third mortgage processing center in the fourth quarter of 2012. As the mortgage business is a strategic focus for us, we are building capacity to meet long-term strategic goals of growing this business, including a greater emphasis on retail origination and new purchase volumes.
Excluding the gain on the investment securities portfolio sale and premium acceleration on our CMO portfolio, noninterest income as a percentage of net revenue (the sum of net interest income and noninterest income) increased from 21.8% for the year ended December 31, 2011 to 24.4% for the year ended December 31, 2012 reflecting the benefits of our acquisitions, low mortgage rates, and our capital markets business.
Noninterest Expenses
The following table presents our noninterest expense for the years ended December 31 (amounts in thousands):
(1)
We believe this non-GAAP measure provides a meaningful comparison of our underlying operational performance and facilitates management’s and investors’ assessments of business and performance trends in comparison to others in the financial services industry and period over period analysis of our fundamental results. The operating efficiency ratio is computed by dividing operating noninterest expense by the sum of net interest income and noninterest income.
(2)
The efficiency ratio is computed by dividing noninterest expense by the sum of net interest income and noninterest income.
Noninterest expense increased $245 million for the year ended December 31, 2012, compared to the same period in 2011, primarily due to the merger and acquisition integration expenses incurred as a result of the HSBC Branch Acquisition, the additional expenses resulting from operating the HSBC branches, and the growth of our infrastructure. FDIC premiums increased due to the growth of our balance sheet which increased our assessment base. However, we were able to partially mitigate the impact of these factors through our Bank's capital management strategies. The Company made capital contributions to the Bank of $150 million and $65 million in the first and third quarters of 2012, respectively, and $645 million in the fourth quarter of 2011 resulting in lower FDIC expense.
Merger and acquisition integration expenses of $178 million and $6 million for the years ended December 31, 2012 and 2011, respectively, were attributable to the HSBC Branch Acquisition while $92 million for the year ended December 31, 2011 were attributable to our merger with NewAlliance.
Consistent with our rapid growth and focus on being more efficient, we restructured certain aspects of our delivery channels and infrastructure. Specifically, we adjusted the branch network in Eastern Pennsylvania by closing 14 branches; consolidated certain back office facilities; and restructured our back office and branch infrastructure and operations, including a branch staffing realignment aimed at enhancing our sales capabilities in small business lending and wealth management. This branch staffing realignment puts more small business bankers and financial advisors in our branches and will support our efforts to drive transaction account growth and greater fee income in the future.
The following table summarizes the restructuring expenses that we recognized for the periods indicated (in thousands):
Income Taxes
Income tax expense for 2012 and 2011 was $71 million and $88 million, respectively, and the effective tax rate was 29.6% and 33.7%, respectively. The effective tax rate for 2012 decreased from 2011 primarily as a result of a decrease in state income tax, an increase in favorable permanent tax adjustments including tax exempt interest in 2012 as well as the reversal of tax reserves in the third quarter of 2012.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2011 AND DECEMBER 31, 2010
Our net income for 2011 was $174 million compared to $140 million for 2010. Diluted earnings per share in 2011 was $0.64, compared to $0.70 in 2010, and reflected the impact of the 94 million shares issued to NewAlliance stockholders in April and our December 2011 issuance of 57 million common shares in an underwritten public offering.
Our operating (non-GAAP) net income, which excludes merger and acquisition integration expenses and restructuring charges, amounted to $267 million, or $0.98 per diluted share, for 2011, compared to $174 million, or $0.87 per diluted share, for 2010. Operating income is a non-GAAP financial measure which provides a meaningful comparison of our underlying operational performance and we believe facilitates management and investors' assessments of business and performance trends in comparison to others in the financial services industry and period over period analysis of our fundamental results. In 2011, we incurred $98 million in merger and acquisition integration expenses and $43 million in restructuring charges as we adjusted certain aspects of our delivery channels and infrastructure. Merger and acquisition integration expenses amounted to $50 million in 2010.
Net interest income increased significantly to $881 million in 2011, up 47% from 2010. This increase was driven by a number of factors, including our April 2011 merger with NewAlliance, the full year impact of our Harleysville merger and strong commercial loan growth. Our net interest margin of 3.58% in 2011 decreased from 3.64% for 2010 as NewAlliance and the low interest rate environment negatively impacted our margins. Noninterest income increased $59 million, or 31%, due primarily to increases in fee based banking services and wealth management services in our recently acquired Pennsylvania, Connecticut and Western Massachusetts markets and an increase in insurance commissions due to our insurance agency acquisitions in 2010 and 2011. In addition, derivatives sales to existing commercial customers increased capital markets revenues by $7 million during 2011.
Our merger with NewAlliance resulted in higher loan, investment and deposit balances in 2011 compared to 2010. In addition, our commercial loan portfolio, which comprised 61% of total loans at December 31, 2011, increased 13% from 2010, excluding loans acquired from NewAlliance, due to organic growth driven by our focus on our commercial lending efforts. Our investment securities balances increased not only due to the securities we acquired from NewAlliance, but also due to our purchase of approximately $1.2 billion of securities in anticipation of asset needs related to the HSBC Branch Acquisition. We funded these purchases with a combination of FHLB advances, repurchase agreements, and cash received through our capital raise in early December 2011. Excluding deposits acquired from NewAlliance, our total deposit balances increased modestly during 2011, driven by planned certificate of deposit runoff offset by a 13% increase in core deposit balances, primarily in money market deposit accounts. Our strategy to not renew maturing certificates of deposit resulted in a decrease of $854 million in these accounts. Excluding $2.3 billion acquired from NewAlliance, our borrowings increased approximately $934 million reflecting our use of borrowings to fund our pre-buying strategy noted above and our issuance of $300 million in subordinated notes.
Net Interest Income
Our net interest income increased 47% to $881 million in 2011 compared to $598 million in 2010. The year over year increase primarily reflected our $8.5 billion increase in average interest-earning assets to $25.2 billion, which was largely attributable to the NewAlliance merger. The increase in average interest-earning assets outpaced the growth in average interest-bearing liabilities, which increased $7.3 billion year over year, resulting in a $1.1 billion increase in net earning assets to $3.6 billion in 2011. The increase, on a taxable equivalent basis, in net interest income due to the increase in our average net earning assets was approximately $310 million.
The increase in net interest income driven by the increase in interest earning assets was offset by a decrease in net interest income of approximately $15 million, on a taxable equivalent basis, or six basis points in our net interest margin, reflecting the challenging interest rate environment in 2011.
In light of the interest rate environment in 2011, we took targeted measures to mitigate the impact of this environment. Deposit pricing actions taken in the third quarter, which were focused primarily on our money market deposit accounts, lowered funding costs by attracting funds from maturing higher priced certificates of deposit and adding new account holders, which presented cross-selling opportunities for other deposit products. In addition, our net interest income benefited from approximately $4 million in accretable yield recapture attributable to better than expected credit performance of certain loans acquired from Harleysville and National City Bank.
Provision for Credit Losses
Our provision for credit losses related to originated loans amounted to $51 million, or 0.58% of average originated loans, for 2011, compared to $49 million, or 0.68% of average originated loans, for 2010. During 2011, our allowance for loan losses related to our originated loans increased $23 million to $118 million, compared to a $7 million increase during 2010.
Due to a decrease in expected cash flows in 2011 related to a portfolio of other consumer loans acquired from Harleysville with an outstanding principal balance of approximately $59 million as of December 31, 2011, we recorded a provision for credit losses related to acquired other consumer loans for $2 million, representing our expected credit losses over the remaining life of the loans. In addition, we recognized $1 million in provision during 2011 related to commercial business and commercial real estate loans acquired from Harleysville due to a deterioration in credit performance. There was no such provision for loan losses related to our acquired loans for 2010 as the loans performed in line with our original estimates established at acquisition.
Additionally, our total provision for credit losses for 2011 included $4 million for unfunded loan commitments, primarily due to the increase in unfunded loan commitments to $5.1 billion at December 31, 2011. The liability resulting from this provision as well as the recognition of assumed liabilities through purchase accounting was $7 million as of December 31, 2011 and is included in Other Liabilities in our Consolidated Statement of Condition.
Noninterest Income
Noninterest income increased $59 million, or 31%, for the year ended December 31, 2011, compared to the year ended December 31, 2010. The increases in revenues from banking services, mortgage banking, lending and leasing, and other noninterest income were primarily attributable to our April 2011 merger with NewAlliance. These increases were also attributable to the full year impact of our April 2010 merger with Harleysville, whereby a full year of activity was included in the results for 2011 and only nine months were included in the results for 2010.
While our results show an increase in revenues from banking services, we were negatively impacted by the provision in the Dodd-Frank Act known as the “Durbin Amendment,” limiting permissible interchange fees that banks may charge. In June 2011, the Federal Reserve adopted regulations setting the maximum permissible interchange fee as the sum of 21 cents per transaction and five basis points multiplied by the value of the transaction, with an additional adjustment of up to one cent per transaction if the issuer implements certain fraud prevention standards. The impact of the Durbin Amendment, net of certain revenue generating initiatives, was a reduction of our banking services revenues by approximately $4 million during the fourth quarter of 2011.
The increase in insurance commissions was attributable to our insurance agency acquisitions in Pennsylvania during 2010 and Connecticut and Western Massachusetts in 2011. A portion of the increase in revenues from wealth management services was due to the NewAlliance merger but the majority of the increase was due to increased activity in Upstate New York and especially Eastern Pennsylvania where we experienced greater cross-selling of securities and insurance products through our branch network.
The increase in other noninterest income was primarily attributable to an $8 million increase in capital markets revenues, reflecting increased derivatives sales driven by cross-selling to existing healthcare, municipal, leasing, and other commercial customers.
Noninterest Expenses
The $283 million, or 54%, increase in noninterest expenses during 2011 from 2010 was primarily due to a $95 million increase in salaries resulting from incremental salaries related to the NewAlliance merger, $48 million increase in merger and acquisition integration expenses, targeted investments in our infrastructure to increase the sophistication and efficiency of our back office processes, increased costs associated with the NewAlliance branches, and $43 million in restructuring charges, which includes $4 million in severance related expenses as a result of our fourth quarter 2011 branch staff realignment designed to enhance our sales capabilities in small business lending and wealth management.
The increase in operating noninterest expenses from 2010 to 2011 was due to increased expenses related to our April merger with NewAlliance and our infrastructure growth. Salaries and benefits increased $95 million, or 39%, as a result of the incremental salaries associated with the NewAlliance merger as well as the continued investment in our infrastructure, reflective of the increase in the number of full-time employees from 3,791 at December 31, 2010 to 4,827 at December 31, 2011. The increase in occupancy and equipment expense resulted from the increase in the number of branches due to the NewAlliance merger, while our technology and communications expense increased not only due to the merger but also due to the expansion of our data center capacity for future growth and other technology enhancements. The launch of our new checking account campaign, “You First,” was the primary contributing factor of the increase in our marketing and advertising expense and the increase in professional services was driven by the outsourcing of our data center. The enactment of new FDIC regulations as mandated by Dodd-Frank combined with the assets acquired from NewAlliance resulted in higher FDIC premiums during 2011.
Merger and acquisition integration expenses of $98 million for the year ended December 31, 2011 were primarily attributable to our merger with NewAlliance. However, $6 million was attributable to our pending HSBC Acquisition. Severance costs comprised more than half of the expenses related to the NewAlliance merger, which also included charitable contributions, professional services, marketing and advertising, technology and communications, occupancy and equipment, and other noninterest expenses. Of the $50 million in merger and acquisition integration expenses for the year ended December 31, 2010, $44 million was attributable to our merger with Harleysville and the remainder was attributable to our merger with NewAlliance.
Income Taxes
Income tax expense for 2011 and 2010 was $88 million and $72 million, respectively, and the effective tax rate was 33.7% and 33.9%, respectively. The effective tax rate for 2011 decreased from 2010 primarily as a result of a decrease in state income tax and increases in tax exempt income and bank owned life insurance in 2011. This decrease was partially offset by an increase in nondeductible transaction costs and minor return to accrual adjustments.
FOURTH QUARTER RESULTS
The following table summarizes our results of operations for the periods indicated on a GAAP basis and on an operating (non-GAAP) basis for the periods indicated. Our operating results exclude the retroactive premium amortization on investment securities portfolio, gain on securities portfolio restructuring, merger and acquisition integration expenses, and restructuring charges. We believe this non-GAAP measure provides a meaningful comparison of our underlying operational performance and facilitates management’s and investors’ assessments of business and performance trends in comparison to others in the financial services industry and period over period analysis of our fundamental results. In addition, we believe the exclusion of the nonoperating items from our performance enables management and investors to perform a more effective evaluation and comparison of our results and to assess performance in relation to our ongoing operations (in thousands).
Comparison to Prior Quarter
GAAP net income for the three months ended December 31, 2012 increased to $61 million, or $0.15 per diluted common share, from $58 million, or $0.14 per diluted common share, for the three months ended September 30, 2012. Our operating (non-GAAP) net income for the three months ended December 31, 2012 remained nearly unchanged at $75 million, or $0.19 per diluted common share, from $74 million, or $0.19 per diluted common share, for the three months ended September 30, 2012.
Operating (non-GAAP) net interest income in the fourth quarter was flat to the prior quarter. Excluding the acceleration of the $16 million retroactive premium amortization, our net interest margin was 3.42%, a 12 basis point decrease from the third quarter of 2012. Continued compression of loan yields from prepayments and lower spreads was partially offset by a three basis point decrease in the cost of interest bearing deposits and a 13% annualized increase in average interest-earning assets.
Average commercial loan balances increased $302 million, or 11% annualized, over the prior quarter, the twelfth consecutive quarter of double digit growth as strong business and commercial real estate demand continued across our footprint. Commercial business loan balances averaged $4.8 billion, representing a 15% annualized increase over the prior quarter. Commercial real estate loans increased 8% annualized to $6.9 billion. Strength in specialty lending business lines such as equipment finance, healthcare lending, and capital markets contributed to robust growth in our traditional middle market and commercial real estate businesses. Commercial loans, excluding small business loans, in our Western and Eastern Pennsylvania and New England markets increased 12%, 28%, and 10%, respectively, while balances in the New York market increased 6% following a strong third quarter, in which they increased 15%.
Average indirect auto loan balances increased $214 million to $515 million. During the fourth quarter, new originations yielded 3.43%. We continue to target and engage new car dealers within our contiguous footprint to lend and finance primarily used car purchases for high credit quality customers.
Average residential real estate loans declined by $143 million, or 14% annualized, from the third quarter reflecting higher prepayments. Average credit card and other consumer loan balances were unchanged.
Our strategic focus on core deposit customer acquisition continued to allow us to successfully reposition our account mix and increase low cost deposits. Average transactional accounts, which include interest-bearing checking and noninterest-bearing balances, increased to $8.8 billion, up 16% annualized compared to the prior quarter, with double-digit increases across each market. These low cost deposits now represent 32% of our deposit base, compared to 26% a year ago.
Average noninterest-bearing deposits increased 2% annualized while interest-bearing checking deposits increased 32% annualized over the prior quarter driven by strong customer engagement that resulted in higher account balances. Due to the higher cost associated with obtaining money market deposit accounts and the potential low rate of retention in a rising interest rate environment, we undertook pricing initiatives to reduce the higher cost money market balances. Average total core deposits, excluding time deposits, increased to $23.5 billion, or 2% annualized, compared to the third quarter.
The provision for loan losses on originated loans totaled $21.4 million for the quarter ended December 31, 2012, unchanged from the prior quarter. This provision included $13.7 million to support sequential originated loan growth of $1.1 billion and $7.6 million to cover net charge-offs. Net charge-offs equaled 24 basis points of average originated loans in the fourth quarter of 2012, a six basis point improvement from the prior quarter. At December 31, 2012, the allowance for loan losses on originated loans totaled $161 million or 1.20% of such loans, compared to $147.2 million or 1.20% of loans at September 30, 2012.
At the end of the fourth quarter, nonperforming assets to total assets were 0.50%, and increased eight basis points from the prior quarter. Nonperforming originated loans as a percentage of originated loans increased to 1.07% at December 31, 2012 from 0.93% at September 30, 2012. Approximately one-third of the $29 million sequential increase in nonperforming originated loans related to guidance issued by the OCC to place consumer loans discharged in bankruptcy on nonaccrual status. The remaining increase in commercial nonaccruals was driven primarily by one large commercial credit in the company's Eastern Pennsylvania market.
The provision for loan losses on acquired loans totaled $0.2 million, compared to $0.4 million in the prior quarter. Net charge-offs on those portfolios totaled $1.3 million during the quarter, compared to $1.0 million in the prior period. At December 31, 2012, the allowance for loan losses on acquired loans totaled $1.6 million, compared to $2.7 million at September 30, 2012. Acquired nonperforming loans totaled $30 million, compared to $28 million at the end of the prior quarter. At December 31, 2012, remaining credit marks available to absorb losses on acquired loans totaled $176 million.
Excluding the $5 million gain in the third quarter on the securities portfolio repositioning, noninterest income decreased $5 million in the fourth quarter of 2012 from the third quarter of 2012. Continued strength in derivative swap activity and increased assets under management in our wealth management platform contributed to 11% and 8% increases in capital markets and wealth management revenues, respectively. These increases were offset by lower mortgage banking revenues as well as typical fourth quarter declines in insurance fees. Mortgage banking revenues decreased $3 million from the prior quarter driven by lower application volumes and gain-on-sale margins. However, closed mortgage origination volumes increased 12% from the prior quarter to an all time high. During the quarter, we opened a third mortgage processing center to expediently meet and exceed the needs of our customers.
Excluding merger and acquisition integration expenses, fourth quarter noninterest expenses decreased $2 million to $235 million from the third quarter, driven by the initial impact of our workforce optimization initiative in the third quarter. The benefit of the resulting $5 million decrease in salaries and benefits was minimized by seasonal increases in occupancy expenses.
Comparison to Prior Year Quarter
GAAP net income for the three months ended December 31, 2012 increased to $61 million, or $0.15 per diluted common share, from $58 million, or $0.19 per diluted common share, for the three months ended December 31, 2011. Our operating (non-GAAP) net income for the three months ended December 31, 2012 increased to $75 million, or $0.19 per diluted common share, from $72 million, or $0.24 per diluted common share, for the three months ended December 31, 2011. Earnings per share in the fourth quarter of 2012 as compared to the fourth quarter of 2011 was impacted by our December 2011 issuance of 57 million common shares and $8 million in dividends on the 14 million preferred shares we issued in December 2011.
Operating (non-GAAP) net interest income, which excludes $16 million of retroactive premium amortization on CMOs in the fourth quarter of 2012, increased $26 million, or 11%, reflecting a $1.2 billion increase in net interest-earning assets reflecting organic loan growth in all of our markets. The favorable impacts of this increase and a 34 basis point decrease in the cost of interest-bearing liabilities were partially offset by lower yields on our investment securities and loans resulting in a six basis point decrease in our net interest margin.
Average commercial loan balances increased $1.8 billion, or 19%, over the prior year quarter, as strong business and commercial real estate demand continued across our footprint. Commercial business loan balances increased 31% over the prior year quarter and commercial real estate loans increased 12%. Double digit increases were seen across our entire footprint.
Average transactional accounts, which include interest-bearing checking and noninterest-bearing balances, increased $3.6 billion, or 70% from the prior year. Average noninterest-bearing deposits increased 51% while interest-bearing checking deposits almost doubled over the prior year quarter driven by strong customer engagement that resulted in higher account balances.
The provision for loan losses on originated loans of $21.4 million for the quarter ended December 31, 2012, increased from $10.8 million for the prior year quarter. The current quarter provision included $13.7 million to support originated loan growth and $7.6 million to cover net charge-offs. Net charge-offs equaled 24 basis points of average originated loans in the fourth quarter of 2012, a modest two basis point increase from the fourth quarter of 2011. At the end of the fourth quarter, nonperforming assets to total assets were 0.50%, compared to 0.29% from the end of 2011. Nonperforming originated loans as a percentage of originated loans increased to 1.07% at December 31, 2012 from 0.91% at December 31, 2011. At December 31, 2012, the allowance for loan losses on originated loans amounted to 1.20% of such loans, unchanged from December 31, 2011.
The provision for losses on acquired loans totaled $0.2 million, compared to $2.3 million in the prior year quarter. Net charge-offs on those portfolios totaled $1.3 million during the quarter, compared to $0.4 million in the prior year. At December 31, 2012, the allowance for loan losses on acquired loans totaled $1.6 million, compared to $1.9 million at December 31, 2011.
Noninterest income increased $28 million for the fourth quarter of 2012 from the same period in 2011, primarily due to the HSBC Branch Acquisition. Deposit service charges increased over $8 million as a result of new checking account openings and ongoing fee income initiatives. The expansion of our credit card business stemming from the acquisition of this business from HSBC contributed to the revenues from merchant and card fees more than doubling from the last quarter of 2011. Continued strength in derivative swap activity and increased assets under management in the company's wealth management platform contributed to increases in capital markets and wealth management revenues, respectively. Mortgage banking revenues increased over the prior year due to higher refinance volumes as well as higher margins on sold loans.
