People's United Financial, Inc.
Item 1. Business
General
People’s United Financial, Inc. (“People’s United” or the “Company”) is a bank holding company and a financial holding company registered under the Bank Holding Company Act of 1956 (the “BHC Act”), as amended, and is incorporated under the state laws of Delaware. People’s United is the holding company for People’s United Bank, National Association (the “Bank”), a national banking association headquartered in Bridgeport, Connecticut.
The principal business of People’s United is to provide, through the Bank and its subsidiaries, commercial banking, retail banking and wealth management services to individual, corporate and municipal customers. Traditional banking activities are conducted primarily within New England and southeastern New York, and include extending secured and unsecured commercial and consumer loans, originating mortgage loans secured by residential and commercial properties, and accepting consumer, commercial and municipal deposits.
In addition to traditional banking activities, the Bank provides specialized financial services tailored to specific markets including: personal, institutional and employee benefit trust; cash management; and municipal banking. Through its non-banking subsidiaries, the Bank offers: brokerage, financial advisory services, investment management services and life insurance through People’s Securities, Inc. (“PSI”); equipment financing through People’s Capital and Leasing Corp. (“PCLC”) and People’s United Equipment Finance Corp. (“PUEFC”); and other insurance services through People’s United Insurance Agency, Inc. (“PUIA”).
This full range of financial services is delivered through a network of 387 branches located in Connecticut, southeastern New York, Massachusetts, Vermont, Maine and New Hampshire, including 84 full-service Stop & Shop supermarket branches throughout Connecticut and 62 in southeastern New York that provide customers with seven-day-a-week banking. The Bank’s distribution network includes investment and brokerage offices, commercial banking offices, online banking and investment trading, a 24-hour telephone banking service and participation in a worldwide ATM network. PCLC and PUEFC maintain a sales presence in 14 states to support equipment financing operations throughout the United States. The Bank maintains a mortgage warehouse lending group located in Kentucky and a national credits group that has participations in commercial loans and commercial real estate loans to borrowers in various industries on a national scale.
People’s United’s operations are divided into three primary operating segments that represent its core businesses: Commercial Banking; Retail Banking; and Wealth Management. In addition, the Treasury area manages People’s United’s securities portfolio, short-term investments, brokered deposits and wholesale borrowings.
The Company’s operating segments have been aggregated into two reportable segments: Commercial Banking and Retail Banking. Commercial Banking consists principally of commercial real estate lending, commercial and industrial lending, and commercial deposit gathering activities. This segment also includes the equipment financing operations of PCLC and PUEFC, as well as cash management, correspondent banking, municipal banking, institutional trust services, corporate trust, insurance services provided through PUIA and private banking. Retail Banking includes, as its principal business lines, consumer lending (including residential mortgage and home equity lending) and consumer deposit gathering activities. This segment also includes brokerage, financial advisory services, investment management services and life insurance provided by PSI and non-institutional trust services.
Further discussion of People’s United’s business and operations appears on pages 22 through 78.
Supervision and Regulation
People’s United Financial, Inc.
General
As a bank holding company and a financial holding company, People’s United is regulated under the BHC Act and is subject to supervision, examination and regulation by the Board of Governors of the Federal Reserve System (the “FRB”). Among other things, this authority permits the FRB to restrict or prohibit activities that are determined to be a serious risk to the subsidiary bank. A bank holding company should have sufficient capital and an effective capital planning process, consistent with its overall risk profile and considering the size, scope, and complexity of its operations, to ensure its safe and sound operation. In addition, the FRB evaluates a bank holding company’s capital planning and capital distribution processes, and its capital sufficiency in light of relevant regulations and supervisory guidance applicable to bank holding companies.
Activities Restrictions Applicable to Bank Holding Companies. The activities of a bank holding company, including People’s United, must be financially-related activities permissible for a bank holding company, unless the bank holding company has elected to be treated as a financial holding company. A bank holding company that has made a financial holding company election may also engage in activities permissible under section 4(k) of the BHC Act.
Federal law prohibits a bank holding company directly or indirectly, from acquiring:
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control (as defined under the BHC Act) of another bank (or a holding company parent) without prior FRB approval;
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through merger, consolidation or purchase of assets, another bank or a holding company thereof, or acquiring all or substantially all of the assets of such institution or holding company without prior approval by the FRB or the Office of the Comptroller of the Currency (the “OCC”); or
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control of any depository institution not insured by the Federal Deposit Insurance Corporation (the “FDIC”) (except through a merger with and into the holding company’s bank subsidiary that is approved by the OCC).