Excluding merger and acquisition integration expenses and restructuring charges, noninterest expenses increased $53 million in the fourth quarter of 2012 from the same period in 2011, primarily attributable to the HSBC Branch Acquisition and the costs to operate the acquired branches. Additionally, higher occupancy and equipment and technology and communications expenses reflect targeted investments to enhance the sophistication and efficiency of our back office processes to support our larger franchise. An $8 million increase in amortization of intangibles resulted from the intangibles we recorded in connection with the HSBC Branch Acquisition.
ANALYSIS OF FINANCIAL CONDITION
Overview
On May 18, 2012, we completed the HSBC Branch Acquisition and the results are included in our consolidated statement of financial condition at December 31, 2012. The acquisition significantly impacted our balance sheet as can be seen through our comparison of December 31, 2012 balances to December 31, 2011 presented below. The table below details the balances at December 31, 2012, as well as the December 31, 2011 balances adjusted to include HSBC balances acquired on May 18, 2012 (in thousands):
(1) Represents opening balance sheet balances at May 18, 2012 closing.
We noted the following balance trends during 2012, exclusive of the impact of the HSBC Branch Acquisition:
•
Our investment securities portfolio increased $338 million over the balance at December 31, 2011. The increase is attributable to completing our strategy to purchase securities in anticipation of receiving cash proceeds from the pending HSBC Branch Acquisition and purchases for others purposes partially offset by the securities portfolio repositioning in the second quarter of 2012.
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Our ending loan balances increased to $19.7 billion at December 31, 2012 from $18.1 billion on a proforma basis. The increase was driven by continued organic growth in our commercial loan portfolio of $1.7 billion, or 17%. Our residential real estate loans decreased $575 million. This is due to the current low rate environment resulting in increased prepayments and the demand for long-term, fixed rate products which we typically sell rather than hold in portfolio. This decrease was offset by an increase of $586 million in other consumer loans, primarily driven by the expansion of our indirect auto lending business.
•
Core deposits decreased by $914 million, or 4%, primarily in money market deposit accounts, due to our interest rate and treasury management strategies as we continue to move down deposit pricing. We continue to focus on core customer acquisition reflected in the increase in interest-bearing checking account balances from December 31, 2011.
•
Total borrowings decreased by $4.4 billion, as cash proceeds received from the HSBC Branch Acquisition and securities portfolio repositioning were used to pay down borrowings. These paydowns were partially offset in the
second half of the year as the Bank's strong liquidity position enabled the Bank to borrow at lower costs than the cost of incremental deposits in order to fund the Bank's asset growth.
Lending Activities
Our total loans and leases outstanding increased $3.2 billion from December 31, 2011 to December 31, 2012, including the $1.6 billion of loans we acquired from the HSBC Branch Acquisition.
Our commercial loan portfolio increased $2.0 billion, or 20%, resulting from our continued strategic focus on the portfolio. Our period over period results display the strong organic growth across our footprint in our commercial lending activities. Commercial loans as a percentage of our total loans of approximately 60% remained in line with the loan type composition at December 31, 2011.
We experienced a net decrease of $251 million in our residential real estate portfolio. The net decrease reflects the addition of $324 million of loans acquired from HSBC, offset by net run-off in the portfolio as ongoing consumer preference is for long-term fixed rate products, which we generally sell and do not hold in our portfolio. Our home equity and other consumer loan portfolios increased as a result of the HSBC Branch Acquisition. Other consumer loans also increased due to significant growth in our indirect auto portfolio, including $641 million of loan originations during 2012.
Loan Portfolio Composition
The table below reflects the composition of our loan and lease portfolios as of December 31 (amounts in thousands):
Included in the table above are acquired loans with a carrying value of $6.3 billion, $6.6 billion and $2.6 billion at December 31, 2012, 2011 and 2010 respectively. Such loans were acquired through our mergers and acquisitions and were initially recorded at fair value with no carryover of any related allowance for loan losses.
Our loan portfolio has grown significantly over the past three years, both through origination activity and through acquisitions, across all loan categories. Acquired loans provided the bulk of the increase in real estate loans during the past few years as we expanded into Eastern Pennsylvania and New England through two different acquisitions in 2010 and 2011, and filled in our footprint in Upstate New York with acquisition of the HSBC branches in 2012. After peaking at 75% at December 31, 2011, our concentration in real estate loans has decreased to 70% as of December 31, 2012, its lowest level since 2009.
Growing significantly over the past four years through acquisitions has enabled us to diversify our real estate loan portfolio from a geographical perspective. Our concentration of real estate loans in Upstate New York steadily declined between the end of 2009 and 2011, from 94% at December 31, 2009 to 69% and 42% at December 31, 2010 and 2011, respectively. Our acquisition of the HSBC branches in 2012 has increased our Upstate New York real estate loans moderately, to 46% of total loans at December 31, 2012.
Our lending standards have remained consistent over this time period. Our real estate loan underwriting standards remain conservative and consistent with guidance provided by various regulatory agencies. Residential mortgages are underwritten to secondary market standards, and commercial real estate loans are structured with sufficient borrower equity positions and guarantees of principal (in most instances) which provide a cushion against unexpected changes in property cash flow or collateral values.
The table below presents the composition of our loan and lease portfolios, including net deferred costs and unearned discounts, based on the region in which the loan was originated (in thousands):
(1)
Other consists of indirect auto loans made in states that border our footprint, and our capital markets portfolio. Our capital markets portfolio includes participations in syndicated loans that have been underwritten and purchased by us where we are not the lead bank. Nearly all of these loans are to companies in our footprint states or in states that border our footprint states.
We continue to expand our commercial lending activities by taking advantage of opportunities to move up market while remaining focused on our sound credit fundamentals. Our enhanced specialty offerings in equipment financing, healthcare, and syndications provide additional opportunities to enhance our relationship with our commercial customers. Our Upstate New York market continues to perform well as the commercial loan portfolio increased $896 million, or 18%. Excluding the HSBC Branch Acquisition, the commercial loan portfolio increased $1.6 billion, or 11% over the fourth quarter of 2011. In addition to the continued growth trends in Upstate New York, our Eastern and Western Pennsylvania markets have exhibited strong growth with an increase in their commercial loan portfolios of $473 million, or 32% annualized and $195 million, or 16% annualized, respectively, from the end of fourth quarter of 2011.
The table below presents a breakout of the unpaid principal balance of individual loans for our commercial real estate and commercial business loan portfolios by loan size as of the dates indicated (amounts in millions):
(1)
Multiple loans to one borrower have not been aggregated for purposes of this table.
(2)
Includes net deferred fees and costs and other adjustments.
At December 31, 2012 and 2011, 70% and 71% of our commercial real estate loans are non-owner occupied, respectively. The table below provides the principal balance of our non-owner occupied commercial real estate loans by location and property type at the dates indicated (in thousands):
(1) Primarily consists of loans located in states bordering our footprint.
Investing Activities
Securities Portfolio
In anticipation of receiving cash from the HSBC Branch Acquisition, we purchased $1.2 billion of securities during 2011 and approximately $2.3 billion of securities during 2012. The purchases were comprised of commercial mortgage-backed securities, agency residential mortgage-backed securities, asset-backed securities, collateralized loan obligations, corporate bonds, and U.S. Treasury bonds. The average yield of the $3.5 billion in purchases was approximately 3.35%. The purchases were temporarily funded with a combination of short-term FHLB advances, repurchase agreements, and brokered certificates of deposit.
With the goal of de-levering and de-risking our balance sheet, and subsequent to the HSBC Branch Acquisition, during the second quarter of 2012 we transferred certain mortgage-backed securities with a carrying value of $861 million from our held to maturity portfolio to our available for sale portfolio. We then sold these and other mortgage-backed securities in our available for sale portfolio with a total carrying value of $3.1 billion for a total pre-tax gain of $21 million. The securities sold were selected based on an assessment of their potential prepayment risk based on our evaluation of future refinancing volumes and did not include any that were purchased in conjunction with the HSBC Branch Acquisition. The proceeds from these sales were used to pay down short-term borrowings.
The sale of the securities reduced volatility in our net interest margin by reducing the impact of prepayments on the mortgage-backed securities portfolio yield. In addition, the sale of these securities with the greatest levels of prepayment risk coupled with the pay down of short-term borrowings improved our asset sensitivity by 200 to 300 basis points, allowing us to be better positioned to benefit when interest rates rise while at the same time managing the near term volatility created by the current low interest rate environment.
In December 2012, the Federal Open Market Committee (“FOMC”) stated it anticipates that the current exceptionally low federal funds rate will be appropriate at least as long as the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than 0.5% above the FOMC's 2% longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the FOMC will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the FOMC decides to begin to remove policy accommodation, it intends to take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2%. The FOMC also announced it would continue purchasing additional agency mortgage-backed securities at the pace of $40 billion each month and longer-term Treasury securities initially at a pace of $45 billion per month. Additionally, the FOMC stated 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, in January, will resume rolling over maturing Treasury securities at auction. We expect these actions to continue to maintain downward pressure on longer-term interest rates, and thus, on the industry net interest margin by; (i) continuing to reduce the yields on earning assets relative to the cost of funding; (ii) causing borrowers to repay their higher-yielding fixed rate loans at a faster rate; and (iii) reducing the rates at which cash flows from these repayments could be reinvested.
When we evaluated our CMO portfolio in June 2012, we assumed a conditional prepayment rate ("CPR") of 23 over the remaining life with a peak modeled speed of 33 and a 26 for the first year. However, prepayment activity since the June 2012 balance sheet repositioning, particularly in the fourth quarter, has made clear that speeds will be much higher, averaging 32 CPR for the last six months of 2012. As a result of these increased prepayment speeds, we recognized a pre-tax retroactive adjustment of $16 million, or $0.03 per share, in the fourth quarter of 2012 to accelerate premium amortization on our CMO portfolio. The adjustment reduced the amount of unamortized premium on our CMO portfolio to reflect the impacts of the substantial level of prepayments received in recent months and the expected elevated levels of cash flows to be received for the foreseeable future. The unamortized premiums on our CMO portfolio decreased to $74 million, or 1.6% of the portfolio, at December 31, 2012, from $183 million, or 2.65% of the portfolio, at December 31, 2011. The yield to maturity on our CMO portfolio, excluding the purchases after our June 2012 portfolio repositioning, was 2.37% as of December 31, 2012. Approximately $1 billion of our CMO portfolio at December 31, 2012 was purchased subsequent to June 2012 at little or no premium. In January 2013, actual cash flows from our CMO portfolio were $173 million, which was lower than the $196 million we estimated at December 31, 2012. CMO cash flows for 2013 were estimated at December 31, 2012 to be $1.9 billion, or 40% of the CMO portfolio.
The unamortized premiums on our other residential mortgage-backed securities decreased to $22 million, or 2.7% of the portfolio, at December 31, 2012, from $49 million, or 5.85% of the portfolio, at December 31, 2011. The yield to maturity on our other residential mortgage-backed securities, excluding purchases after June 2012, was 2.95% as of December 31, 2012.
While mortgage rates have rebounded since the lows seen in the fourth quarter of 2012, our expectations of future prepayment speeds in our collateralized mortgage obligation and mortgage-backed securities portfolios reflects the expectation of the prolonged lower interest rate environment and that the pace of the mortgage prepayment cycle will likely persist, and therefore will impact premium amortization on our collateralized mortgage obligation and mortgage-backed securities portfolios in the future.
Further changes in our expectations regarding the expected magnitude and duration of a lower interest rate environment could have a material impact on our net interest income in both the period of change, attributable to any retroactive accounting adjustment that would be required to maintain a constant effective yield, and in subsequent periods attributable to lower prospective yields on our investment securities. Additionally, principal repayments on our securities would be reinvested at lower rates.
Our residential mortgage-backed securities portfolio offers some protection from higher prepayment rates and lower cash flow volatility in this low interest rate environment. Within our CMOs, we own a combination of first pay and second pay sequential securities as well as planned amortization class (“PAC”) securities. These types of bonds provide us with more stable and consistent cash flows in various interest rate environments. Second pay sequential securities are protected from prepayments by the first pay tranche. A PAC security is also protected with a principal payment rate that is stabilized by support tranches in the structure. These support tranches, which we do not own, absorb excess prepayments when rates fall, and receive fewer prepayments to prevent extension of average life as rates rise. However, as prepayments reduce the principal of the support security, the PAC security is less protected from prepayment fluctuations. The high level of prepayments witnessed in the second half of 2012 has eroded some of our protection quicker and thus the protection is less than previously given.
The sale of the residential mortgage-backed investment securities reduced our holdings in such mortgage-backed securities to 48% at December 31, 2012 from 73% at December 31, 2011. At each of December 31, 2012 and December 31, 2011, 99% of our residential mortgage-backed securities in our available for sale portfolio were issued by the Government National Mortgage Association (“GNMA”), Federal National Mortgage Association (“FNMA”), or Federal Home Loan Mortgage Corporation (“FHLMC”). GNMA, FNMA, and FHLMC guarantee the contractual cash flows of these investments. FNMA and FHLMC are government sponsored enterprises that are currently under the conservatorship of the U.S. government. Our GNMA mortgage-backed securities are backed by the full faith and credit of the U.S. government.
Our investment in FHLB stock consisted of $140 million, $24 million, and $121 million of FHLB of New York common stock, FHLB of Pittsburgh common stock, and FHLB of Boston common stock, respectively, at December 31, 2012 and of $101 million, $27 million, and $121 million of FHLB of New York common stock, FHLB of Pittsburgh common stock, and FHLB of Boston common stock, respectively, at December 31, 2011. Our investment in FRB stock amounted to $136 million and $109 million at December 31, 2012 and 2011, respectively.
The following table shows certain information with respect to the amortized cost and fair values of our portfolio as of December 31 (amounts in thousands):
(1)
Average remaining life is computed utilizing estimated maturities and prepayment assumptions.
The duration of our investment securities portfolio decreased to 3.0 years at December 31, 2012 from 4.1 years at December 31, 2011.
Deposits
Excluding the $9.9 billion in deposits (at fair value) acquired in the HSBC Branch Acquisition, our total deposits decreased $1.6 billion from December 31, 2011 and core deposits increased to 85% of total deposits at December 31, 2012 from 80% at December 31, 2011. The decrease in balances, primarily in certificates of deposits and money market deposits, resulted from our pricing initiatives to reduce higher cost certificates of deposit and money market deposit accounts, which pay a higher rate and have higher customer acquisition costs. The weighted average rate paid on market deposit accounts in 2012 was one-half of the rate paid in 2011 and the weighted average rate on certificates of deposit was down 18 basis points from 2011. We partially offset the decreases in these balances through our strategic focus on customer acquisition, which allowed us to successfully reposition our deposit mix and grow low cost deposits, resulting in an increase in interest-bearing checking deposits to 16% of total balances at the end of 2012 from 12% at the end of 2011.
The table below contains selected information on the composition of our deposits as of December 31 (amounts in thousands):
The table below contains selected information on the composition of our deposits by geographic region at the dates indicated (in thousands):
The following table shows maturities of outstanding certificates of deposit and other time deposits in denominations of $100,000 and greater and $250,000 and greater at December 31, 2012 (in thousands):
Borrowings
Borrowings decreased to $3.7 billion at December 31, 2012 from $8.1 billion at December 31, 2011. Short-term borrowings increased by $775 million from December 31, 2011 to $3.0 billion, and long-term borrowings decreased by $5.2 billion during that same period to $732 million. As noted above under Investment Securities, during the year ended December 31, 2012, we sold certain mortgage-backed securities and used the $3.1 billion in proceeds to repay short-term borrowings. This action improved our funding profile. In addition, upon completion of the HSBC Branch Acquisition, we paid down short and long-term wholesale borrowings, including the short term borrowings used to purchase investment securities in advance of this transaction.
At December 31, 2012, wholesale borrowing totaled $2.4 billion. Wholesale borrowings are generally used as an alternative to deposit funding. Wholesale funding is generally utilized over deposits if the wholesale funding can be originated at lower incremental costs than deposits or if the structure of the wholesale borrowing is more advantageous to the bank's interest rate risk or for hedging the bank's balance sheet.
On December 13, 2011, the Company issued $300 million of 7.25% subordinated notes due December 15, 2021 (the “Subordinated Notes”), the proceeds of which were used to consummate the HSBC Branch Acquisition. The Subordinated Notes are not redeemable at any time prior to the maturity date.
Our junior subordinated debentures include amounts related to First Niagara Financial Group Statutory Trust I as well as junior subordinated debentures associated with six statutory trust affiliates that were acquired from our merger with Harleysville and three statutory trusts acquired from NewAlliance (the “Trusts”). The Trusts qualify as variable interest entities and were formed to issue mandatorily redeemable trust preferred securities to investors and loan the proceeds to us for general corporate purposes. The Trusts hold, as their sole assets, junior subordinated debentures of the Company with face amounts totaling $142 million at December 31, 2012. The carrying value of the trust preferred junior subordinated debentures, net of the unamortized purchase accounting fair value adjustment of approximately $30 million, was $112 million at December 31, 2012. We own all of the common securities of the Trusts and have accordingly recorded $4 million in equity method investments classified as other assets in our Consolidated Statement of Condition at December 31, 2012 representing our investment in those common securities. As the shareholders of the trust preferred securities are the primary beneficiaries of these trusts, the Trusts are not consolidated in our financial statements.
Our junior subordinated debentures are redeemable prior to the maturity date at our option upon each trust’s stated option repurchase dates, and from time to time thereafter. These debentures are also redeemable in whole at any time upon the occurrence of specific events defined within the trust indenture. Our obligations under the debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the issuers’ obligations under the trust preferred securities.
The following table shows certain information about our borrowings for the dates indicated (amounts in thousands):
Capital
Our stockholders’ equity increased $128 million to $4.9 billion at December 31, 2012 from $4.8 billion at December 31, 2011. Primary drivers of the increase were net income of $168 million and $101 million of unrealized gains, net of taxes, on our investment securities available for sale, offset by $112 million, or $0.32 per share, of common stock dividends and $28 million of preferred stock dividends. Our tangible common equity ratio decreased to 5.77% at December 31, 2012 from 8.57% at December 31, 2011 primarily due to the HSBC Branch Acquisition.
In December 2011, we issued 14 million shares of fixed-to-floating rate noncumulative preferred stock, series B, with a par value of $0.01 and a liquidation preference of $25 per share, in an underwritten stock offering. Net proceeds totaled $338 million.
The preferred stock pays dividends quarterly, when, as and if declared by our board of directors, at a rate per annum of 8.625% until February 15, 2017, and thereafter at a floating rate per annum equal to three month LIBOR plus 7.327%. The preferred stock has no maturity date. We may redeem the preferred stock, in whole or in part, from time to time, on any dividend payment date on or after February 15, 2017, at a redemption price of $25 per share, plus any declared and unpaid dividends.
At December 31, 2012, we held 13.4 million shares of our common stock as treasury shares. During 2012, we did not repurchase any shares of our common stock. We currently have authorization from our Board of Directors to repurchase 12 million shares as part of our capital management initiatives. We issued 0.8 million shares from treasury stock in connection with the exercise of stock options and grants of restricted stock awards during 2012. Although treasury stock purchases are an important component of our capital management strategy, the extent to which we repurchase shares in the future will depend on a number of factors including the market price of our stock and alternative uses for our capital.
As of December 31, 2012, we met all capital adequacy requirements to which we were subject and both First Niagara Financial Group, Inc. and First Niagara Bank, N.A. were considered well-capitalized under the Federal Reserve’s Regulation Y (in the case of First Niagara Financial Group, Inc.) and the OCC’s prompt corrective action regulations (in the case of First Niagara Bank, N.A.).
In preparation for the pending regulatory capital rule revisions, we have analyzed the impact of the proposed Basel III requirements on our capital ratios over the phase in period called for in the NPRs. Upon further clarity on the finalized regulatory capital rule revisions, we will implement strategies to manage the impact of assets receiving higher risk weightings under the proposed Basel III requirements. We are confident in our ability to meet targeted capital ratios upon implementation of the NPRs.
Our ability to pay dividends to our stockholders is substantially dependent upon the ability of the Bank to pay dividends to the Company. Subject to First Niagara Bank, N.A. meeting or exceeding regulatory capital requirements, the prior approval of the OCC is required if the total of all dividends declared by First Niagara Bank, N.A. in any calendar year would exceed the sum of the Bank’s net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits the Bank from paying dividends that would be greater than its undivided profits after deducting statutory bad debt in excess of its allowance for loan losses. Under the foregoing dividend restrictions, and while maintaining its “well-capitalized” status, First Niagara Bank, N.A. could pay aggregate dividends of approximately $484 million to the Company, without obtaining affirmative regulatory approvals, as of December 31, 2012. The Bank paid dividends of $45 million, $75 million and $60 million to the Company, during 2012, 2011, and 2010, respectively.
The current requirements and our actual capital levels are detailed in Note 11 of “Notes to Consolidated Financial Statements” in Part II, Item 8, “Financial Statements and Supplementary Data.”
RISK MANAGEMENT
Credit Risk
Allowance for Loan Losses and Nonperforming Assets
Credit risk is the risk associated with the potential inability of some of our borrowers to repay their loans according to their contractual terms. This inability to repay could result in higher levels of nonperforming assets and credit losses, which could potentially reduce our earnings.
A detailed description of our methodology for calculating our allowance for loan losses is included in “Critical Accounting Policies and Estimates” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Allowance for Loan Losses
The primary indicators of credit quality are delinquency status and our internal loan gradings for our commercial loan portfolio segment and delinquency status and current FICO scores for our consumer loan portfolio segment. We place non-credit card originated loans on nonaccrual status when they become more than 90 days past due, or earlier if we do not expect the full collection of interest or principal. When a loan is placed on nonaccrual status, any interest previously accrued and not collected is reversed from interest income. Credit cards are not placed on nonaccrual status until 180 days past due, at which time they are charged-off.
Our evaluation of our allowance for loan losses is based on a continuous review of our loan portfolio. The methodology that we use for determining the amount of the allowance for loan losses consists of several elements. We use an internal loan grading
system with nine categories of loan grades used in evaluating our business and commercial real estate loans. In our loan grading system, pass loans are graded 1 through 5, special mention loans are graded 6, substandard loans are graded 7, doubtful loans are graded 8 and loss loans (which are fully charged off) are graded 9. Our definition of special mention, substandard, doubtful and loss are consistent with regulatory definitions.
In the normal course of our loan monitoring process, we review all pass graded individual commercial and commercial real estate loans and/or total loan concentration to one borrower no less frequently than annually for those greater than $3 million, every 18 months for those greater than $1 million but less than $3 million and every 36 months for those greater than $500 thousand and less than $1 million.
As part of our credit monitoring process, our loan officers perform formal reviews based upon the credit attributes of the respective loans. Pass graded loans are continually monitored through our review of current information related to each loan. The nature of the current information available and used by us includes, as applicable, review of payment status and delinquency reporting, receipt and analysis of interim and annual financial statements, rent roll data, delinquent property tax searches, periodic loan officer inspections of properties, and loan officer knowledge of their borrowers, as well as the business environment in their respective market areas. We perform a formal review on a more frequent basis if the above considerations indicate that such review is warranted. Further, based upon consideration of the above information, if appropriate, loan grading can be reevaluated prior to the scheduled full review.
Quarterly Classified Asset Quality Reports ("QCARs") are prepared every quarter for all special mention exposures greater than $300 thousand and substandard or doubtful exposures greater than $200 thousand. The purpose of the QCAR is to document as applicable, current payment status, payment history, charge-off amounts, collateral valuation information (including appraisal dates), and commentary on collateral valuations, guarantor information, interim financial data, cash flow, historical data and projections, rent roll data, and account history.
QCARs for substandard loans are reviewed on a quarterly basis by either management's Classified Loan Review Committee (for such loans greater than $2 million) or by a Senior Credit Manager (for such loans between $200 thousand and $2 million). QCARs for all special mention loans greater than $300 thousand are reviewed on a quarterly basis by either management's Classified Loan Review Committee (for such loans greater than $2 million) or by a Senior Credit Manager (for such loans between $300 thousand and $2 million). Special mention and substandard loans below $300 thousand and $200 thousand, respectively, are reviewed by a loan officer on a quarterly basis ensuring that loan grade and accrual status are appropriate.
Updated valuations are obtained periodically in accordance with Interagency Appraisal and Evaluation Guidelines and internal policy. Appraisals or evaluations for assets securing substandard rated loans are completed within 90 days of the downgrade. On an ongoing basis, real estate collateral supporting substandard loans with an outstanding balance greater than $500 thousand is required to have an appraisal or evaluation performed at least every 18 months for general commercial properties and at least every 12 months for land and acquisition and development loans. Real estate collateral supporting substandard loans with an outstanding balance equal to or less than $500 thousand is required to have an appraisal or evaluation performed at least every 24 months for general commercial properties and at least every 18 months for land and acquisition and development loans. However, an appraisal or evaluation may be obtained more frequently than 18 to 24 months when volatile or unusual market conditions exist that could affect the ultimate realization of the value of the real estate collateral. Non-real estate collateral is reappraised on an as-needed basis, as determined by the loan officer, our Classified Loan Review Committee, or by credit risk management based upon the facts and circumstances of the individual relationship.
Among other factors, our quarterly reviews consist of an assessment of the fair value of collateral for all loans reviewed, including collateral dependent impaired loans. During this review process, an internal estimate of collateral value, as of each quarterly review date, is determined utilizing current information such as comparables from more current appraisals in our possession for similar collateral in our portfolio, recent sale information, current rent rolls, operating statements and cash flow information for the specific collateral. Further, we have an Appraisal Institute designated MAI appraiser on staff available for consultation during our quarterly estimation of collateral fair value. This current information is compared to the assumptions made in the most recent appraisal as well as in previous quarters. Quarterly adjustments to the estimated fair value of the collateral are made as determined necessary in the judgment of our experienced senior credit officers to reflect current market conditions and current operating results for the specific collateral.
Adjustments are made each quarter to the related allowance for loan losses for collateral dependent impaired loans to reflect the change, if any, in the estimated fair value of the collateral less estimated costs to sell as compared to the previous quarter. The determination of the appropriateness of obtaining new appraisals is also specifically addressed in each quarterly review. New appraisals will be obtained prior to the above noted required time frames if it is determined appropriate during these quarterly reviews. Further, our in-house MAI appraiser is available for consultation regarding the need for new valuations.
In addition to the credit monitoring procedures described above, our loan review department, which is independent of the lending function and is part of our risk management function, verifies the accuracy of loan grading, classification, and, if a loan is impaired, the related allowance for loan losses.
Commensurate with the increase in the size of commercial loans that we are underwriting, we have augmented our credit staffing. During 2012, we promoted our chief credit officer to chief risk officer to raise the level of credit risk management in the organization. At the end of the year, we recruited and hired a new chief credit officer from a larger commercial bank to report to the chief risk officer. We continue to enhance our staffing and improve the tools available to monitor and manage credit risk.
The following table details our allocation of our allowance for loan losses by loan category at December 31 (amounts in thousands):
The following table presents the activity in our allowance for originated loan losses of the associated loans by portfolio segment for the years ended December 31 (in thousands):
We did not have any activity in our allowance for loan losses for acquired loans in 2010. The following table presents the activity in our allowance for loan losses for our acquired loan portfolio for the years ended December 31 (in thousands):
As of December 31, 2012, we had a liability for unfunded commitments of $12 million. For the year ended December 31, 2012, we recognized a provision for credit loss related to our unfunded commitments of $1.3 million. We acquired an additional $3.0
billion in unfunded loan commitments as part of our HSBC Branch Acquisition, and consequently increased our liability by $4 million to recognize probable losses inherent in the commitments assumed in the HSBC Branch Acquisition. Our total unfunded commitments were $8.7 billion as of December 31, 2012.
Our net charge-offs of $48 million in 2012 were $18 million higher than our net charge-offs of $30 million in 2011. The period over period increases were driven primarily by an $8 million charge-off of one large commercial loan based in Upstate New York and $5 million of charge-offs on three commercial loans acquired in the Harleysville acquisition. Total net charge-offs for the year ended December 31, 2012 represented 0.26% of average total loans compared with 0.20% of average total loans for the year ended December 31, 2011. Excluding our acquired loans, our net charge-off ratio for originated loans was 0.35% for the year ended December 31, 2012 compared to 0.32% for the year ended December 31, 2011.
The following table details our net charge-offs by loan category for the years ended December 31 (in thousands):
Our nonaccruing loans increased to $173 million at December 31, 2012 compared to $90 million at December 31, 2011. The increase of $83 million from December 31, 2011 to December 31, 2012 was the result of several factors. Interagency guidance issued by the OCC related to junior lien home equity loans and further OCC guidance related to loans discharged in a Chapter 7 bankruptcy added $8 million and $11 million, respectively, of additional nonaccrual loans during 2012. Acquired lines of credit added $22 million to our nonaccrual loan totals. These acquired lines of credit, which are outside the scope of ASC 310-30, were initially recorded at fair value on the date of acquisition and follow our normal nonaccrual loan policy. The remaining credit discount, recorded at acquisition, remains adequate to cover losses on these balances. Of the remaining $40 million increase in nonaccrual loans, $34 million were commercial loans.
The composition of our nonaccruing loans and total nonperforming assets consisted of the following at December 31 (amounts in thousands):
(1)
Includes $29 million of nonperforming acquired lines of credit, primarily in home equity. The remaining credit discount, recorded at acquisition, is adequate to cover losses on these balances.
(2)
Nonperforming assets do not include $46 million, $44 million, $22 million, $12 million, and $7 million of performing renegotiated loans that are accruing interest at December 31, 2012, 2011, 2010, 2009, and 2008 respectively.
(3)
Includes credit card loans, loans that have matured and are in the process of collection, and acquired loans that were originally recorded at fair value upon acquisition,
The primary indicators of credit quality are delinquency status and our internal loan gradings for our commercial loan portfolio segment and delinquency status and current FICO scores for our consumer loan portfolio segment. Early stage delinquencies of $39 million at December 31, 2012 in our originated loan portfolio increased from $36 million at December 31, 2011 of loans that are 30 to 89 days past due. Our acquired loans that were 30 to 89 days past due increased $20 million from $75 million as of December 31, 2011 to $95 million as of December 31, 2012, reflective of loans acquired from the HSBC Branch Acquisition.
The following table contains a percentage breakout of the delinquency composition of our loan portfolio segments as of December 31:
Our internal loan gradings provide information about the financial health of our commercial borrowers and our risk of potential loss. The following table presents a breakout of our commercial loans by loan grade at December 31:
(1)
Includes special mention, substandard, doubtful, and loss, which are consistent with regulatory definitions, and as described in Item 1, “Business”, under the heading “Asset Quality Review.”
Borrower FICO scores provide information about the credit quality of our consumer loan portfolio as they provide an indication as to the likelihood that debtors will repay their debts. We obtain the scores from a nationally recognized consumer rating agency on a quarterly basis and trends are evaluated for consideration as a qualitative adjustment to the allowance. The composition of our consumer portfolio segment is presented in the table below at December 31:
(1)
Primarily includes loans that are serviced by others for which refreshed FICO scores were not available as of the indicated date.
We maintain an allowance for loan losses for our originated portfolio segment, which is concentrated in the Upstate New York region and includes to a lesser degree, loan balances from organic growth in our acquired markets of Eastern Pennsylvania, Western Pennsylvania, Connecticut and Western Massachusetts. Despite the challenging market conditions, our asset quality continues to perform well when compared to peer averages.
As part of our determination of the fair value of our acquired loans at time of acquisition, we established a credit mark to provide for future losses in our acquired loan portfolio. Our credit mark, which represents the remaining principal balance on acquired loans that we do not expect to collect, was $176 million and $205 million as of December 31, 2012 and 2011, respectively.
The following table provides information about our acquired loan portfolio by acquisition as of the dates indicated or for the related year (amounts in thousands):
(1)
Represents carrying value of acquired loans plus the principal not expected to be collected.
(2)
Represents principal on acquired loans not expected to be collected.
(3)
Includes special mention, substandard, doubtful, and loss, which are consistent with regulatory definitions, and as described in Item 1, “Business”, under the heading “Asset Quality Review”.
(4)
Includes consumer loans, which are considered classified when they are 90 days or more past due. Classified loans include substandard, doubtful, and loss, which are consistent with regulatory definitions, and as described in Item 1, “Business”, under the heading “Asset Quality Review”.
(5)
Includes credit card loans, loans that have matured and are in the process of collection, and acquired loans that were originally recorded at fair value upon acquisition. Acquired loans are considered to be accruing as we can reasonably estimate future cash flows on these acquired loans and we expect to fully collect the carrying value of these loans net of the allowance for acquired loan losses. Therefore, we are accreting the difference between the carrying value of these loans and their expected cash flows into interest income. In connection with the HSBC Branch Acquisition, we changed our nonaccrual policy related to credit cards from 90 days to 180 days past due, at which time the balance is charged-off. This policy change did not have a significant impact on our interest income or allowance for credit losses.
The following table provides information about our originated loan portfolio as of the dates indicated or for the year ended (dollars in thousands):
(1)
Includes consumer loans, which are considered classified when they are 90 days or more past due. Classified loans include substandard, doubtful, and loss, which are consistent with regulatory definitions, and as described in Item 1, “Business”, under the heading “Asset Quality Review”.
(2)
Includes credit card loans and loans that have matured and are in the process of collection. In connection with the HSBC Branch Acquisition, we changed our nonaccrual policy related to credit cards from 90 days to 180 days past due, at which time the balance is charged-off. This policy change did not have a significant impact on our interest income or allowance for credit losses.
Our total allowance for loan losses related to both our originated and acquired loans increased $42 million from December 31, 2011 to $163 million at December 31, 2012 as our total provision for credit losses of $91 million exceeded our total net charge-offs of $48 million. The ratio of our total allowance for loan losses to total loans of 0.82% at December 31, 2012 compared to 0.73% as of December 31, 2011. Excluding acquired loans, the ratio of our allowance for originated loan losses to total originated loans was 1.20% December 31, 2012 and remained consistent with the measure at December 31, 2011.
Of the $2.7 billion and $2.2 billion home equity portfolio at December 31, 2012 and December 31, 2011, respectively, $884 million were in a first lien position at each period end. We hold or service the first lien loan for approximately 10% of the remainder of the home equity portfolio that was in a second lien position as of December 31, 2012 and December 31, 2011. The Interagency Supervisory Guidance issued during the first quarter of 2012 related to junior lien home equity loans resulted in $8 million of additional nonaccrual loans at December 31, 2012, but did not have a significant impact on our allowance for loan losses.
As part of our credit risk management, we enter into modification agreements with troubled borrowers in order to mitigate our credit losses. Our aggregate recorded investment in impaired loans modified through troubled debt restructurings (“TDRs”) increased to $89 million at December 31, 2012 from $77 million at December 31, 2011. The modifications made to these restructured loans typically consist of an extension of the payment terms, providing for a period with interest-only payments with deferred principal payments, or a rate reduction. We generally do not forgive principal when restructuring loans. These modifications were considered to be concessions provided to the respective borrower due to the borrower’s financial distress. Our aggregate recorded investment in TDRs does not include modifications to acquired loans that are accounted for as part of a pool under ASC 310-30. We accrue interest on a TDR once the borrower has demonstrated the ability to perform for six consecutive payments. TDRs accruing interest totaled $46 million and $44 million at December 31, 2012 and December 31, 2011, respectively.
Certain pass-graded commercial loans may have repayment dates extended at or near original maturity dates in the normal course of business. When such extensions are considered to be concessions and provided as a result of the financial distress of the borrower, these loans are classified as TDRs and considered to be impaired. However, if such extensions or other modifications at or near the original maturity date or at any time during the life of a loan are not made as a result of financial distress related to the borrower, such a loan would not be classified as a TDR or as an impaired loan. Repayment extensions typically provided in a TDR are for periods of greater than six months. When providing loan modifications because of the financial distress of the borrowers, we consider that, after the modification, the borrower would be in a better position to continue with the payment of principal and interest. While such loans may be collateralized, they are not typically considered to be collateral dependent.
Residential Mortgage Banking
We often originate and sell residential mortgage loans with servicing retained. Our loan sales activity is generally conducted through loan sales in a secondary market sponsored by FNMA and FHLMC. Subsequent to the sale of mortgage loans, we do not typically retain any interest in the underlying loans except through our relationship as the servicer of the loans.
As is customary in the mortgage banking industry, we, or banks we have acquired, have made certain representations and warranties related to the sale of residential mortgage loans and to the performance of our obligations as servicer. The breach of any such representations or warranties could result in losses for us. Our maximum exposure to loss is equal to the outstanding principal balance of the sold loans; however, any loss would be reduced by any payments received on the loans or through the sale of collateral.
Our liability for estimated repurchase obligations on our serviced loan portfolio was $9 million and $8 million at December 31, 2012 and 2011, respectively, and is included in other liabilities in our Consolidated Statements of Condition.
The delinquencies in our serviced loan portfolio were as follows at December 31:
Investments
A securities credit rating is one measure of risk. The bank has a Credit Portfolio Oversight Committee (the "Committee") that meets monthly to analyze and monitor the securities portfolio from a credit perspective. In addition to any ratings changes, the Committee reviews various credit metrics for each of the portfolios including these metrics under stressed environments. For structured securities, the Committee generally reviews changes in the underlying collateral and changes in credit enhancement. In the discussion of our investment portfolio below, we have included certain credit rating information because the information is one indication of the degree of credit risk to which we are exposed and significant changes in ratings classifications for our investment portfolio could result in increased risk for us.
The following table presents the latest available underlying investment ratings of the fair value of our investment securities portfolio at the dates indicated (in thousands):
The weighted average credit rating of our portfolio was AA at each of December 31, 2012 and 2011. Our investment securities portfolio included securities issued by FHLMC, FNMA and GNMA with a fair value of $1.7 billion, $2.1 billion, and $2.2 billion, respectively, at December 31, 2012. We had no other investments in securities of a single issuer that exceeded 10% of our stockholders’ equity.
Our commercial mortgage-backed securities ("CMBS") portfolio has grown from $163 million at December 31, 2010 to $1.9 billion at December 31, 2012. Gross unrealized losses on our CMBS portfolio amounted to $1.3 million and $0.6 million at December 31, 2012 and December 31, 2011, respectively. While market spreads on CMBS tightened in the second half of the year, the fair value of our securities benefited from having completed 92% of our purchases before that time. Additionally, the structure of our CMBS and the underlying mortgage prepayment penalties limit unscheduled principal prepayments.
Securities in our CMBS portfolio have significant credit enhancement that provides us protection from default, and 87% of this portfolio was rated investment grade or higher at December 31, 2012. Over 99% of our CMBS portfolio has either credit enhancement greater than 25% or underlying loans which collateralize our securities with loan to values of less than 100%. The following table provides information on the credit enhancements of securities in our CMBS portfolio at December 31, 2012 (amounts in thousands):
Our collateralized loan obligation ("CLO") portfolio had an amortized cost of $1.5 billion at December 31, 2012. Gross unrealized losses on our CLO portfolio amounted to $0.9 million and $0.1 million at December 31, 2012 and December 31, 2011, respectively. Our CLO portfolio is predominantly variable rate and returns a 3% yield at a credit quality level superior to middle market lending. The collateral underlying our CLOs consists of approximately 90% senior secured loans, and over 90% of the obligors are domiciled in the United States. Half of the portfolio is comprised of CLOs originated in 2011 or later, and no CLO investments were made by us until the fourth quarter of 2011. As shown in the table above, of the underlying investment ratings of our portfolio, 99% of our CLO portfolio was rated investment grade or higher at December 31, 2012 and significant credit enhancements for our securities provide us protection from default. The following table provides information on the credit enhancements for our securities in our CLO portfolio at December 31, 2012 (amounts in thousands):
We have assessed our securities that were in an unrealized loss position at December 31, 2012 and 2011 and determined that any decline in fair value below amortized cost was temporary. In making this determination we considered the following factors: the period of time the securities were in an unrealized loss position, the percentage decline in comparison to the securities’ amortized cost, credit rating, the financial condition of the issuer and guarantor, where applicable, the delinquency or default rates of underlying collateral, projected collateral losses, projected cash flows and credit enhancement. If the level of credit enhancement is sufficient based on our expectations of future collateral losses, we conclude that we will receive all of the originally scheduled cash flows. If the present value of the cash flows indicates that we should not expect to recover the amortized cost basis of the security, we would consider the security to be other than temporarily impaired and write down the credit component of the unrealized loss through a charge to current period earnings. We do not intend to sell these securities in an unrealized loss position and it is not more likely than not that we will be required to sell these securities before the recovery of their amortized cost bases, which may be at maturity.
As of December 31, 2012, the unrealized losses on our corporate debt securities were due to a general widening of credit spreads for the types of these securities, causing their fair values to decrease. As of December 31, 2012, the unrealized losses on our commercial mortgage-backed securities and collateralized loan obligations were caused by increasing volatility resulting from the European debt crisis, proposed financial regulation, political tensions, and weak market data leading to wider spreads. The unrealized losses on our trust preferred securities were due to a general reduction in liquidity of these types of securities since acquisition, causing their fair values to decrease. We have assessed all securities in an unrealized loss position at December 31, 2012 and 2011 and determined that the declines in fair value below amortized cost were temporary.