The BHC Act prohibits a bank holding company (directly or indirectly, or through one or more subsidiaries) from acquiring another bank or holding company thereof without prior written approval of the FRB; acquiring or retaining, with certain exceptions, more than 5% of a non-subsidiary bank, a non-subsidiary holding company or a non-subsidiary company engaged in activities other than those permitted by the BHC Act; or acquiring or retaining control of a depository institution that is not federally insured. In evaluating applications by holding companies to acquire banks, the FRB must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the Deposit Insurance Fund (the “DIF”), the convenience and needs of the community, and competitive factors.
Federal Securities Law
People’s United’s common stock is registered with the Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934 (the “Exchange Act”), as amended. People’s United is subject to the information, proxy solicitation, insider trading, and other requirements and restrictions of the Exchange Act.
Delaware Corporation Law
People’s United is incorporated under the laws of the State of Delaware and is, therefore, subject to regulation by the state of Delaware. The rights of People’s United’s stockholders are governed by the Delaware General Corporation Law.
Regulatory Capital Requirements
Bank holding companies and national banks are subject to various regulations regarding capital requirements administered by U.S. banking agencies. The FRB (in the case of a bank holding company) and the OCC (in the case of a bank) may initiate certain actions if a bank holding company or a bank fails to meet minimum capital requirements. In addition, under its prompt corrective action regulations, the OCC is required to take certain supervisory actions (and may take additional discretionary actions) with respect to an undercapitalized bank. These actions could have a direct material effect on a bank’s financial statements. People’s United and the Bank are subject to regulatory capital requirements administered by the FRB and the OCC, respectively.
In December 2010, the Basel Committee on Banking Supervision released its final framework for capital requirements (the “Basel III framework” or “Basel III”). Final interagency rules to address implementation of the Basel III framework for U.S. financial institutions, including the Company and the Bank, became effective on January 1, 2015. When fully phased-in, these rules will: (i) set forth changes in the calculation of risk-weighted assets; (ii) introduce limitations on what is permissible for inclusion in Tier 1 capital; and (iii) require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity.
See Management’s Discussion and Analysis-Regulatory Capital Requirements beginning on page 72 for a further discussion regarding capital requirements.
Dividends and Capital Distributions
People’s United is dependent upon dividends from the Bank to provide funds for the payment of dividends to shareholders and other general corporate purposes. People’s United’s ability to pay cash dividends is governed by federal law and regulations, including requirements to maintain adequate capital above regulatory minimums and safety and soundness practices.
The National Bank Act and OCC regulations impose limitations upon dividend payments by national banks. A national bank must file an application with the OCC if the total amount of its dividends for the applicable calendar year exceeds the national bank’s net income for that year plus its retained net income for the preceding two years. The Bank may not pay dividends to People’s United if, after paying those dividends, it would fail to meet the required minimum levels under risk-based capital guidelines or if the OCC notified the Bank that it was in need of more than normal supervision.
In addition, a national bank is required to file an application with the OCC for the redemption of subordinated debt under certain circumstances, as well as for reductions in permanent capital.
Under the Federal Deposit Insurance Act (the “FDI Act”), an insured depository institution, such as the Bank, is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is used in the FDI Act). Payment of dividends by the Bank also may be restricted at any time at the discretion of the appropriate regulator if it deems the payment to constitute an unsafe and unsound banking practice. See Note 13 to the Consolidated Financial Statements for a further discussion on capital distributions.
Supervision and Regulation
People’s United Bank, National Association
General
The Bank is subject to regulation, examination, supervision and reporting requirements by the OCC as its primary regulator, by the FDIC as the deposit insurer and by the Consumer Financial Protection Bureau (the “CFPB”) with respect to compliance with designated consumer financial laws. Its deposit accounts are insured up to applicable limits by the FDIC under the DIF.
The Bank files reports with the OCC concerning its activities and financial condition, and must obtain regulatory approval from the OCC prior to entering into certain transactions, such as mergers with, or acquisitions of, other depository institutions. The OCC conducts periodic examinations to assess compliance with various regulatory requirements. The OCC has substantial discretion to impose enforcement action on a national bank that fails to comply with applicable regulatory requirements, particularly with respect to capital requirements imposed on national banks. In addition, the FDIC has the authority to recommend to the OCC that enforcement action be taken with respect to a particular national bank and, if action is not taken by the OCC, the FDIC has authority to take such action under certain circumstances.