As of December 31, 2012, we have no direct exposure to the debt of European countries.
Liquidity Risk
Liquidity risk is the risk to earnings or capital arising from our inability to meet our obligations as they come due. Liquidity risk arises from our failure to recognize or address changes in market conditions that affect the ability to liquidate assets quickly or to obtain adequate funding to continue to operate profitably.
Liquidity refers to our ability to obtain cash, or to convert assets into cash timely, efficiently, and economically. Our Asset and Liability Committee establishes procedures, guidelines and limits for managing and monitoring our liquidity to ensure we maintain adequate liquidity under both normal and stressed operating conditions at all times. We manage our liquidity to ensure that we have sufficient cash to:
•
Support our operating activities,
•
Meet increases in demand for loans and other assets,
•
Provide for repayments of deposits and borrowings, and
•
To fulfill contract obligations.
Factors or conditions that could affect our liquidity management objectives include profitability changes in the mix of assets and liabilities on our balance sheet; our investment, loan, and deposit balances; our reputation; and our credit rating. A significant change in our financial performance or credit rating could reduce the availability, or increase the cost, of funding from national markets.
Consolidated liquidity
Sources of liquidity
We obtain our liquidity from multiple sources, including gathering deposit balances, cash generated by principal and interest repayments on our investment and loan portfolios, short and long-term borrowings, as well as short-term federal funds, internally generated capital, and other credit facilities. The primary source of our non-deposit borrowings are FHLB advances, of which we had $2.4 billion outstanding at December 31, 2012.
Cash, interest-bearing demand accounts at correspondent banks and brokerage houses, federal funds sold, and short-term money market investments are our most liquid assets. The levels of those assets are monitored daily and are dependent on operating, financing, lending, and investing activities during any given period. Excess short-term liquidity is usually invested in overnight federal funds sold. In the event that funds beyond those generated internally are required due to higher than expected loan demand, deposit outflows, or the amount of debt maturing, additional sources of funds are available through the use of FHLB advances, repurchase agreements, the sale of loans or investments, or the use of our lines of credit.
We have a total borrowing capacity of up to $8.9 billion from various funding sources which include the FHLB, Federal Reserve Bank, and commercial banks that we can use to fund lending activities, liquidity needs, and/or to adjust and manage our asset and liability position, of which $6.4 billion was available as of December 31, 2012.
Uses of Liquidity
The primary uses of our liquidity are to support our operating activities, fund loans or obtain other assets, and provide for repayments of deposits and borrowings.
In addition to cash flow from operations, deposits and borrowings, our funding is provided from the principal and interest payments that we receive from our loans and investment securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, our deposit balances and loan prepayments are greatly influenced by the level of interest rates, the economic environment and local competitive conditions.
Our primary investing activities are the origination of loans and the purchase of investment securities. Loan balances increased $1.8 billion in 2012 and $950 million in 2011. Our purchases of investment securities amounted to $6.3 billion for 2012 and $3.9 billion for 2011. Principal payments on and proceeds from maturities of our investment securities amounted to $2.8 billion and $2.3 billion, for 2012 and 2011 respectively. Proceeds from sales of investment securities of $3.2 billion for 2012 resulted primarily from our second quarter sale of residential mortgage-backed securities for which we recorded a $21 million gain. Proceeds from sales of investment securities totaled $638 million in 2011. Additionally, we received $7.7 billion in cash from our HSBC Branch Acquisition and branch sales.
Payments of long-term borrowings of $5.1 billion and a decrease in net deposits of $1.6 billion were the primary drivers in the $6.1 billion in net cash used in our financing activities for 2012. An increase in net deposits of $839 million and $1.1 billion in proceeds from the issuance of common stock, preferred stock, and subordinated debt were the primary contributors to the $2.3 billion in net cash provided by financing activities for 2011. We paid common dividends of $112 million, or $0.32 per share, during 2012 and $175 million, or $0.64 per share, during 2011. In addition, we paid preferred dividends of $28 million during 2012.
Contractual Obligations and Other Commitments(1)
The following table indicates certain of our funding obligations by time remaining until maturity as of December 31, 2012 (in thousands):
(1)
Amounts do not include contractual interest.
(2)
We do not expect all of our commitments to extend credit and standby letters of credit to be fully funded. Thus, the total commitment amounts do not necessarily represent our future cash requirements. Our commitments to extend credit include $7.7 billion available under lines of credit and credit cards.
Loan Commitments
In the ordinary course of business, we extend commitments to originate commercial and consumer loans. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Our commitments generally have fixed expiration dates or other termination clauses and may require our customer to pay us a fee. Since we do not expect all of our commitments to be funded, the total commitment amounts do not necessarily represent our future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. We may obtain collateral
based upon our assessment of the customer’s creditworthiness. We may write a commitment to extend credit on a fixed rate basis exposing us to interest rate risk given the possibility that market rates may change between the commitment date and the actual extension of credit. We had outstanding commitments to originate residential real estate, commercial real estate and business, and consumer loans of approximately $8.7 billion and $4.9 billion at December 31, 2012 and 2011, respectively.
Included in these commitments are lines of credit to both consumer and commercial customers. The borrowers are able to draw on these lines as needed, making our funding requirements generally difficult to predict. Indicative of our strategic focus on commercial lending and relationship based home equity lending, at December 31, 2012 our unused commercial lines of credit increased to $3.2 billion from $2.8 billion at December 31, 2011, and our unused home equity and other consumer lines of credit increased to $4.4 billion at December 31, 2012 from $1.5 billion at the end of 2011, due primarily to consumer credit cards acquired in the HSBC Branch Acquisition. Our commercial business lines of credit generally possess an expiration period of less than one year and our home equity and other consumer lines of credit have an expiration period of up to ten years.
In addition to the commitments discussed above, we issue standby letters of credit to third parties that guarantee payments on behalf of our commercial customers in the event the customer fails to perform under the terms of the contract between our customer and the third party. Our standby letters of credit, which generally have an expiration period of less than two years, amounted to $352 million and $278 million at December 31, 2012 and 2011, respectively. Since the majority of our unused lines of credit and outstanding standby letters of credit expire without being fully funded, our actual funding requirements may be substantially less than the amounts above. We anticipate that we will have sufficient funds available to meet our current loan commitments and other obligations through our normal business operations. The credit risk involved in our issuance of these commitments is essentially the same as that involved in extending loans to customers and is limited to the contractual notional amount of those instruments.
Given the current interest rate environment and current customer preference for long-term fixed rate mortgages, coupled with our desire to not hold these assets in our portfolio, we generally sell newly originated fixed rate conventional, 20 to 30 year and most FHA and VA loans in the secondary market to government sponsored enterprises such as FNMA and FHLMC or to wholesale lenders. We generally retain the servicing rights on residential mortgage loans sold which results in monthly service fee income. We will, however, sell select loans with servicing released on a nonrecourse basis. Not reflected in the table above, our commitments to sell residential mortgages amounted to $474 million and $275 million at December 31, 2012 and 2011, respectively.
Parent Company liquidity
The Company obtains its liquidity from multiple sources, including dividends from the Bank, principal repayments on investment securities, interest received from the Bank, a line of credit facility with a bank, and the issuance of debt and equity securities. The primary uses of the Company's liquidity are dividends to stockholders, capital contributions to the Bank, debt service, operating expenses, repurchases of our common stock, and acquisitions. The Company's most liquid assets are cash, interest-bearing demand accounts at correspondent banks, and federal funds sold, all of which totaled $415 million at December 31, 2012. As of December 31, 2012, the Company has in excess of nine quarters of cash liquidity without reliance on dividends from the Bank.
The Company's ability to pay dividends to our stockholders is substantially dependent upon the Bank's ability to pay dividends to the Company. Subject to the Bank meeting or exceeding regulatory capital requirements, the prior approval of the OCC is required if the total of all dividends declared by the Bank in any calendar year would exceed the sum of the Bank's net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits the Bank from paying dividends that would be greater than its undivided profits after deducting statutory bad debt in excess of its allowance for loan losses. The Bank paid dividends of $45 million and $75 million to the Company during 2012 and 2011, respectively. Under the foregoing dividend restrictions, and while maintaining its "well-capitalized" status, the Bank could pay additional dividends of approximately $484 million to the Company without obtaining regulatory approvals.
Security Yields, Maturities and Repricing Schedule
The following table sets forth certain information as of December 31, 2012 regarding the carrying value, weighted average yields and contractual maturities of our investment securities portfolio. Our adjustable-rate securities are included in the period in which interest rates are next scheduled to adjust and fixed-rate securities are included in the period in which the final contractual repayment is due. We have made no adjustments for prepayment of principal. Actual maturities are expected to be significantly shorter as a result of loan repayments underlying mortgage-backed securities. The tax benefits of certain of our tax exempt investment securities have not been factored into the yield calculations in this table (amounts in thousands):
(1) Other securities available for sale include investments with no stated maturity date.
Loan Maturity and Repricing Schedule
The following table sets forth certain information as of December 31, 2012 regarding the amount of loans maturing or repricing in our portfolio. Demand loans having no stated schedule of repayment and no stated maturity are reported as due in one year or less. Adjustable-rate loans are included in the period in which interest rates are next scheduled to adjust rather than the period in which they contractually mature, and fixed-rate loans (including bi-weekly loans) are included in the period in which contractual payments are due. No adjustments have been made for prepayment of principal (in thousands):
For the loans reported in the preceding table, the following sets forth at December 31, 2012, the dollar amount of all of our fixed-rate and adjustable-rate loans due after December 31, 2013 (in thousands):
The following table sets forth at December 31, 2012, the dollar amount of all of our fixed-rate loans due after December 31, 2013 by the period in which the loans mature (in thousands):
The following table sets forth at December 31, 2012, the dollar amount of all of our adjustable-rate loans due after December 31, 2013 by the period in which the loans reprice (in thousands):
Interest Rate and Market Risk
Our primary market risk is interest rate risk, which is defined as the potential variability of our earnings that arises from changes in market interest rates and the magnitude of the change at varying points along the yield curve. Changes in market interest rates, whether they are increases or decreases, can trigger repricings and changes in the pace of payments for both assets and liabilities (prepayment risk), which individually or in combination may affect our net income, net interest income and net interest margin, either positively or negatively.
Most of the yields on our earning assets, including adjustable-rate loans and investments, and the rates we pay on interest-bearing deposits and liabilities are related to market interest rates. Interest rate risk occurs when the interest income (yields) we earn on our assets changes at a pace that differs from the interest expense (rates) we pay on liabilities.
For example, as part of our normal commercial lending activities, a portion of our commercial and commercial real estate loans have adjustable interest rates that are based on longer term rates. The yield on these loans could fluctuate to a greater degree than loans that are based on relatively short-term rates. Accordingly, as a result of actions taken by the Federal Reserve, the yield on our commercial loans was negatively impacted by lower long-term interest rates. Conversely, our cost of funding was not significantly affected by this change in interest rates because the pricing of these instruments is related to a shorter-term part of the interest rate curve.
The primary tool we use to assess our exposure to interest rate risk is a computer modeling technique that simulates the effects of variations in interest rates on net interest income. These simulations, which we conduct at least quarterly, compare multiple hypothetical interest rate scenarios to a stable or current interest rate environment. As a result of these simulations, we take actions to limit the variability on our net interest income due to changes in interest rates. Such actions include: (i) employing interest rate swaps; (ii) emphasizing the origination and retention of residential and commercial adjustable-rate loans, home equity loans, and residential fixed-rate mortgage loans having contractual maturities of no more than 20 years; (iii) selling the majority of 30 year fixed-rate, conforming residential mortgage loans into the secondary market without recourse; (iv) investing in securities with predictable cash flows; (v) growing core deposits; and (vi) utilizing wholesale borrowings to support cash flow needs and help match asset repricing.
Our Asset and Liability Committee monitors our sensitivity to interest rates and approves strategies to manage our exposure to interest rate risk. Our goal is to maximize the growth of net interest income on a consistent basis by minimizing the effects of fluctuations associated with changing market interest rates.
The following table shows the estimated impact on net interest income for the next 12 months resulting from potential changes in interest rates. The calculated changes assume a gradual parallel shift across the yield curve over the next 12 months. These estimates require us to make certain assumptions including loan and mortgage-related investment prepayment speeds, reinvestment rates, and deposit maturities and decay rates. These assumptions are inherently uncertain and, as a result, we cannot precisely predict the impact of changes in interest rates on our net interest income. Actual results may differ significantly due to timing, magnitude, and frequency of interest rate changes and changes in market conditions (amounts in thousands):
(1)
Our Board of Directors has established a policy limiting the adverse change to net interest income to less than 5% under this scenario.
ITEM 7A.
ITEM 7A.
Quantitative and Qualitative Disclosures about Market Risk
A discussion regarding our management of market risk is included in “Interest Rate and Market Risk” in this report in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Management’s Report on Internal Control Over Financial Reporting
We are responsible for establishing and maintaining adequate internal control over financial reporting for First Niagara Financial Group, Inc. and its subsidiaries (“we” and “our”), as that term is defined in Exchange Act Rules 13a-15(f). We conducted an evaluation of the effectiveness of our internal control over our financial reporting as of December 31, 2012 based on the framework in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, we concluded that our internal control over financial reporting is effective as of December 31, 2012.
KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report and has issued a report on the effectiveness of our internal control over financial reporting. Their reports follow this statement.
/s/ John R. Koelmel
/s/ Gregory W. Norwood
John R. Koelmel
Gregory W. Norwood
President and Chief Executive Officer
Chief Financial Officer
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
First Niagara Financial Group, Inc.:
We have audited First Niagara Financial Group, Inc. and subsidiaries' (the Company) internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of condition of First Niagara Financial Group, Inc. and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2012, and our report dated February 25, 2013 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Buffalo, New York
February 25, 2013
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
First Niagara Financial Group, Inc.:
We have audited the accompanying consolidated statements of condition of First Niagara Financial Group, Inc. and subsidiaries (the Company) as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2012. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Niagara Financial Group, Inc. and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 25, 2013 expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
/s/ KPMG LLP
Buffalo, New York
February 25, 2013
FIRST NIAGARA FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Condition
(in thousands, except share and per share amounts)
See accompanying notes to consolidated financial statements.
FIRST NIAGARA FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands, except per share amounts)
See accompanying notes to financial statements.
FIRST NIAGARA FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(in thousands)
See accompanying notes to consolidated financial statements.
FIRST NIAGARA FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders’ Equity
(in thousands, except share and per share amounts)
See accompanying notes to consolidated financial statements.
FIRST NIAGARA FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
FIRST NIAGARA FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands) (continued)
See accompanying notes to consolidated financial statements.
FIRST NIAGARA FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years ended December 31, 2012, 2011, and 2010
(Amounts in thousands, except as noted and per share amounts)
Note 1. Summary of Significant Accounting Policies
First Niagara Financial Group, Inc. (the “Company”), a Delaware corporation, and its subsidiaries provide financial services to individuals and businesses in Upstate New York, Pennsylvania, Connecticut, and Western Massachusetts. Through our wholly owned subsidiary, First Niagara Bank, N.A. (the “Bank”), a federally chartered national bank, we provide a full range of products and services through our retail consumer, commercial, business services, and wealth management operations, including retail banking, consumer and commercial lending, cash management, insurance and wealth management products.
Our accounting and reporting policies conform to U.S. generally accepted accounting principles (“GAAP”) and general practices within the banking industry. Reclassifications of prior years’ amounts are made whenever necessary to conform to the current year’s presentation. The following is a description of our significant accounting policies:
Principles of Consolidation
Our Consolidated Financial Statements include the accounts of the Company and its subsidiaries. We have eliminated all significant intercompany balances in consolidation.
Subsequent Events
We reviewed subsequent events and determined that no further disclosures or measurements were required.
Cash and Cash Equivalents
For purposes of our Consolidated Statement of Cash Flows, cash and cash equivalents include cash and due from banks, money market investments, and federal funds sold which have an original term of less than three months.
Investment Securities
We have classified our investments in debt and equity securities as held to maturity or available for sale. We classify investment securities as held to maturity if we have the positive intent and ability to hold them to maturity. Held to maturity securities are reported at amortized cost. We classify investment securities not classified as held to maturity as available for sale, and report them at fair value with unrealized gains and losses, net of deferred taxes, reported in other comprehensive income as a separate component of stockholders’ equity.
We are required to maintain an investment in common stock of the Federal Home Loan Bank (“FHLB”) of New York, Pittsburgh, and Boston as well as the Federal Reserve Bank because our Bank is a member of the FHLB and the Federal Reserve System. We consider these stocks to be nonmarketable equity securities and carry them at cost.
We conduct a quarterly review and evaluation of our investment securities portfolio to determine if any declines in fair value below amortized cost are other than temporary. In making this determination, we consider some or all of the following factors: the period of time the securities have been in an unrealized loss position, the percentage decline in fair value in comparison to the securities’ amortized cost, credit rating, the financial condition of the issuer and guarantor, where applicable, the delinquency or default rates of underlying collateral, credit enhancement, projected losses, level of credit loss, and projected cash flows. If we intend to sell a security with a fair value below amortized cost or if it is more likely than not that we will be required to sell such a security before recovery, we record an other than temporary impairment charge through current period earnings for the full decline in fair value below amortized cost. For debt securities that we do not intend to sell or it is more likely than not that we will not be required to sell before recovery, we record an other than temporary impairment charge through current period earnings for the amount of the valuation decline below amortized cost that is attributable to credit losses. The remaining difference between the debt security’s fair value and amortized cost (i.e. decline in fair value not attributable to credit losses) is recognized in other comprehensive income.
Our investment securities portfolio includes residential mortgage-backed securities and collateralized mortgage obligations. As the underlying collateral of each of these securities is comprised of a large number of similar residential mortgage loans for which prepayments are probable and the timing and amount of such prepayments can be reasonably estimated, we consider
estimates of future principal prepayments of these underlying residential mortgage loans in the calculation of the constant effective yield used to apply the interest method for income recognition, with retroactive adjustments made as warranted.
Purchases and sales of investment securities are recorded on trade date, with realized gains and losses on sales included in our Consolidated Statements of Income using the specific identification method. We amortize premiums and accrete discounts on our investment securities to interest income utilizing the interest method.
Originated Loans and Leases
Loans we originate and intend to hold in our portfolio are stated at the principal amount outstanding, adjusted for unamortized deferred fees and costs which we amortize to interest income over the expected life of the loan using the interest method. We discontinue accrual of interest on originated loans after payments become more than 90 days past due, or earlier if we do not expect the full collection of principal or interest, with the exception of credit cards. Credit cards are placed on nonaccrual status at 180 days past due. The delinquency status is based upon the contractual terms of the loans. We reverse all uncollected interest income that we previously recognized on nonaccrual loans. When we have doubt as to the collectibility of a loan’s principal, we apply interest payments to principal. For loans other than residential mortgages, cash receipts received on nonperforming impaired loans are first applied to the loan’s principal. Once the remaining principal balance has been collected in full, cash receipts are then applied as recoveries of any partially charged-off amount on the loan. Once a loan’s principal balance, including any previously charged-off amounts are collected in full, cash receipts are recorded as interest income. For residential mortgage loans, where the loan is both well-secured and in the process of collection, we recognize interest income on a cash basis. Interest income on performing troubled debt restructurings, which are considered impaired loans, are applied in accordance with the terms of the modified loan.
We return loans to accrual status when principal and interest payments are current, we expect full collectibility of principal and interest, and a consistent repayment record, generally six consecutive payments, has been demonstrated.
We charge loans off against our allowance for loan losses when it becomes evident that we will not fully collect the balance of the loan. For business and commercial real estate loans, we record a charge off when it is determined that the collection of all or a portion of a loan may not be collected and the amount of that loss is reasonably estimable. For our consumer loans secured by real estate, including our residential mortgages, home equity loans and home equity lines of credit, we order broker price opinions (“BPOs”) at 90 days past due and record partial or full charge-offs based upon the results of such valuations by no later than 180 days past due. All other closed end consumer loans are charged off at 120 days past due and all other open ended consumer lines, including credit card loans are charged off at 180 days past due.
We consider a loan impaired when, based on current information, it is probable that we will be unable to collect all amounts of principal and interest due under the original terms of the agreement. Nonaccrual business and commercial real estate loans greater than $200 thousand are evaluated individually for impairment. Additionally, all loans modified in a troubled debt restructuring (“TDR”) are considered to be impaired, even if the principal balance is less than $200 thousand. We measure the impairment in these loans based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical alternative, the loan’s observable market price or the fair value of the underlying collateral, if the loan is collateral dependent.
At origination, a determination is made whether a loan will be held in our portfolio or is intended for sale in the secondary market. Loans that will be held in our portfolio are carried at amortized cost. Beginning in the second quarter of 2011, we elected the fair value option for substantially all residential mortgage loans held for sale as we believe the fair value measurement of such loans reduces certain timing differences in our Statement of Income and better aligns with our management of the portfolio from a business perspective. This loan by loan election is made at the time of origination and is irrevocable. Residential mortgage loans held for sale for which the fair value option has not been elected, including those originated prior to the second quarter of 2011, are recorded at the lower of the aggregate cost or market value (“LOCOM”). For residential mortgage loans held for sale where we have elected the fair value option, any change in fair value subsequent to origination is recognized immediately in earnings in mortgage banking income. For residential mortgage loans held for sale that are recorded at LOCOM, we recognize any subsequent decreases in fair value in a valuation allowance through a charge to earnings at the time the decline in value occurs. We include gains and losses occurring during the holding period as well as those resulting from sales of our loans held for sale in mortgage banking income.
Acquired Loans
Loans that we acquire in acquisitions subsequent to January 1, 2009 are recorded at fair value with no carryover of the related allowance for loan losses. Determining the fair value of the loans involves estimating the amount and timing of principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest.
We have acquired loans in four separate acquisitions after January 1, 2009. For each acquisition, we reviewed all loans greater than $1 million and considered the following factors as indicators that such an acquired loan had evidence of deterioration in credit quality and was therefore in the scope of Accounting Standards Codification (“ASC”) 310-30:
•
Loans that were 90 days or more past due,
•
Loans that had an internal risk rating of substandard or worse. Substandard is consistent with regulatory definitions and is defined as having a well defined weakness that jeopardizes liquidation of the loan,
•
Loans that were classified as nonaccrual by the acquired bank at the time of acquisition, or
•
Loans that had been previously modified in a troubled debt restructuring.
Any acquired loans that were not individually in the scope of ASC 310-30 because they did not meet the criteria above were either (i) pooled into groups of similar loans based on the borrower type, loan purpose, and collateral type and accounted for under ASC 310-30 by analogy or (ii) accounted for under ASC 310-20 (Nonrefundable fees and other costs.)
Acquired loans accounted for under ASC 310-30 by analogy
We performed a fair valuation of each of the pools and each pool was recorded at a discount. We determined that at least part of the discount on the acquired pools of loans was attributable to credit quality by reference to the valuation model used to estimate the fair value of these pools of loans. The valuation model incorporated lifetime expected credit losses into the loans’ fair valuation in consideration of factors such as evidence of credit deterioration since origination and the amounts of contractually required principal and interest that we did not expect to collect as of the acquisition date. Based on the guidance included in the December 18, 2009 letter from the AICPA Depository Institutions Panel to the Office of the Chief Accountant of the Securities and Exchange Commission (“SEC”), we have made an accounting policy election to apply ASC 310-30 by analogy to all of these acquired pools of loans as they all i) were acquired in a business combination or asset purchase, ii) resulted in recognition of a discount attributable, at least in part, to credit quality; and iii) were not subsequently accounted for at fair value.
The excess of expected cash flows from acquired loans over the estimated fair value of acquired loans at acquisition is referred to as the accretable discount and is recognized into interest income over the remaining life of the acquired loans using the interest method. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable discount. The nonaccretable discount represents estimated future credit losses expected to be incurred over the life of the acquired loans. Subsequent decreases to the expected cash flows require us to evaluate the need for an addition to the allowance for loan losses. Subsequent improvements in expected cash flows result in the reversal of a corresponding amount of the nonaccretable discount which we then reclassify as accretable discount that is recognized into interest income over the remaining life of the loan using the interest method. Our evaluation of the amount of future cash flows that we expect to collect takes into account actual credit performance of the acquired loans to date and our best estimates for the expected lifetime credit performance of the loans using currently available information. Charge-offs of the principal amount on acquired loans would be first applied to the nonaccretable discount portion of the fair value adjustment. To the extent that we experience a deterioration in credit quality in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses would be established based on our estimate of future credit losses over the remaining life of the loans.
In accordance with ASC 310-30, recognition of income is dependent on having a reasonable expectation about the timing and amount of cash flows expected to be collected. We perform such an evaluation on a quarterly basis on both our acquired loans individually accounted for under ASC 310-30 and those in pools accounted for under ASC 310-30 by analogy.
Cash flows for acquired loans individually accounted for under ASC 310-30 are estimated on a quarterly basis. Based on this evaluation, a determination is made as to whether or not we have a reasonable expectation about the timing and amount of cash flows. Such an expectation includes cash flows from normal customer repayment, foreclosure or other collection efforts. Cash flows for acquired loans accounted for on a pooled basis under ASC 310-30 by analogy are also estimated on a quarterly basis. For residential real estate, home equity and other consumer loans, cash flow loss estimates are calculated by a vintage and FICO based model which incorporates a projected forward loss curve. For commercial loans, lifetime loss rates are assigned to each pool with consideration given for pool make-up, including risk rating profile. Lifetime loss rates are developed from internally generated loss data and are applied to each pool.
To the extent that we cannot reasonably estimate cash flows, interest income recognition is discontinued. The unit of account for loans in pools accounted for under ASC 310-30 by analogy is the pool of loans. Accordingly, as long as we can reasonably estimate cash flows for the pool as a whole, accretable yield on the pool is recognized and all individual loans within the pool - even those more than 90 days past due - would be considered to be accruing interest in our financial statement disclosures,
regardless of whether or not we expected to collect any principal or interest cash flows on an individual loan 90 days or more past due.
Allowance for Loan Losses
We determined our allowance for loan losses by portfolio segment, which consist of commercial loans and consumer loans. Our commercial loan portfolio segment includes both business and commercial real estate loans. Our consumer portfolio segment includes residential real estate, home equity, and other consumer loans. We further segregate these segments between loans which are accounted for under the amortized cost method (referred to as “originated” loans) and loans acquired (referred to as “acquired” loans), as acquired loans were originally recorded at fair value, which includes an estimate of lifetime credit losses, resulting in no carryover of the related allowance for loan losses.
Originated loans
We establish our allowance for loan losses through a provision for credit losses based on our evaluation of the credit quality of our loan portfolio. This evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers, among other matters, the estimated fair value of the underlying collateral, economic conditions, historical net loan loss experience, and other factors that warrant recognition in determining our allowance for loan losses. We continue to monitor and modify the level of our allowance for loan losses to ensure it is adequate to cover losses inherent in our loan portfolio.
For our originated loans, our allowance for loan losses consists of the following elements: (i) specific valuation allowances based on probable losses on specifically identified impaired loans; and (ii) valuation allowances based on net historical loan loss experience for similar loans with similar inherent risk characteristics and performance trends, adjusted, as appropriate, for qualitative risk factors specific to respective loan types.
For our originated loans, when current information and events indicate that it is probable that we will be unable to collect all amounts of principal and interest due under the original terms of a business or commercial real estate loan greater than $200 thousand, such loan will be classified as impaired. Additionally, all loans modified in a TDR are considered impaired. The need for specific valuation allowances are determined for impaired loans and recorded as necessary. For impaired loans, we consider the fair value of the underlying collateral, less estimated costs to sell, if the loan is collateral dependent, or we use the present value of estimated future cash flows in determining the estimates of impairment and any related allowance for loan losses for these loans. Confirmed losses are charged off immediately. Prior to a loan becoming impaired, we typically would obtain an appraisal through our internal loan grading process to use as the basis for the fair value of the underlying collateral.
Commercial loan portfolio segment
We estimate the allowance for our commercial loan portfolio segment by considering their type and loan grade. We first apply a historic loss rate to loans based on their type and loan grade. This amount is then adjusted, as necessary, for qualitative considerations to reflect changes in underwriting, market or industry conditions, or based on changes in trends in the composition of the portfolio, including risk composition, seasoning, and underlying collateral. Our loan grading system is described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Credit Risk.”
Consumer loan portfolio segment
We estimate the allowance for loan losses for our consumer loan portfolio segment by first estimating the amount of loans that will eventually default based on delinquency severity. We then apply a loss rate to the amount of loans that we predict will default based on our historical net loss experience. This amount is then adjusted, as necessary, for qualitative considerations to reflect changes in underwriting, market or industry conditions or based on changes in trends in the composition of the portfolio, including risk composition, seasoning, and underlying collateral. We obtain and review refreshed FICO scores on a quarterly basis, and trends are evaluated for consideration as a qualitative adjustment to the allowance. Other qualitative considerations include, but are not limited to, the evaluation of trends in property values, building permits and unemployment.
Acquired Loans
Acquired loans accounted for under ASC 310-30 (including those accounted for under ASC 310-30 by analogy)
For our acquired loans accounted for under ASC 310-30, our allowance for loan losses is estimated based upon our expected cash flows for these loans. To the extent that we experience a deterioration in borrower credit quality resulting in a decrease in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses is established based on our estimate of future credit losses over the remaining life of the loans.
Acquired loans accounted for under ASC 310-20
We establish our allowance for loan losses through a provision for credit losses based upon an evaluation process that is similar to our evaluation process used for originated loans. This evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers, among other matters, the estimated fair value of the underlying collateral, economic conditions, historical net loan loss experience, carrying value of the loans, which includes the remaining net purchase discount or premium, and other factors that warrant recognition in determining our allowance for loan losses.
Premises and Equipment
Our premises and equipment are carried at cost, net of accumulated depreciation and amortization. We compute depreciation on the straight-line method over the estimated useful lives of the assets. We amortize our leasehold improvements on the straight-line method over the lesser of the life of the improvements or the lease term. We generally depreciate buildings over a period of 20 to 39 years, furniture and equipment over a period of 3 to 10 years, and capital leases over the lesser of the useful life or the respective lease term.
Goodwill and Intangible Assets
We record the excess of the cost of acquired entities over the fair value of identifiable tangible and intangible assets acquired less the fair value of liabilities assumed as goodwill. We amortize our acquired identifiable intangible assets with definite useful economic lives over their useful economic life utilizing an accelerated amortization method. On a periodic basis, we assess whether events or changes in circumstances indicate that the carrying amounts of our core deposit and other intangible assets may be impaired. We do not amortize goodwill or any acquired identifiable intangible assets with an indefinite useful economic life, but we review them for impairment at our reporting unit level on an annual basis, or when events or changes in circumstances indicate that the carrying amounts may be impaired. We define a reporting unit as a distinct, separately identifiable component of one of our operating segments for which complete, discrete financial information is available and reviewed regularly by that segment’s management.
We have the option to first assess qualitative factors to determine whether there are events or circumstances that exist that make it more likely than not that the fair value of the reporting unit is less than its carrying amount (Step 0). If it is more likely than not that the fair value of the reporting unit is less than its carrying amount, or if we choose to bypass the qualitative assessment, we proceed to compare each reporting unit's fair value to carrying value to identify potential impairment (Step 1). If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired. However, if the carrying amount of the reporting unit were to exceed its estimated fair value, a second step (Step 2) would be performed that would compare the implied fair value of the reporting unit's goodwill with the carrying amount of the goodwill for the reporting unit. The implied fair value of goodwill is determined in the same manner as goodwill that is recognized in a business combination. Significant judgment and estimates are involved in estimating the fair value of the assets and liabilities of the reporting units.
We perform our annual impairment review of goodwill on November 1 of each year utilizing valuation methods we believe appropriate, given the availability and applicability of market-based inputs for those methods.
Derivative Instruments
We use interest rate swaps to manage our interest rate risk. We also act as an interest rate swap counterparty for certain commercial customers, and manage the interest rate risk of these positions by entering into offsetting interest rate swap agreements with third parties. Interest rate swaps are recorded on our Consolidated Statements of Condition as either an asset or liability at estimated fair value and recognition of the changes in fair value in the income statement depends upon whether the interest rate swaps are in a designated hedging relationship. The change in the fair value of interest rate swaps designated as fair value hedges, including both the effective and ineffective portions, is recognized in earnings. These amounts are offset by the change in fair value of the hedged item, which is also recognized in earnings. The gain or loss associated with the effective portion of our cash flow hedges is recognized in other comprehensive income and is subsequently reclassified into earnings in the period during which the hedged forecasted transactions affects earnings. The gain or loss associated with the ineffective portion of our cash flow hedges is recognized immediately in earnings. We formally document our risk management objectives, strategy, and the relationship between the hedging instrument and the hedged items. We evaluate the effectiveness of the hedge relationship both at inception of the hedge and on an ongoing basis. If the interest rate swap is not designated in a hedge relationship, gains or losses reflecting changes in fair value are recorded in earnings.
Employee Benefits
We maintain an employer sponsored 401(k) plan where participants may make contributions in the form of salary deferrals and we provide matching contributions in accordance with the terms of the plan. Contributions due under the terms of our defined contribution plans are accrued as earned by employees.
We also maintain noncontributory, qualified, defined benefit pension plans for certain employees who meet age and service requirements. We provide post-retirement benefits, principally health care and group life insurance, to employees who meet certain age and service requirements. We have frozen all benefit participation in our pension and post-retirement plans. Pension plans that we acquired in connection with our previous whole-bank acquisitions were frozen prior to or shortly after the completion of the transactions. The actuarially determined pension benefit in the form of a life annuity is based on the employee’s combined years of service, age, and compensation. The cost of our pension plan is based on actuarial estimates of current and future benefits for employees and is charged to current operating expenses.
We recognize an asset for a plan’s overfunded status or a liability for a plan’s underfunded status in our financial statements. We report changes in the funded status of our pension and postretirement plans as a component of other comprehensive income, net of applicable taxes, in the year in which changes occur.
We measure our plans’ assets and obligations that determine its future funded status as of December 31st each year.
Stock-Based Compensation
We maintain various long-term incentive stock benefit plans under which we grant stock options, restricted stock awards, and restricted stock units to certain key employees and directors. We recognize compensation expense in our income statement over the requisite service period, based on the grant-date fair value of the award. The fair values of stock options are estimated using the Black-Scholes option pricing model. For restricted stock awards and units, we recognize compensation expense on a straight-line basis over the vesting period for the fair value of the award, measured at the grant date.
Income Taxes
We account for income taxes under the asset and liability method. Our deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the periods in which we expect the deferred tax assets or liabilities to be realized or settled. Deferred tax assets are recognized only to the extent that it is probable that sufficient taxable profit will be available against which those unused tax losses, unused tax credits or deductible temporary differences can be utilized. As changes in tax laws or rates are enacted, we adjust our deferred tax assets and liabilities through income tax expense. We recognize penalties and accrued interest related to unrecognized tax benefits in income tax expense.
Earnings per Share
We compute earnings per common share (“EPS”) in accordance with the two-class method, which requires that our unvested restricted stock awards that contain nonforfeitable rights to dividends be treated as participating securities in the computation of EPS pursuant to the two-class method. The two-class method is an earnings allocation that determines EPS for each class of common stock and participating security. Our basic EPS is computed by dividing net income allocable to common stockholders by the weighted average number of our common shares outstanding for the period. Our diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in our earnings. Unallocated common shares held by the Employee Stock Ownership Plan (“ESOP”) are not included in the weighted-average number of common shares outstanding for either basic or diluted earnings per share calculations.
Investment and Fiduciary Services
Assets that we hold in a fiduciary or agency capacity for our customers are not included in our accompanying Consolidated Statements of Condition, since these assets are not our assets and we are not the primary beneficiary. We recognize fee income from the management of these assets using the accrual method.
Use of Estimates
We have made a number of estimates and assumptions relating to the reporting of assets and liabilities and disclosure of contingent assets and liabilities in order to prepare these financial statements in conformity with GAAP. The estimates and assumptions that we deem to be critical involve our accounting policies relating to our allowance for loan losses, our accounting estimates relating to investment securities accounting (valuation, other than temporary impairment analysis, and
prepayment assumptions on our collateralized mortgage obligations and mortgage-backed securities), the accounting treatment and valuation of acquired loans, and the analysis of the carrying value of goodwill for impairment. These estimates and assumptions are based on management’s best estimates and judgment and we evaluate them on an ongoing basis using historical experience and other factors, including the current economic environment. We adjust our estimates and assumptions when facts and circumstances dictate. As future events cannot be determined with precision, actual results could differ significantly from our estimates.
Accounting Standards Adopted in 2012
In April 2011, the Financial Accounting Standards Board (the “FASB”) released amended guidance to improve the accounting for repurchase transactions by amending the “effective control” criteria for transactions involving repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The revised guidance removes the criterion requiring a transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in default by a transferee, from the assessment of effective control. As a result, the level of cash collateral received by the transferor in a repurchase agreement or other similar agreement is no longer relevant in determining if a transfer should be accounted for as a sale. This guidance became effective for us in the first quarter of 2012 and is being applied prospectively. It did not have a significant impact on our financial statements.
In May 2011, the FASB released an amendment to change the format in which entities report comprehensive income in their financial statements. Under the new guidance, entities have the option to present total comprehensive income, the components of net income, and the components of other comprehensive income in a single continuous statement or two separate but consecutive statements. This guidance became effective for us on January 1, 2012. See our Consolidated Statements of Comprehensive Income. Guidance related to the presentation requirements for reclassification adjustments was issued by the FASB in February 2013. We do not expect this newly issued guidance will have a significant impact on our financial statements.
In May 2011, the FASB released new guidance to converge the fair value measurement guidance in GAAP with that of International Financial Reporting Standards (“IFRS”). The amendment provides both clarifying guidance regarding the FASB’s intent about the application of existing requirements as well as changes in certain principles or requirements. This guidance became effective for us on January 1, 2012. The amendments related to fair value measurements did not have a significant impact on our financial statements and the additional disclosure requirements have been incorporated into Note 7, Fair Value Measurements.
In September 2011, the FASB released new guidance on the testing of goodwill for impairment. The update permits an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step impairment test required by GAAP. The amendments became effective on January 1, 2012.
Accounting Standards Not Yet Required to be Adopted as of December 31, 2012
In December 2011, the FASB announced new disclosure requirements for offsetting arrangements. The new rules seek to enhance the comparability of financial statements for users by providing information about offsetting and related arrangements. The rules require entities to disclose gross amounts subject to right of set-off, amounts set-off, net amounts presented in the balance sheet, amounts subject to master netting agreements that have not been offset including related amounts of financial collateral. The requirements will become effective for us beginning January 1, 2013 and we do not expect they will have a significant impact on our financial statements.
Note 2. Acquisitions
HSBC Bank Branches
On May 18, 2012, the Bank acquired 137 full-service branches from HSBC Bank USA, National Association (“HSBC”) and its affiliates (the “HSBC Branch Acquisition”) in the Buffalo, Rochester, Syracuse, Albany, Downstate New York and Connecticut banking markets, as contemplated by the Purchase and Assumption Agreement, dated July 30, 2011, as amended and restated as of May 17, 2012 (the “Purchase Agreement”). The purchase price, net of deposit premiums received of $122 million upon closing of the assignments from HSBC to KeyBank N.A. (“Key”), Five Star Bank (“Five Star”), and Community Bank System, Inc. (“Community Bank”), was $772 million. We also acquired certain wealth management relationships, which included approximately $2.5 billion of assets under management. While the HSBC Branch Acquisition is considered a purchase of a business for accounting purposes, pro forma income statement information is not presented because the HSBC Branch Acquisition does not represent the acquisition of a business which has continuity both before and after the acquisition.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:
(1)
Amount is net of $772 million deposit premium paid to HSBC.
(2)
Deposits reported exclude $0.5 billion in municipal deposits that were subject to a price concession.
In connection with the regulatory process for the HSBC Branch Acquisition, we agreed with the U.S. Department of Justice (“DOJ”) to assign our purchase rights related to 26 HSBC branches in the Buffalo area. In January 2012, we entered into an agreement with Key assigning our right to purchase the 26 HSBC Buffalo branches as well as 11 additional HSBC branches in the Rochester area. On July 13, 2012, Key acquired these 37 branches with a total of $2.0 billion in deposits and approximately $256.5 million in loans, and paid us a deposit premium of $91.5 million.
In January 2012, we also entered into separate agreements with Five Star Bank and Community Bank for them to purchase seven First Niagara branches and 20 HSBC branches, for which we had assigned our purchase rights.
On June 22, 2012, Five Star acquired four First Niagara branches with $58.6 million in loans, assumed approximately $129.3 million in deposits, and paid us a deposit premium of $5.3 million. On August 17, 2012, Five Star acquired four of the HSBC branches, assumed approximately $18 million in loans, $157.2 million in deposits, and paid us a deposit premium of $6.5 million.
On July 20, 2012, Community Bank acquired the 16 HSBC branches, with a total of $107.0 million in loans, $696.6 million in deposits, and paid us a deposit premium of $23.8 million. On September 7, 2012, Community Bank acquired three First Niagara branches, assumed approximately $55.4 million in loans, $100.8 million in deposits, and paid us a deposit premium of $3.1 million.