This regulation and supervisory structure establishes a comprehensive framework of activities in which a national bank can engage and is intended primarily for the protection of the DIF, depositors and consumers. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such laws and regulations or interpretations thereof, whether by the OCC, the FDIC, and the CFPB or through legislation, could have a material adverse impact on the Bank and its operations.
The Bank’s brokerage subsidiary, PSI, is regulated by the SEC, the Financial Industry Regulatory Authority and state securities regulators. PUIA is subject to regulation by applicable state insurance regulators.
Activity Powers. National association banks derive their lending, investment and other activity powers primarily from the National Bank Act and the regulations of the OCC thereunder. Under these laws and regulations, national banks generally may invest in:
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real estate mortgages;
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consumer and commercial loans;
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certain types of debt securities; and
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certain other assets.
The ability of a national bank to invest in debt securities is limited to those securities that are readily marketable, investment grade and primarily non-speculative. OCC regulations also impose limits on the amount of investments in certain types of debt securities.
Safety and Soundness Standards. Each federal banking agency, including the OCC, has adopted guidelines establishing general standards relating to internal controls, information and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines.
In addition, the OCC adopted regulations to require a national bank that is given notice by the OCC that it is not satisfying any of such safety and soundness standards to submit a compliance plan to the OCC. If, after being so notified, a national bank fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the OCC may issue an order directing corrective and other actions of the types to which a significantly undercapitalized institution is subject under the “prompt corrective action” provisions of the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”). If a national bank fails to comply with such an order, the OCC may seek to enforce the order in judicial proceedings and to impose civil monetary penalties.
Prompt Corrective Action. FDICIA also established a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, federal bank regulators, including the OCC, are required to take certain, and authorized to take other, supervisory actions against undercapitalized institutions, based upon five categories of capitalization which FDICIA created: “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.”
The severity of the action authorized or required to be taken under the prompt corrective action regulations increases as a bank’s capital decreases within the three undercapitalized categories. All banks are prohibited from paying dividends or other capital distributions or paying management fees to any controlling person if, following such distribution, the bank would be undercapitalized. The OCC is required to monitor closely the condition of an undercapitalized savings bank and to restrict the growth of its assets. An undercapitalized bank is required to file a capital restoration plan within 45 days of the date the bank receives notice or is deemed to have notice that it is within any of the three undercapitalized categories, and the plan must be guaranteed by any parent holding company.
The aggregate liability of a parent holding company is limited to the lesser of:
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an amount equal to 5% of the bank’s total assets at the time it became “undercapitalized”; and
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the amount that is necessary (or would have been necessary) to bring the bank into compliance with all capital standards applicable with respect to such bank as of the time it fails to comply with a capital restoration plan.
If a bank fails to submit an acceptable plan, it is treated as if it were “significantly undercapitalized.” Banks that are significantly or critically undercapitalized are subject to a wider range of regulatory requirements and restrictions. Under OCC regulations, generally, a national bank is treated as “well-capitalized” if its Total risk-based capital ratio is 10% or greater, its Tier 1 risk-based capital ratio is 8% or greater, its Common Equity Tier 1 (“CET 1”) capital ratio is 6.5% and its Tier 1 leverage ratio is 5% or greater, and it is not subject to any order or directive by the OCC to meet a specific capital level. As of December 31, 2016, the Bank’s regulatory capital ratios exceeded the OCC’s numeric criteria for classification as a “well-capitalized” institution. Basel III also revised the prompt corrective action framework by incorporating new regulatory capital minimums, including a requirement for tangible common equity.
Insurance Activities. National banks are generally permitted to engage in certain insurance and annuity activities through subsidiaries. However, federal banking laws prohibit depository institutions from conditioning the extension of credit to individuals upon either the purchase of an insurance product or annuity from an entity affiliated with the depository institution or an agreement by the consumer not to purchase an insurance product or annuity from an entity that is not affiliated with the depository institution. Applicable regulations also require prior disclosure of this prohibition to potential insurance product or annuity customers.
Federal banking agencies, including the OCC, also require depository institutions that offer non-deposit investment products, such as certain annuity and related insurance products, to disclose to the consumer that the products are not federally insured, are not guaranteed by the institution and are subject to investment risk including possible loss of principal. These disclosure requirements apply if the institution offers the non-deposit investment products directly or through affiliates or subsidiaries.
Deposit Insurance. The Bank is a member of, and pays its deposit insurance assessments to, the DIF.