We estimated the fair value of loans acquired from HSBC by utilizing a methodology wherein similar loans were aggregated into pools. Cash flows for each pool were determined by estimating future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value based on a market rate for similar loans. There was no carryover of HSBC’s allowance for loan losses associated with the loans we acquired as the loans were initially recorded at fair value.
Information about the acquired HSBC loan portfolio as of May 18, 2012 is in the following table, and excludes home equity lines of credit, credit card, and any other line of credit:
The $41 million core deposit intangible asset recognized as part of the HSBC Branch Acquisition is being amortized over its estimated useful life of approximately three years using an accelerated method and the $9 million wealth management and $34 million purchased credit card relationships intangibles are being amortized over their useful lives of ten years using an accelerated method. The goodwill, which is not amortized for book purposes, was assigned to our banking segment and is deductible for tax purposes.
The fair value of savings and transaction deposit accounts acquired from HSBC was assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. Certificates of deposit were valued by projecting out the expected cash flows based on the remaining contractual terms of the certificate of deposit. These cash flows were discounted based on a market rate for a certificate of deposit with a corresponding remaining maturity.
Direct costs related to the HSBC Branch Acquisition were expensed as incurred and amounted to $178 million for the year ended December 31, 2012. These merger and acquisition integration expenses included $65 million in prepayment penalties on borrowings and swap termination fees; redundant facilities and employee severance costs; technology costs related to system conversions; and professional fees.
NewAlliance Bancshares, Inc.
On April 15, 2011, the Company acquired all of the outstanding common shares of NewAlliance Bancshares, Inc. (“NewAlliance”), the parent company of NewAlliance Bank, for total consideration of $1.5 billion, and thereby acquired NewAlliance Bank’s 88 branch locations across eight counties from Greenwich, Connecticut to Springfield, Massachusetts. The merger with NewAlliance enabled us to expand into the New England market, improve our core deposit base, and add additional scale in our banking operations. The results of NewAlliance’s operations are included in our Consolidated Statements of Income from the date of acquisition.
Under the terms of the merger agreement, as amended, each outstanding share of NewAlliance stock was converted into the right to receive either 1.10 shares of common stock of the Company, or $14.28 in cash, or a combination thereof. As a result, NewAlliance stockholders received 94 million shares of Company common stock, valued at $1.3 billion, based on the $14.00 closing price of the Company’s stock on April 15, 2011, and cash consideration of $199 million. Also under the terms of the merger agreement, NewAlliance employees became 100% vested in any NewAlliance stock options they held and these options converted into options to purchase Company common stock. These options had a fair value of $16 million on the date of acquisition.
In connection with the merger, the consideration paid, the assets acquired, and the liabilities assumed were recorded at fair value on the date of acquisition, as summarized in the following table:
We estimated the fair value of loans acquired from NewAlliance by utilizing a methodology wherein similar loans were aggregated into pools. Cash flows for each pool were determined by estimating future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value based on a market rate for similar loans. There was no carryover of NewAlliance’s allowance for loan losses associated with the loans we acquired as the loans were initially recorded at fair value.
Information about the acquired NewAlliance loan portfolio as of April 15, 2011 is in the following table, and excludes lines of credit:
The core deposit intangible asset recognized as part of the NewAlliance merger is being amortized over its estimated useful life of approximately seven years utilizing an accelerated method. The goodwill, which is not amortized for book purposes, was assigned to our banking segment and is not deductible for tax purposes. The fair values of savings and transaction deposit accounts acquired from NewAlliance were assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. Certificates of deposit were valued by projecting out the expected cash flows based on the contractual terms of the certificates of deposit. These cash flows were discounted based on a market rate for a certificate of deposit with a corresponding maturity.
The fair value of borrowings, which were largely comprised of Federal Home Loan Bank (“FHLB”) advances, was determined by obtaining settlement quotes from the FHLB.
Direct costs related to the NewAlliance acquisition were expensed as incurred and amounted to $91.5 million for the year ended December 31, 2011. Severance costs comprised more than half of these acquisition and integration expenses, which also included charitable contributions, professional services, marketing and advertising, technology and communications, occupancy and equipment, and other noninterest expenses.
The following table presents financial information regarding the former NewAlliance operations included in our Consolidated Statement of Income from the date of acquisition through December 31, 2011 under the column “Actual from acquisition date through December 31, 2011.” These amounts do not include merger and acquisition integration expenses. In addition, the following table presents unaudited pro forma information as if the acquisition of NewAlliance had occurred on January 1, 2010 under the “Pro forma” column. This pro forma information gives effect to certain adjustments, including purchase accounting fair value adjustments, amortization of core deposit and other intangibles and related income tax effects. Merger and acquisition integration costs of $91.5 million related to the NewAlliance merger that we incurred during the year ended December 31, 2011 are not reflected in the unaudited pro forma amounts. The pro forma information does not necessarily reflect the results of operations that would have occurred had the Company merged with NewAlliance at the beginning of 2010. Cost savings are also not reflected in the unaudited pro forma amounts for the year ended December 31, 2011.
Note 3. Investment Securities
The amortized cost, gross unrealized gains and losses, and fair value of our investment securities at December 31, 2012 and 2011 are summarized as follows:
The table below details certain information regarding our investment securities that were in an unrealized loss position at December 31, 2012 and 2011 by the length of time those securities were in a continuous loss position:
We have assessed the securities in an unrealized loss position at December 31, 2012 and 2011 and determined that the declines in fair value below amortized cost were temporary. We also do not intend to sell these securities and it is not more likely than not that we will be required to sell these securities before the recovery of their amortized cost bases, which may be at maturity.
During the quarter ended June 30, 2012 and subsequent to the HSBC Branch Acquisition, we transferred certain mortgage-backed securities with a carrying value of $861 million from our held to maturity portfolio to our available for sale portfolio. We then sold these and other mortgage-backed securities in our available for sale portfolio with a total carrying value of $3.1 billion for a total pre-tax gain of $21 million in order to manage our interest rate risk and strengthen key financial metrics. The
securities sold were selected based on an assessment of their prepayment risk and did not include any that were purchased in conjunction with the HSBC Branch Acquisition. The proceeds from these sales were used to pay down short-term borrowings.
At March 31, 2011, we transferred $2.0 billion of securities from our available for sale portfolio to our held to maturity portfolio as we determined that we had the intent and ability to hold these securities to maturity. The transferred securities consisted of residential mortgage-backed securities and collateralized mortgage obligations and had net unrealized gains, net of tax, of $4 million on the date of transfer, which is being amortized over the remaining life of the related securities as an adjustment to yield in a manner consistent with the amortization of the premium on the same transferred debt securities.
Scheduled contractual maturities of our investment securities at December 31, 2012 are as follows:
While the contractual maturities of our mortgage-backed securities, collateralized loan obligations, asset-backed securities, and other securities generally exceed ten years, we expect the effective lives to be significantly shorter due to prepayments of the underlying loans and the nature of these securities. The duration of our investment securities portfolio decreased to 3.0 years at December 31, 2012 from 4.1 years at December 31, 2011.
At December 31, 2012 and 2011, $5.5 billion and $9.2 billion, respectively, of our investment securities were pledged to secure borrowings and lines of credit from the FHLB and Federal Reserve Bank (“FRB”), as well as repurchase agreements, certain deposits, and derivative instruments. At December 31, 2012, our investment portfolio included securities issued by the Federal Home Loan Mortgage Corporation, Federal National Mortgage Association, and Government National Mortgage Association with a fair value of $1.7 billion, $2.1 billion, and $2.2 billion, respectively. We had no other investments in securities of a single issuer that exceeded 10% of our stockholders’ equity.
Our investment in FHLB stock consists of $140 million, $24 million, and $121 million of FHLB of New York common stock, FHLB of Pittsburgh common stock, and FHLB of Boston common stock, respectively, at December 31, 2012 and of $101 million, $27 million, and $121 million of FHLB of New York common stock, FHLB of Pittsburgh common stock, and FHLB of Boston common stock, respectively, at December 31, 2011.
Our investment in FRB stock amounted to $136 million and $109 million at December 31, 2012 and 2011, respectively.
Note 4. Loans and Leases
Overall Portfolio
Our loan portfolio is made up of two segments, commercial loans and consumer loans. Those segments are further segregated between our loans initially accounted for under the amortized cost method (referred to as “originated” loans) and loans acquired (referred to as “acquired” loans). Our commercial loan portfolio segment includes both business and commercial real estate loans. Our consumer portfolio segment includes residential real estate, home equity, and other consumer loans.
Our loans and leases receivable consisted of the following at December 31:
As of December 31, 2012, we had a liability for unfunded loan commitments of $12 million. For the year ended December 31, 2012, we recognized provision for credit losses related to our unfunded loan commitments of $1.3 million. We acquired an additional $3.0 billion in unfunded loan commitments as part of our HSBC Branch Acquisition, and consequently increased our liability by $4 million to recognize probable losses inherent in the commitments assumed in the HSBC Branch Acquisition.
Of the $2.7 billion and $2.2 billion home equity portfolio at December 31, 2012 and 2011, respectively, $884 million were in a first lien position at each period end. We hold or service the first lien loan for approximately 10% of the remainder of the home equity portfolio that was in a second lien position as of December 31, 2012 and 2011. Interagency Supervisory Guidance related to junior lien home equity loans issued during 2012 resulted in $8 million of additional nonaccrual loans at December 31, 2012, but did not have a significant impact on our allowance for loan losses.
During 2012, the Office of the Comptroller of the Currency ("OCC") updated their Bank Accounting Advisory Series which states that consumer loans restructured in bankruptcy should be written down to their collateral value. This guidance also states that such restructures are also considered troubled debt restructurings ("TDRs"). This guidance resulted in $12.4 million of additional TDRs at December 31, 2012, and all such loans were placed on nonaccrual status. As a result of stable home values in our footprint markets, only $2.3 million of these loans have collateral that has a current fair value less than the balance of the loan. We recorded $0.6 million of charge-offs on such loans.
Acquired loans
We have acquired loans in four acquisitions since January 1, 2009. All acquired loans were initially measured at fair value and subsequently accounted for under either Accounting Standards Codification Topic (“ASC”) 310-30 (Loans and Debt Securities Acquired with Deteriorated Credit Quality) or ASC 310-20 (Nonrefundable Fees and Other Costs.) The outstanding principal balance and the related carrying amount of our acquired loans included in our Consolidated Statements of Condition are as follows at December 31:
The following table presents changes in the accretable discount, which includes income recognized from contractual interest cash flows, for the dates indicated. Acquired lines of credit accounted for under ASC 310-20 are not included in this table.
Allowance for loan losses
As further discussed in Note 1, Summary of Significant Accounting Policies, we establish our allowance for loan losses through a provision for credit losses based on our evaluation of the credit quality of our loan portfolio. We determined our allowance for loan losses by portfolio segment as defined above. For our originated loans, our allowance for loan losses consists of the following elements: (i) specific valuation allowances based on probable losses on specifically identified impaired loans; and (ii) valuation allowances based on net historical loan loss experience for similar loans with similar inherent risk characteristics and performance trends, adjusted, as appropriate for qualitative risk factors specific to respective loan types.
We also maintain an allowance for loan losses on acquired loans when: (i) for loans accounted for under ASC 310-30, there is deterioration in credit quality subsequent to acquisition, and (ii) for loans accounted for under ASC 310-20, the inherent losses in the loans exceed the remaining credit discount recorded at the time of acquisition.
The following table presents the activity in our allowance for loan losses on originated loans and related recorded investment of the associated loans in our originated loan portfolio segment for the periods indicated:
The following table presents the activity in our allowance for loan losses and related recorded investment of the associated loans in our acquired loan portfolio for the periods indicated. We did not have any activity in our allowance for loan losses for acquired commercial or consumer loans for the year ended December 31, 2010.
Credit Quality
We monitor credit quality as indicated by various factors and utilize such information in our evaluation of the adequacy of the allowance for loan losses. The following sections discuss the various credit quality indicators that we consider.
Nonperforming loans
Our nonaccruing loans consisted of the following at the dates indicated:
Beginning in the second quarter of 2012, we began reporting acquired lines of credit not subject to ASC 310-30 as acquired nonperforming loans when these loans become 90 days past due. Prior to the HSBC Branch Acquisition, such amounts were immaterial. The remaining credit discount recorded at acquisition is adequate to cover losses inherent in these balances.
The table below provides information about the interest income that would have been recognized if our nonperforming loans had performed in accordance with terms for the years ending December 31:
Impaired loans
The following tables provide information about our impaired loans including recorded investments, principal balances and related allowance amounts at the dates indicated. Loans with no related allowance for loan losses have adequate collateral securing their carrying value and in some circumstances have been charged down to their current carrying value based on the fair value of the collateral. The carrying value of our impaired loans, less any related allowance for loan losses, was 67% and 68% of the loans’ contractual principal balance at December 31, 2012 and 2011, respectively.
(1)
Amounts include the following balances of impaired acquired loans with no related allowance at December 31, 2012. The remaining credit mark is considered adequate to cover any loss on these balances. There were no impaired acquired loans at December 31, 2011.
The following tables provide information about our impaired loans including the average recorded investment and interest income recognized on impaired loans for the years ending December 31:
(1)
Amounts include the following balances of impaired acquired loans with no related allowance at December 31, 2012. The remaining credit mark is considered adequate to cover any loss on these balances. There were no impaired acquired loans at December 31, 2011.
Period end nonaccrual loans differed from the amount of total impaired loans as certain TDRs, which are considered impaired loans, were accruing interest because the borrower demonstrated its ability to satisfy the terms of the restructured loan for at least six consecutive payments. Also contributing to the difference are nonaccrual commercial loans less than $200 thousand and nonaccrual consumer loans, which are not considered impaired unless they have been modified in a TDR as they are evaluated collectively when determining the allowance for loan losses. The following table is a reconciliation between nonaccrual loans and impaired loans at the dates indicated:
Credit Quality Indicators
The primary indicators of credit quality are delinquency status and our internal loan gradings for our commercial loan portfolio segment and delinquency status and current FICO scores for our consumer loan portfolio segment. The following tables contain an aging analysis of our loans by class at the dates indicated:
(1)
Includes credit card loans, loans that have matured and are in the process of collection, and acquired loans that were originally recorded at fair value upon acquisition. Acquired loans are considered to be accruing as we can reasonably estimate future cash flows on these acquired loans and we expect to fully
collect the carrying value of these loans net of the allowance for acquired loan losses. Therefore, we are accreting the difference between the carrying value of these loans and their expected cash flows into interest income. In connection with the HSBC Branch Acquisition, we changed our nonaccrual policy related to credit cards from 90 days to 180 days, at which time the balance is charged-off. This policy change did not have a significant impact on our interest income or allowance for credit losses.
Our internal loan risk assessment provides information about the financial health of our commercial borrowers and our risk of potential loss. The following tables present information about the credit quality of our commercial loan portfolio at the dates indicated:
(1)
Includes special mention, substandard, doubtful, and loss, which are consistent with regulatory definitions, and as described in Part I, Item 1, “Business,” under the heading “Asset Quality Review.”
Borrower FICO scores provide information about the credit quality of our consumer loan portfolio as they provide an indication as to the likelihood that a debtor will repay their debts. The scores are obtained from a nationally recognized consumer rating agency and are presented in the table below at the dates indicated:
(1)
Primarily includes loans that are serviced by others for which refreshed FICO scores were not available as of the indicated date.
Troubled Debt Restructures
The following table details additional information on our TDRs at December 31:
(1)
Includes 44 acquired loans that were restructured with a recorded investment of $2.9 million at December 31, 2012. There were no acquired loans that were considered TDRs at December 31, 2011.
The modifications made to restructured loans typically consist of an extension of the payment terms, deferral of principal, or a rate reduction. Additionally, loans restructured in a Chapter 7 bankruptcy are considered TDRs. We generally do not forgive principal when restructuring loans. The financial effects of our modifications are as follows for the periods indicated:
(1)
Postmodification balances approximate premodification balances. The aggregate amount of charge-offs as a result of the restructuring is not significant.
The recorded investment in loans modified as TDRs within 12 months of the balance sheet date and for which there was a payment default during the periods indicated are shown below:
Residential Mortgage Banking
The following table provides information about our residential mortgage banking activities at December 31:
Note 5. Premises and Equipment
A summary of our premises and equipment at December 31, 2012 and 2011 follows:
Our rent expense, which is included in occupancy and equipment in our Consolidated Statements of Income, was $27.6 million, $34.0 million, and 17.7 million, for 2012, 2011, and 2010, respectively.
Note 6. Goodwill and Other Intangible Assets
The following table shows information regarding our goodwill for 2012 and 2011:
Goodwill
We perform our annual impairment test of goodwill on November 1st of each year. After giving appropriate consideration to all available information, we determined that no impairment of goodwill had been incurred in either 2012 or 2011. However, as a result of the challenging economic environment in 2012 for the banking industry as a whole, the excess of fair value over the carrying value of our reporting units narrowed. Continuation of the depressed economic environment or further deterioration in market conditions may result in an impairment of goodwill in the future.
As part of our impairment test, we utilized both the income and market approaches to compare the carrying values of our Banking and Financial Services reporting units to their estimated fair values.
Key changes in the market and our operations were monitored from our impairment test date of November 1st to each year end date in order to identify circumstances necessitating further testing of impairment. No such changes were noted for 2012 or 2011.
The following table provides information regarding our amortizing intangible assets at December 31:
The estimated future amortization expense for our amortizing intangible assets is as follows at December 31, 2012:
Note 7. Deposits
Our deposits consist of the following at December 31:
Interest expense on our deposits is summarized as follows:
Interest rates on our certificates range from 0.05% to 5.12% at December 31, 2012. Certificates of deposit that we issued in amounts over $100 thousand amounted to $1.7 billion, $1.3 billion, and $997 million at December 31, 2012, 2011, and 2010, respectively. Interest expense on certificates of deposit over $100 thousand totaled $11.2 million, $15.5 million, and $12.7 million in 2012, 2011, and 2010, respectively. Included in certificates of deposit issued in amounts over $100 thousand at December 31, 2012, 2011 and 2010 are $635 million, $62 million and $145 million, respectively, of brokered deposits.
Included in total deposits are municipal deposits totaling $3.3 billion and $1.7 billion at December 31, 2012 and 2011, respectively.
Note 8. Borrowings
Our outstanding borrowings at December 31, 2012 and 2011 are summarized as follows:
Our FHLB advances bear interest rates ranging from 0.31% to 0.47% and had a weighted average rate of 0.43% at December 31, 2012 and 1.90% at December 31, 2011. Our repurchase agreements bear interest rates ranging from 0.02% to 0.20% and had a weighted average rate of 0.18% at December 31, 2012 and 1.27% at December 31, 2011. Our senior notes and subordinated notes bear interest at annual rates of 6.75% and 7.25%, respectively. Our junior subordinated debentures bear interest rates ranging from 1.59% to 10.88% and have a weighted average interest rate of 2.72% at December 31, 2012.
Interest expense on our borrowings is summarized as follows:
Our Bank has lines of credit with the FHLB, FRB, and commercial banks that serve as secondary funding sources for lending, liquidity, and asset and liability management. At December 31, 2012 and 2011, the FHLB facility totaled $4.0 billion and $5.0 billion, respectively, of which $2.4 billion and $3.5 billion was utilized and secured by approximately $4.0 billion and $2.6 billion, respectively, of our commercial real estate, residential real estate, and multifamily loans, as well as $2.8 billion of investment securities in 2011. As of December 31, 2012 and 2011, our lines of credit totaled $738 million and $844 million, respectively with the FRB, and $200 million and $175 million, respectively, with commercial banks, neither of which was utilized at December 31, 2012 and 2011. Our lines of credit with commercial banks include a committed line of credit agreement, which contains a negative pledge against our First Niagara Bank stock and the maintenance of certain standard financial covenants. The interest rate on outstanding borrowings under this line of credit is, at our election, equal to the London Interbank Offered Rate (“LIBOR”) rate plus 150 basis points, resetting every 30, 60 or 90 days. Interest on the other lines of credit with commercial banks is payable at the overnight federal funds rate.
During 2012, we entered into repurchase agreements with various broker-dealers, whereby certain of our securities available for sale and certain of our securities held to maturity were pledged to collateralize the borrowings. We treat these repurchase agreements as financing transactions and our obligation to repurchase is reflected as a borrowing in our Consolidated Statements of Condition. The dollar amount of our securities underlying the agreements is included in our securities available for sale and securities held to maturity in our Consolidated Statements of Condition. These securities however, are delivered to the dealer with whom we execute each transaction. The dealers may sell, loan or otherwise dispose of these securities to other parties in the normal course of their business, but they agree to resell to us the same securities at the maturity of the agreements. We also retain the right of substitution of collateral throughout the terms of the agreements. At December 31, 2012, we did not have any outstanding repurchase agreements with broker-dealers and therefore, none of our investment securities were pledged to collateralize these borrowings. However, such repurchase agreements averaged $912 million and $2.5 billion during 2012 and 2011, respectively. At December 31, 2011, we had no amounts at risk under repurchase agreements with any individual counterparty or group of related counterparties that exceeded 10% of our stockholders’ equity. The amount at risk to us would be equal to the excess of our carrying value (or fair value if greater) of the securities sold under agreements to repurchase over the amount of our repurchase liability.
On December 13, 2011, we issued $300 million of 7.25% subordinated notes due December 15, 2021, the proceeds of which were used to consummate our previously announced acquisition of HSBC branches. The notes are not redeemable at any time prior to the maturity date.
Our junior subordinated debentures include amounts related to our First Niagara Financial Group Statutory Trust I as well as junior subordinated debentures associated with six statutory trust affiliates that were acquired from our merger with Harleysville and three statutory trusts acquired from NewAlliance (the “Trusts”). The Trusts qualify as variable interest entities and were formed to issue mandatorily redeemable trust preferred securities to investors and loan the proceeds to us for general corporate purposes. The Trusts hold, as their sole assets, junior subordinated debentures of the Company with face amounts totaling $142 million at December 31, 2012. The carrying value of the trust preferred junior subordinated debentures, net of the unamortized purchase accounting fair value adjustment of approximately $30 million, is $112 million at December 31, 2012. We own all of the common securities of the Trusts and have accordingly recorded $4 million in equity method investments classified as other assets in our Consolidated Statement of Condition at December 31, 2012. As the shareholders of the trust preferred securities are the primary beneficiaries of these trusts, the Trusts are not consolidated in our financial statements.
Our junior subordinated debentures are redeemable prior to the maturity date at our option upon each trust’s stated option repurchase dates, and from time to time thereafter. These debentures are also redeemable in whole at any time upon the occurrence of specific events defined within the trust indenture. Our obligations under the debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the issuers’ obligations under the trust preferred securities.
The aggregate maturities of our long-term borrowings at December 31, 2012 are as follows (by year of maturity):
There were no outstanding long-term repurchase agreements included in our borrowing amounts in the preceding table that would be affected if interest rates in 2013 were to rise significantly from current levels.
Note 9. Derivative Financial Instruments
We are a party to derivative financial instruments in the normal course of business to manage our own exposure to fluctuations in interest rates and to meet the needs of our customers. These financial instruments have been limited to interest rate swap agreements, which are entered into with counterparties that meet established credit standards and, where appropriate, contain master netting and collateral provisions protecting the party at risk. We believe that the credit risk inherent in all of our derivative contracts is minimal based on our credit standards and the netting and collateral provisions of the interest rate swap agreements.
Our derivative positions include both instruments that are designated as hedging instruments and instruments that are customer related and not designated in hedging relationships. The following table presents information regarding our derivative financial instruments, at the dates indicated:
(1)
Included in Other assets in our Consolidated Statements of Condition.
(2)
Included in Other liabilities in our Consolidated Statements of Condition.
Derivatives designated in hedging relationships
We designate interest rate swap agreements used to manage changes in the fair value of loans due to interest rate changes as fair value hedges. We have designated the risk of changes in the fair value of loans attributable to changes in the benchmark rate as the hedged risk. Accordingly, changes to the fair value of the hedged items or derivatives attributable to a change in credit risk
are excluded from our assessment of hedge effectiveness. The change in fair value of the derivatives, including both the effective and ineffective portions, is recognized in earnings and, so long as our fair value hedging relationships remain highly effective, such change is offset by the gain or loss due to the change in fair value of the loans. The net impact of the fair value hedging relationships on net income was not significant during the years ended December 31, 2012 and 2011.
Historically, we have also entered into interest rate swaps to offset the variability in the interest cash outflows of LIBOR based borrowings. These derivative instruments have been designated as cash flow hedges. At December 31, 2012, we did not have any derivatives classified as cash flow hedges. During the second quarter of 2012, borrowings that were hedged in cash flow hedging relationships were paid off in connection with the HSBC Branch Acquisition and the related swaps that were hedging these borrowings were terminated. We had designated the risk of changes in the amount of interest payment cash flows to be made during the term of the borrowings attributable to changes in the benchmark rate as the hedged risk. Accordingly, changes to the amount of interest payment cash flows for the hedged items or derivatives attributable to a change in credit risk have been excluded from our assessment of hedge effectiveness. Our interest rate swaps designated as cash flow hedges had maturities that correspond to the maturity of the related hedged borrowing. Any gain or loss associated with the effective portion of our cash flow hedges was recognized in other comprehensive income and is subsequently reclassified into earnings in the period during which the hedged forecasted transactions affects earnings. Any gain or loss associated with the ineffective portion of our cash flow hedges, including ineffectiveness, is recognized immediately in earnings.
The following table presents information about amounts recognized for our derivative financial instruments designated in cash flow hedging relationships for the years ended December 31:
(1)
Of this amount, $11.7 million was recognized in merger and acquisition integration expenses when the associated borrowings were repaid in connection with the HSBC Branch Acquisition and $3.7 million was recognized in interest expense on borrowings in our Consolidated Statements of Income.
(2)
Recognized in interest expense on borrowings.
Derivatives not designated in hedging relationships
In addition to our derivatives designated in hedge relationships, we act as an interest rate swap counterparty for certain commercial borrowers in the normal course of servicing our customers, which are accounted for at fair value. We manage our exposure to such interest rate swaps by entering into corresponding and offsetting interest rate swaps with third parties that mirror the terms of the interest rate swaps we have with the commercial borrowers. These positions (referred to as “customer swaps”) directly offset each other and our exposure is the positive fair value of the derivatives due to changes in credit risk of our commercial borrowers and third parties. We recognized revenue for this service that we provide our customers of $25 million and $8 million for the years ended December 31, 2012 and 2011, respectively, included in Capital Markets income in our Consolidated Statements of Income.
In the second quarter of 2012, we sold $3.1 billion of investment securities to a third party (“purchaser”) at a certain price as of the date of the sale. Under the sales agreement, the purchaser subsequently sold all of the investment securities over a set period of time and we received a portion of the additional net profits received in excess of the floor price. The agreement qualified as a free standing derivative and was accounted for at fair value. During the third and fourth quarters of 2012, we recorded a total gain of $5.3 million for the increase in the fair value of the derivative. The agreement concluded with the sale of all of the investment securities.
Note 10. Commitments and Contingent Liabilities
Loan Commitments
In the ordinary course of business, we extend commitments to originate commercial and residential mortgages, commercial loans, and consumer loans. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established under the contract. Our commitments generally have fixed expiration dates or other termination clauses, and may require our customer to pay us a fee. Since we do not expect all of the commitments to be funded, the total commitment amounts do not necessarily represent our future cash requirements. We evaluate each customer’s creditworthiness
on a case-by-case basis. We may obtain collateral based upon our assessment of the customer’s creditworthiness. In addition, we may extend commitments on fixed rate loans which expose us to interest rate risk given the possibility that market rates may change between the commitment date and the actual extension of credit. We also extend credit to our retail and commercial customers, up to a specified amount, through lines of credit. The borrower is able to draw on these lines as needed, therefore our funding requirements for these products are generally more difficult to predict.
In addition to the above, we issue standby letters of credit to third parties that guarantee payments on behalf of our commercial customers in the event our customer fails to perform under the terms of the contract between our customer and the third party. Since the majority of our unused commercial lines of credit and our outstanding standby letters of credit expire without being funded, our actual funding requirements may be substantially less than the amounts that we report. The credit risk involved in issuing these commitments is essentially the same as that involved in extending loans to customers and is limited to the contractual notional amount of these instruments.
We had a liability for unfunded commitments of $12 million and $7 million as of December 31, 2012 and 2011, respectively. For the years ending December 31, 2012, and 2011, we recognized provision for credit losses related to our unfunded commitments of $1.3 million and $3.7 million, respectively.
Information pertaining to our loan commitments is as follows as of December 31:
To assist with our asset and liability management and to provide us cash flow to support our loan growth, we generally sell certain residential real estate loans in the secondary market to government sponsored enterprises such as FNMA and FHLMC or to wholesale lenders. When we retain the servicing rights on residential mortgage loans that we sell, we recognize a mortgage servicing asset upon sale and monthly service fee income thereafter, net of servicing asset amortization.
Lease Obligations
Our future minimum rental commitments for premises and equipment under non-cancelable operating leases at December 31, 2012 were $33.1 million in 2013; $31.3 million in 2014; $28.6 million in 2015; $25.6 million in 2016; $19.4 million in 2017; and a total of $84.1 million thereafter through 2041. Our future commitments under capital lease obligations at December 31, 2012 were $2.1 million in 2013; $2.5 million in 2014; $2.5 million in 2015; $2.5 million in 2016; $2.5 million in 2017; and a total of $20.3 million thereafter through 2032. Under these leases we are obligated for real estate taxes, insurance, and maintenance expenses.
Contingent Liabilities
In the ordinary course of our business there are various threatened and pending legal proceedings against us. Based on our review and consultation with our outside legal counsel, we believe that the aggregate liability, if any, arising from such litigation would not have a material adverse effect on our Consolidated Financial Statements at December 31, 2012.
Note 11. Capital
First Niagara Financial Group, Inc. and our bank subsidiary, First Niagara Bank, N.A. are subject to regulatory capital requirements administered by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the Office of the Comptroller of Currency (the “OCC”), respectively. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under
regulatory accounting practices. Such quantitative measures are also subject to qualitative judgment of the regulators regarding components, risk weightings, and other factors.
The actual capital amounts, ratios, and requirements for First Niagara Financial Group, Inc. and First Niagara Bank, N.A. at December 31, 2012 and 2011 are presented in the following table:
As of December 31, 2012, we met all capital adequacy requirements to which we were subject and both First Niagara Financial Group, Inc. and First Niagara Bank, N.A. were considered well-capitalized under the Federal Reserve’s Regulation Y (in the case of First Niagara Financial Group, Inc.) and the OCC’s prompt corrective action regulations (in the case of First Niagara Bank, N.A.). We are unaware of any conditions or events since the latest notification from federal regulators that have changed our capital adequacy categories. During 2012 and 2011, the Company contributed $215 million and $645 million, respectively, of capital to the Bank for the HSBC Branch Acquisition.
Our ability to pay dividends to our stockholders is substantially dependent upon the ability of the Bank to pay dividends to the Company. Subject to First Niagara Bank, N.A. meeting or exceeding regulatory capital requirements, the prior approval of the OCC is required if the total of all dividends declared by First Niagara Bank, N.A. in any calendar year would exceed the sum of the Bank’s net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits the Bank from paying dividends that would be greater than its undivided profits after deducting statutory bad debt in excess of its allowance for loan losses. Under the foregoing dividend restrictions, and while maintaining its “well capitalized” status, First Niagara Bank, N.A. could pay aggregate dividends of approximately $484.2 million to the Company, without obtaining affirmative regulatory approvals, as of December 31, 2012. The Bank paid $45 million and $75 million in dividends to the Company in 2012 and 2011, respectively.
Preferred Stock Issuance
In December 2011, we issued 14 million shares of fixed-to-floating rate perpetual noncumulative preferred stock, Series B, with a par value of $0.01 and a liquidation preference of $25 per Series B share. Net proceeds totaled $338.0 million after deducting underwriting discounts and commission and offering expenses.
The preferred stock pays dividends quarterly when, as and if declared by our board of directors, at a rate of 8.625% per year until February 15, 2017, whereby the dividends are then paid at a floating rate equal to three month LIBOR plus 7.327% per
year. Additionally, the preferred stock has no maturity date. We may redeem the preferred stock, in whole or in part, from time to time, on any dividend payment date on or after February 15, 2017, at a redemption price of $25 per share, plus any declared and unpaid dividends.
Common Stock Issuance
In December 2011, we issued 57 million shares of common stock in an underwritten public offering at a price of $8.50 per share. Net proceeds totaled $467.7 million after deducting underwriting discounts and commissions and offering expenses.
Common Stock Repurchases
We did not repurchase shares of our common stock during 2012. As of December 31, 2012, we are authorized to repurchase up to 12 million shares of our common stock.
Note 12. Income Taxes
The components of our income tax expense are as follows:
Our effective tax rates for 2012, 2011, and 2010 were 29.6%, 33.7%, and 33.9%, respectively. Our income tax expense differs from our expected tax expense (computed by applying the Federal corporate tax rate of 35% to income before income taxes) as follows:
The tax effects of our temporary differences that give rise to significant portions of our deferred tax assets and deferred tax liabilities at December 31, 2012 and 2011 are presented below:
In assessing the realizability of our deferred tax assets, we consider whether it is more likely than not that we will not realize some portion or all of our deferred tax assets. The ultimate realization of our deferred tax assets is dependent upon our generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of our deferred tax liabilities, availability of net operating loss carry backs, our projected future taxable income, and our tax planning strategies in making this assessment. Based upon the level of our available historical taxable income, the opportunity for our net operating loss carry backs, and projections for our future taxable income over the periods which our deferred tax assets are realizable, we believe it is more likely than not that we will realize the benefits of these deductible differences at December 31, 2012.
We may carry net operating losses back to the preceding two years for Federal income tax purposes and forward to the succeeding 20 years for Federal and State income tax purposes, subject to certain limitations. At December 31, 2012, we had net operating loss carryforwards of $187.8 million for Federal income tax purposes, which will begin to expire in 2020. These losses, subject to an annual limitation, were obtained through our acquisitions of Great Lakes Bancorp, Inc. in 2008 and Harleysville in 2010. State net operating loss carryforwards at December 31, 2012 were $42.8 million and are expected to expire by 2030. As of December 31, 2012, a valuation allowance of $1.7 million has been established for net operating loss carryovers that are not expected to be utilized by the end of the carryover period.
At December 31, 2012, we had a valuation allowance of $0.6 million against a portion of our state deferred tax asset in connection with the continuation of a Connecticut passive investment company acquired from NewAlliance and pursuant to legislation enacted in 1998. Under this legislation, Connecticut passive investment companies are not subject to the Connecticut Corporate Business Tax and dividends paid by the passive investment company to the Company are exempt from the Connecticut Corporate Business Tax.
We have Federal alternative minimum tax credits of approximately $6.8 million that have an unlimited carryforward period.
At December 31, 2012, our Bank’s Federal pre-1988 loan loss reserve, for which no Federal income tax provision has been made, was approximately $92.0 million. Under current Federal law, these reserves are subject to recapture into taxable income should our Bank make non-dividend distributions, make distributions in excess of earnings and profits retained, as defined, or cease to maintain a banking type charter. A deferred tax liability is not recognized for the base year amount unless it becomes apparent that those temporary differences will reverse into taxable income in the foreseeable future. No deferred tax liability has been established as these two events are not expected to occur in the foreseeable future.
A reconciliation of our unrecognized tax benefits is as follows for the years ended December 31:
The entire balance of unrecognized tax benefits, if recognized, would favorably affect our effective income tax rate. We recognize penalties and accrued interest related to unrecognized tax benefits in tax expense. Accrued penalties and interest amounted to $0.3 million at December 31, 2012. We anticipate that approximately $0.5 million in unrecognized tax benefits will reverse in 2013.
We are subject to routine audits of our tax returns by the Internal Revenue Service and various state taxing authorities. With few exceptions, we are no longer subject to Federal and state income tax examinations by tax authorities for years before 2008. There are no indications of any material adjustments relating to any examination currently being conducted by any taxing authority.
Note 13. Earnings Per Share
The following table is a computation of our basic and diluted earnings per share using the two-class method for the years ended December 31:
Note 14. Other Comprehensive Income
The following table presents the activity in our other comprehensive income for the years ended December 31:
The following table presents the activity in our accumulated other comprehensive income for the periods indicated:
During the next twelve months, we expect to reclassify $1.1 million of pre-tax net loss on previous cash flow hedges from accumulated other comprehensive income to earnings.
Note 15. Stock-Based Compensation
We offer several stock-based incentive plans which are described below. Stock-based compensation expense for 2012, 2011, and 2010 totaled $11.1 million, $7.5 million, and $5.6 million, respectively, which is included in salaries and benefits in our Consolidated Statements of Income.
Stock Option Plan
We have two stock-based compensation plans under which we grant options to our directors and key employees. The Amended and Restated 2002 Long-Term Incentive Stock Benefit Plan (the “2002 Plan”), which expires in 2015, authorizes us to issue up to 8 million shares of common stock for grants of stock options, stock appreciation rights, restricted stock awards, restricted stock units, or performance unit awards. The 2012 Equity Incentive Plan (the "2012 Plan"), which expires in 2022, authorizes us to issue up to 7 million shares of common stock for grants of stock options, stock appreciation rights, accelerated ownership option rights, restricted stock awards or restricted stock units. During 2012, we granted stock options and stock awards and units under both plans. We grant stock options with an exercise price equal to the market price of our stock on the date of grant. All options have a ten year term and become fully vested and exercisable over a period of three to five years from the grant date. When option recipients exercise their options, we issue shares from treasury stock and record the proceeds as additions to capital. At December 31, 2012, we had approximately 1.0 million and 6.0 million shares available for grant under the 2002 and 2012 plans, respectively.
Restricted Stock Plan
As discussed above, restricted stock awards and restricted stock units may also be granted under both the 2002 Plan and 2012 Plan. Restricted stock grants to non-employee directors vest over one year while restricted stock grants to employees generally vest over three years from the grant date. When restricted stock grants are forfeited before they vest, we reacquire the shares into treasury stock, and hold them to use for new awards.
Long-Term Performance Plan
We also have a Long-Term Performance Plan (the “LTPP Plan”) which provides our key executives and other employees with long-term incentives based primarily on performance, as a motivation for future performance and as a retention tool for continued employment. The LTPP Plan is a multi-year performance plan, with stock-based incentive award opportunities if certain company performance targets are met. The LTPP Plan is funded by shares previously approved and authorized under the 2002 Plan and 2012 Plan. For the year ended December 31, 2012, we allocated approximately 36 thousand shares to the LTPP Plan.
At December 31, 2012, we held approximately 13.4 million shares of our stock as treasury shares, which is adequate to meet the share requirements of our current stock-based compensation plans. During 2012, we issued 0.8 million shares from treasury stock in connection with the exercise of stock options and grants of restricted stock.
Stock Option Grants
The following is a summary of our stock option activity for 2012:
(1)
Intrinsic value is the difference between the fair value of our stock at December 31, 2012 and the exercise price of the stock award. Due to the price of our stock at December 31, 2012, the outstanding and exercisable options had no intrinsic value.
The following is a summary of our nonvested stock option activity for 2012:
The following is a summary of our stock options outstanding as of the dates indicated:
No options were exercised during 2012. The total intrinsic value of stock options exercised during 2011 and 2010 was $0.6 million and $1.8 million, respectively. As of December 31, 2012, we have $0.8 million of unrecognized compensation cost related to unvested options that we have granted. We expect this cost to be recognized over a weighted average period of 1.8 years.
We use the Black-Scholes valuation method to estimate the fair value of our stock option awards. This method is dependent upon certain assumptions. The following is a summary of our stock options granted for the years ended December 31, as well as the weighted average assumptions that we utilized to compute the fair value of the options:
In the table above the risk-free interest rate is the zero coupon U.S. Treasury rate commensurate with the expected life of options on the date of their grant. We based the volatility of our stock on historical volatility over a span of time equal to the expected life of the options.
Restricted Stock Awards
We expense the grant date fair value of our restricted stock awards over their respective vesting periods. At December 31, 2012 we had $6.6 million of unrecognized compensation cost related to unvested restricted stock awards and we expect this cost to be recognized over a weighted average period of 2.0 years.
The following is a summary of our restricted stock activity for 2012:
The fair value of restricted stock awards that vested during 2012, 2011, and 2010 was $3.1 million, $2.5 million, and $3.2 million, respectively.
Restricted Stock Units
During 2012 and 2011, we granted 37,448 and 24,684 restricted stock units, respectively, with a weighted average grant date fair value of $9.84 and $14.07, respectively, to certain members of our Board of Directors. These grants vested on December 31, 2012 and 2011 but are not released until the board member retires. Dividend equivalent units earned during 2012 and 2011 on restricted stock units totaled 3,020 and 2,805, respectively.
Note 16. Benefit Plans
We account for our pension and postretirement plans by recognizing in our financial statements an asset for a plan’s overfunded status or a liability for a plan’s underfunded status. We report changes in the funded status of our pension and postretirement plan as a component of other comprehensive income, net of applicable taxes, in the year in which changes occur.
Pension Plans
We maintain a legacy employer sponsored defined benefit pension plan (the “First Niagara Plan”) for which participation and benefit accruals have been frozen since 2002. Additionally, any pension plans acquired in connection with previous whole-bank acquisitions, and subsequently merged into the First Niagara Plan were frozen prior to or shortly after completion of the transactions. Upon our merger with NewAlliance, we acquired the Employees’ Retirement Plan of NewAlliance Bank (the “NewAlliance Plan”), an employer sponsored defined benefit pension plan. The NewAlliance Plan was frozen prior to completion of the merger and has not been merged into the First Niagara Plan.
Accordingly, no employees are permitted to commence participation in the First Niagara Plan or the NewAlliance Plan (collectively, the “Plans”) and future salary increases and years of credited service are not considered when computing an employee’s benefits under the Plans. During the first quarter of 2012, we made a $111 million tax deductible contribution to the Plans. As of December 31, 2012, we have met all minimum ERISA funding requirements.
We also have unfunded supplemental executive retirement plans (“SERPs”) for which we have recorded an accumulated other comprehensive loss of $5 million and $2 million at December 31, 2012 and 2011, respectively. We had assumed these plans in connection with the NewAlliance and other previous acquisitions, therefore no employees are eligible to commence participation in the SERPs. The projected benefit obligation and accumulated benefit obligation for these SERPs was $24 million and $29 million, respectively, at December 31, 2012 and 2011.
Information regarding our pension plans at December 31, 2012 and 2011 is as follows:
Net pension cost is comprised of the following for the years ended December 31:
Changes in plan assets and benefit obligations recognized in other comprehensive income during 2012 and 2011 are as follows:
The principal actuarial assumptions we used were as follows:
The discount rate that we used in the measurement of our pension obligation is determined by modeling the pension plan expected future retirement payment cash flows to the Milliman Bond Matching Model as of the measurement date. The expected long-term rate of return on plan assets reflects long-term earnings expectations on existing plan assets and those
contributions expected to be received during the current plan year. In estimating that rate, we gave appropriate consideration to historical returns earned by plan assets in the fund and the rates of return expected to be available for reinvestment. We adjusted rates of return to reflect current capital market assumptions and changes in investment allocations.
Our overall investment strategy with respect to the assets of the Retirement Plan of the First Niagara Financial Group, Inc. is primarily for preservation of capital and to provide regular dividend and interest payments. The Plan’s target asset allocation is 75% fixed income securities, 20% equity securities and 5% cash. The fixed income portion of the Plan assets is to be managed as a high-grade intermediate term fixed income account. Equity securities primarily include investments in large cap value and growth stocks as well as mid and small cap companies. We assumed equity securities to earn a return in the range of 8.5% to 9.5% and fixed income securities to earn a return in the range of 3.5% to 4.5%. The long-term inflation rate was estimated to be 2.5%. When these overall return expectations are applied to our Plan's target allocation, we expect the rate of return to be approximately 5.0%.
Our overall investment strategy with respect to the assets of the Employees' Retirement Plan of NewAlliance Bank is primarily for preservation of capital and to provide regular dividend and interest payments. The Plan’s target asset allocation is 30% fixed income securities, 65% equity securities and 5% cash. The fixed income portion of the Plan assets is to be managed as a high-grade intermediate term fixed income account. Equity securities primarily include investments in large cap value and growth stocks as well as mid and small cap companies. We assumed equity securities to earn a return in the range of 8.5% to 9.5% and fixed income securities to earn a return in the range of 3.5% to 4.5%. The long-term inflation rate was estimated to be 2.5%. When these overall return expectations are applied to our Plan’s target allocation, we expect the rate of return to be approximately 6.5%.
The fair values of the Plans’ assets by asset category and level within the fair value hierarchy are as follows at the dates indicated:
The Plans did not hold any assets classified as Level 3 during 2012 or 2011.
Estimated benefit payments under our pension plans over the next ten years at December 31, 2012 are as follows:
Other Post-retirement Benefits
We have an unfunded post-retirement medical plan which we have modified so that participation is closed to those employees who did not meet the retirement eligibility requirements by December 31, 2001. We also acquired three unfunded post-retirement employee benefit plans from our merger with NewAlliance which are also frozen. Information regarding these post-retirement plans at December 31, 2012 and 2011 is as follows:
The components of net periodic post-retirement benefit cost for the years ended December 31 are as follows:
Changes in plan benefit obligations recognized in other comprehensive income during the years ended December 31 are as follows:
The principal actuarial assumptions used were as follows:
The assumed health care cost trend rate used in measuring the accumulated post-retirement benefit obligation was 7.8% for 2012, and gradually decreased to 6.4% by 2015. This assumption can have a significant effect on the amounts reported. If the rate were increased one percent, our accumulated post-retirement benefit obligation as of December 31, 2012 and our total periodic cost for 2012 would have increased by 6% and 7%, respectively. If the rate were decreased one percent, our accumulated post-retirement benefit obligation as of December 31, 2012 and our total periodic cost would have each decreased by 5%. We do not anticipate making any contributions to the post-retirement plan in 2013, except to continue funding benefit payments as they come due.
Estimated benefit payments under the post-retirement plan over the next ten years at December 31, 2012 are as follows:
Amounts recognized in our Consolidated Statements of Condition related to our pension and post-retirement plans for the years ended December 31 are as follows:
401(k) Plan
Our employees that meet certain age and service requirements are eligible to participate in our employer sponsored 401(k) plan. Under the plan, participants may make contributions, in the form of salary deferrals, up to the maximum Internal Revenue Code limit. We contribute to the plan an amount equal to 100% of the first 4% of employee contributions plus 50% of employee contributions between 5% and 6%. These matching contributions are 100% vested. Our total contributions to the 401(k) plan amounted to $11.3 million, $8.8 million, and $6.3 million for 2012, 2011, and 2010, respectively.
Employee Stock Ownership Plan (“ESOP”)
Our employees that meet certain age and service requirements are eligible to participate in our ESOP. Our ESOP holds shares of First Niagara Financial Group, Inc. common stock that were purchased in our 1998 initial public offering and in the open market. The purchased shares were funded by loans in 1998 and 2003 from the Company to the Bank payable in equal annual installments over 30 years bearing a fixed interest rate. Loan payments are funded by cash contributions from the Bank and dividends on allocated and unallocated First Niagara Financial Group, Inc. stock held by the ESOP. The loans can be prepaid without penalty. As the loan is internally leveraged, the loan receivable from the Bank to the Company is not reported as an asset nor is the debt of the Bank shown as a liability in the Company’s financial statements.
Shares purchased by the ESOP are maintained in a suspense account and held for allocation among the participants. As annual loan payments are made, shares are released and allocated to employee accounts. We recognize compensation expense in an amount equal to the average market price of the shares released during the respective periods in which they are committed to be released. Compensation expense of $2.1 million, $2.1 million, and $2.5 million was recognized for 2012, 2011, and 2010, respectively, in connection with 178 thousand shares allocated to participants during 2012, 265 thousand shares allocated to participants during 2011, and 252 thousand shares allocated to participants during 2010. The amount of unallocated and allocated shares held by the ESOP were 2.2 million and 2.0 million respectively, at December 31, 2012 and 2.4 million and 1.9 million, respectively, at December 31, 2011. The fair value of unallocated ESOP shares was $17 million and $20 million at December 31, 2012 and 2011, respectively.
Other Plans
We also sponsor various nonqualified compensation plans for officers and employees. Awards are payable if certain earnings and performance objectives are met. Expenses under these plans amounted to $17.5 million, $21.7 million and $16.0 million for 2012, 2011, and 2010, respectively.
Note 17. Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Current accounting guidance establishes a fair value hierarchy based on the transparency of inputs participants use to price an asset or liability. The fair value hierarchy prioritizes these inputs into the following three levels:
Level 1 Inputs-Unadjusted quoted prices in active markets for identical assets or liabilities that are available at the measurement date.
Level 2 Inputs-Inputs, other than quoted prices included within Level 1, that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.), or inputs that are derived principally from or corroborated by market data through correlation or other means.
Level 3 Inputs-Unobservable inputs for determining the fair value of the asset or liability and are based on the entity’s own estimates about the assumptions that market participants would use to price the asset or liability.
A financial instrument’s categorization within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement. A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While we believe our valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Securities Available for Sale
The fair value estimates of available for sale securities are based on quoted market prices of identical securities, where available (Level 1). However, as quoted prices of identical securities are not often available, the fair value estimate for almost our entire investment portfolio is based on quoted market prices of similar securities, adjusted for differences between the securities (Level 2). Adjustments may include amounts to reflect differences in underlying collateral, interest rates, estimated prepayment speeds, and counterparty credit quality. Where sufficient information is not available from the pricing services to produce a reliable valuation, we estimate fair value based on either broker quotes or internally developed models. Due to the lack of observable market data, we have classified our trust preferred securities and collateralized loan obligations in Level 3 of the fair value hierarchy. We determined the fair value using third party pricing services, including brokers. As of December 31, 2012, $121 million of our investment securities were priced utilizing broker quotes and $1.5 billion were internally priced. For details regarding our pricing process and sources, refer to Note 1, Summary of Significant Accounting Policies.
Loans held for sale
We have elected the fair value option for certain residential real estate loans held for sale as we believe the fair value measurement of such loans reduces certain timing differences in our Statement of Income and better aligns with our management of the portfolio from a business perspective. This election is made at the time of origination, on a loan by loan basis, and is irrevocable. The secondary market for securities backed by similar loan types is actively traded, which provides readily observable market pricing to be used as input for the estimate for the fair value of our loans. Accordingly, we have classified this fair value measurement as Level 2. Interest income on these loans is recognized in Interest Income-Loans and Leases in our Consolidated Statements of Income.
There were no loans held for sale that were nonaccrual or 90 or more days past due as of December 31, 2012 or December 31, 2011. The table below presents information about our loans held for sale for which we elected the fair value option as of the dates indicated:
Derivatives
We obtain fair value measurements of our interest rate swaps from a third party. The fair value measurements are determined using a market standard methodology of netting discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). Variable cash payments (or receipts) are based on an expectation of future interest rates derived from observable market interest rate curves. Credit valuation adjustments are incorporated to appropriately reflect our nonperformance risk as well as the counterparty’s nonperformance risk. The impact of netting and any applicable credit enhancements, such as bilateral collateral postings, thresholds, mutual puts, and guarantees are also considered in the fair value measurement.
The fair value of our interest rate swaps was estimated using primarily Level 2 inputs. However, Level 3 inputs were used to determine credit valuation adjustments, such as estimates of current credit spreads to evaluate the likelihood of default. We have determined that the impact of these credit valuation adjustments was not significant to the overall valuation of our interest rate swaps. Therefore, we have classified the entire fair value of our interest rate swaps in Level 2 of the fair value hierarchy.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table summarizes our assets and liabilities measured at fair value on a recurring basis at the dates indicated:
(1)
Represents loans for which we have elected the fair value option
During the first quarter of 2012, we transferred $158 million of collateralized loan obligations ("CLOs") from level 2 to level 3 of the fair value hierarchy. We began purchasing the investments in the fourth quarter of 2011 and while our purchase price provided observable data regarding the fair value of the securities in the fourth quarter of 2011, observable market data has not been available to incorporate into the pricing during 2012 and our purchase price becomes less relevant as time elapses from the purchase date. As a result, the fair values utilized significant unobservable inputs and warranted classification as level 3 fair value measurements. There were no significant transfers of assets or liabilities into or out of Level 1, Level 2, or Level 3 of the fair value hierarchy during the year ended December 31, 2011.
(1)
Represents loans for which we have elected the fair value option
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The following table summarizes our assets and liabilities measured at fair value on a nonrecurring basis for the years ended December 31:
Collateral Dependent Impaired Loans
We record nonrecurring fair value adjustments to the carrying value of collateral dependent impaired loans when establishing the allowance for loan losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan less estimated costs to sell the collateral. When the fair value of such collateral, less costs to sell, is less than the carrying value of the loan, a specific allowance or charge off is recorded through a provision for credit losses. Real estate collateral is typically valued using independent appraisals that we review for acceptability, or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace and the related nonrecurring fair value measurements have been classified as Level 2. Under certain circumstances significant adjustments may be made to the appraised value due to the lack of direct marketplace information. Such adjustments are made as determined necessary in the judgment of our experienced senior credit officers to reflect current market conditions and current operating results for the specific collateral. When the fair value of collateral dependent impaired loans is based on appraisals containing significant adjustments, such collateral dependent impaired loans are classified as Level 3. We obtain new appraisals from an approved appraiser, in accordance with Interagency Appraisal and Evaluation Guidelines and internal policy. Appraisals or evaluations for assets securing substandard rated loans are usually completed within 90 days of the downgrade. An appraisal may be obtained more frequently when volatile or unusual market conditions exist that could affect the ultimate realization of the value of the real estate collateral.
During the year ended December 31, 2012 we recorded an increase of $2.1 million to our specific allowance as a result of adjusting the fair value of the collateral for certain collateral dependent impaired loans to $48 million at December 31, 2012. During the year ended December 31, 2011 we recorded an increase of $7.4 million to our specific allowance as a result of adjusting the fair value of the collateral for certain collateral dependent impaired loans to $21 million at December 31, 2011.
Level 3 Assets
The changes in Level 3 assets and liabilities measured at estimated fair value on a recurring basis during 2012 and 2011 were as follows:
(1) Our policy is to recognize the transfer at the beginning of the period.
Our level 3 fair value measurements include trust preferred securities and CLOs, on a recurring basis, as well as collateral dependent loans, on a nonrecurring basis. We engage a third party specialist with direct industry experience in trust preferred securities valuations to provide pricing. We did not make any adjustments to the pricing of our trust preferred securities received as of December 31, 2012.
Our CLOs are securitized products where payments from multiple middle sized and large business loans are pooled together and passed on to different classes of owners in various tranches. The markets for such securities are generally characterized by low trading volumes and wide bid-ask spreads, all driven by more limited market participants. Although estimated prices are generally obtained for such securities, the level of market observable assumptions used is limited in the valuation. Specifically, market assumptions regarding credit adjusted cash flows and liquidity influences on discount rates were difficult to observe at the individual bond level. Accordingly, the securities are valued either by a third party specialist using a discounted cash flow approach and proprietary pricing model or internally using similarly developed models. The models consider estimated prepayment speeds, losses, recoveries, default rates that are implied by the underlying performance of collateral in the structure or similar structures, and discount rates that are implied by market prices for similar securities and collateral structure types.
The table below provides a summary of our level 3 fair value measurements, valuation techniques, and the significant unobservable inputs at the date indicated:
Note: The fair values of our trust preferred securities are based upon third party pricing without adjustment and as a result the assets are not included in this table.
Significant changes in any of the unobservable inputs would result in changes in fair value of the related assets. The fair value of our CLOs is inversely related to the market spreads. Increases in market spreads would decrease the fair value of our CLOs while decreases in the market spreads would increase our fair value. For our collateral dependent impaired loans, the fair value is negatively impacted by discounts taken due to market or saleability conditions. As the discount increases, our fair value of the collateral decreases.
Fair Value of Financial Instruments
The carrying value and estimated fair value of our financial instruments at December 31, 2012 and 2011 are as follows (in thousands):
(1) For a detailed breakout of our investment securities available for sale, refer to our table of recurring fair value measurements.
(2) Loans and leases classified as level 2 are made up of $31 million of collateral dependent impaired loans without significant
adjustments made to appraised values. All other loans and leases are classified as level 3.
Our fair value estimates are based on our existing on and off balance sheet financial instruments without attempting to estimate the value of any anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on our fair value estimates and have not been considered in these estimates.
Our fair value estimates are made as of the dates indicated, based on relevant market information and information about the financial instruments, including our judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in our assumptions could significantly affect the estimates. Our fair value estimates, methods, and assumptions are set forth below for each type of financial instrument. The method of estimating the fair value of the financial instruments disclosed in the table above does not necessarily incorporate the exit price concept used to record financial instruments at fair value in our Consolidated Statements of Condition.
Cash and Cash Equivalents
The carrying value of our cash and cash equivalents approximates fair value because these instruments have original maturities of three months or less.
Investment Securities
The fair value estimates of securities are based on quoted market prices of identical securities, where available. However, as quoted prices of identical securities are not often available, the fair value estimate for almost our entire investment portfolio is based on quoted market prices of similar securities, adjusted for differences between the securities. Adjustments may include amounts to reflect differences in underlying collateral, interest rates, estimated prepayment speeds, and counterparty credit quality.
Federal Home Loan Bank and Federal Reserve Bank Common Stock
The carrying value of our Federal Home Loan Bank and Federal Reserve Bank common stock, which are non-marketable equity investments, approximates fair value.
Loans and Leases
Our variable rate loans reprice as the associated rate index changes. The calculation of fair value for our variable rate loans is driven by the comparison between the loan’s margin and the prevailing margin observed in the market at the time of the valuation. Any caps and floors embedded in the loan’s pricing structure are also incorporated into the fair value. We calculated the fair value of our fixed-rate loans and leases by discounting scheduled cash flows through the estimated maturity using credit adjusted period end origination rates. Our estimate of maturity is based on the contractual cash flows adjusted for prepayment estimates based on current economic and lending conditions.
Accrued Interest Receivable and Accrued Interest Payable
The carrying value of accrued interest receivable and accrued interest payable approximates fair value.
Deposits
The fair value of our deposits with no stated maturity, such as savings and checking, as well as mortgagors’ payments held in escrow, is equal to the amount payable on demand. The fair value of our certificates of deposit is based on the discounted value of contractual cash flows, using the period end rates offered for deposits of similar remaining maturities.
Borrowings
The fair value of our borrowings is calculated by discounting scheduled cash flows through the estimated maturity using period end market rates for borrowings of similar remaining maturities.
Commitments
The fair value of our commitments to extend credit, standby letters of credit, and financial guarantees are not included in the above table as the carrying value generally approximates fair value. These instruments generate fees that approximate those currently charged to originate similar commitments.
Note 18. Segment Information
We have two business segments: banking and financial services. The banking segment includes all of our retail and commercial banking operations. The financial services segment includes our insurance operations and in 2010, our employee benefits consulting operations. Substantially all of our assets relate to the banking segment. Transactions between our banking and financial services segments are eliminated in consolidation.
Selected financial information for our segments follows for the years ended December 31:
Note 19. Condensed Parent Company Only Financial Statements
The following condensed statements of condition of the Company as of December 31, 2012 and 2011 and the related condensed statements of income and cash flows for 2012, 2011, and 2010 should be read in conjunction with our Consolidated Financial Statements and related notes:
(1) See Consolidated Statements of Comprehensive Income for other comprehensive income detail.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Management’s Report on Internal Control Over Financial Reporting - Filed herewith under Part II, Item 8, “Financial Statements and Supplementary Data.”
Evaluation of Disclosure Controls and Procedures - With the participation of management, the Principal Executive Officer and Principal Financial Officer have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2012. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of that date, the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. There has been no change in the Company’s internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
Information regarding directors, executive officers, and corporate governance of the Company in the Proxy Statement for the 2013 Annual Meeting of Stockholders is incorporated herein by reference.
Information regarding executive compensation in the Proxy Statement for the 2013 Annual Meeting of Stockholders is incorporated herein by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information regarding security ownership of certain beneficial owners and the Company’s management in the Proxy Statement for the 2013 Annual Meeting of Stockholders is incorporated herein by reference.
All of our equity compensation plans were approved by stockholders. Shown below is certain information as of December 31, 2012 regarding equity compensation to our directors and employees that have been approved by stockholders.
(1)
Represents shares that have been granted but have not yet vested.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information regarding certain relationships and related transactions, and director independence in the Proxy Statement for the 2013 Annual Meeting of Stockholders is incorporated herein by reference.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding the fees paid to and services provided by KPMG LLP, the Company’s independent registered public accounting firm, in the Proxy Statement for the 2013 Annual Meeting of Stockholders is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial statements are filed as part of this Annual Report on Form 10-K. See Part II, Item 8. “Financial Statements and Supplementary Data.”
(b) Exhibits
The exhibits listed below are filed herewith or are incorporated by reference to other filings.
Exhibit Index to Form 10-K
(1)
Incorporated by reference to the Current Report on Form 8-K, filed with the SEC on April 27, 2011.
(2)
Incorporated by reference to the Current Report on Form 8-K filed with the SEC on December 14, 2011.
(3)
Incorporated by reference to the Current Report on Form 8-K filed with the SEC on September 23, 2010.
(4)
Incorporated by reference to our 2008 Annual Report on Form 10-K filed with the SEC on February 27, 2009.
(5)
Incorporated by reference to our 2005 Annual Report on Form 10-K filed with the SEC on March 15, 2006.
(6)
Incorporated by reference to our Proxy Statement for the 1999 Annual Meeting of Stockholders filed with the SEC on March 31, 1999.
(7)
Incorporated by reference to our Proxy Statement for the 2012 Annual Meeting of Stockholders filed with the SEC on March 15, 2012.
(8)
Incorporated by reference to the Current Report on Form 8-K filed with the SEC on September 23, 2005.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
FIRST NIAGARA FINANCIAL GROUP, INC.
Date: February 25, 2013
By:
/s/ John R. Koelmel
John R. Koelmel
President and Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.