The FDIC has established a system for setting deposit insurance premiums based upon the risks a particular bank poses to the DIF. The assessment is based on a bank’s average consolidated total assets minus average tangible equity (defined as Tier 1 capital). The size of the DIF is targeted at 2% of insured deposits. A reduced assessment rate schedule applies once the DIF reaches 1.15% of insured deposits, with additional reductions when the DIF reaches 2% and 2.5% of insured deposits, respectively. The FDIC applies a scorecard-based assessment system for financial institutions with more than $10 billion in assets (such as the Bank). One of the financial ratios used in the scorecard is the ratio of “higher risk” assets to Tier 1 capital and reserves. The classification of assets such as commercial and industrial loans, securities and consumer loans as “higher risk” is determined in accordance with applicable FDIC regulations and guidance.
In March 2016, the FDIC issued a final rule that will serve to implement a Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “DFA”) provision requiring banks with over $10 billion in assets to be responsible for recapitalizing the DIF to 1.35% of insured deposits after it reaches a 1.15% reserve ratio. The rule became effective on July 1, 2016. For banks with over $10 billion in assets, the rule imposes a 4.5 basis point surcharge to bring the DIF’s reserve ratio to 1.35% by the end of 2018. For the surcharge only, the assessment base would be reduced by $10 billion. The Company anticipates the impact of the surcharge may increase regulatory assessment expense by $2.5 million to $3.0 million on an annual basis. See Management’s Discussion and Analysis-Non-Interest Expense beginning on page 43 for a further discussion regarding regulatory assessments.
In addition, all FDIC-insured institutions are required to pay assessments to the FDIC at an annual rate of approximately 0.0056% of insured deposits to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the Financing Corporation bonds mature between 2017 and 2019.
Under the FDI Act, the FDIC may terminate the insurance of an institution’s deposits upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Transactions with Affiliates. National banks are subject to the affiliate and insider transaction rules set forth in Sections 23A, 23B, 22(g) and 22(h) of the Federal Reserve Act, and their implementing regulations, Regulation W and Regulation O, issued by the FRB. Affiliated transaction provisions, among other things, prohibit or limit a national bank from extending credit to, or entering into certain transactions with, its affiliates and principal stockholders, directors and executive officers.
In addition, national banks are prohibited from making a loan to an affiliate that is engaged in non-bank holding company activities and purchasing or investing in securities issued by an affiliate that is not a subsidiary. The FRB and the OCC require each depository institution that is subject to the affiliate transaction restrictions of Sections 23A and 23B of the Federal Reserve Act to implement policies and procedures to ensure compliance with Regulation W.
In addition to the insider transaction limitations of Sections 22(g) and 22(h) of the Federal Reserve Act, Section 402 of the Sarbanes-Oxley Act of 2002 prohibits the extension of personal loans to directors and executive officers of issuers (as defined in the Sarbanes-Oxley Act). The prohibition, however, does not apply to mortgage loans advanced by an insured depository institution, such as the Bank, that are subject to the insider lending restrictions of Section 22(h) of the Federal Reserve Act.
Privacy Standards. The Bank is subject to OCC regulations implementing statutorily-mandated privacy protection. These regulations require the Bank to disclose its privacy policy, including identifying with whom it shares “non-public personal information,” to customers at the time of establishing the customer relationship and annually thereafter. In addition, the Bank is required to provide its customers with the ability to “opt-out” of having the Bank share their non-public personal information with unaffiliated third parties before the Bank can disclose such information, subject to certain exceptions.
In addition to certain state laws governing protection of customer information, the Bank is subject to federal regulatory guidelines establishing standards for safeguarding customer information. The guidelines describe the agencies’ expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer. Federal guidelines also impose certain customer disclosures and other actions in the event of unauthorized access to customer information.
Community Reinvestment Act. Under the Community Reinvestment Act (the “CRA”), as implemented by the OCC regulations, any national bank, including the Bank, has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the OCC, in connection with its examination of a federally-chartered savings bank, to assess the depository institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution.
Current CRA regulations rate an institution based on its actual performance in meeting community needs. In particular, the evaluation system focuses on three tests:
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a lending test, to evaluate the institution’s record of making loans in its service areas;
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an investment test, to evaluate the institution’s record of investing in community development projects, affordable housing and programs benefiting low or moderate income individuals and businesses; and
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a service test, to evaluate the institution’s delivery of services through its branches, ATMs and other offices.
The CRA also requires all institutions to make public disclosure of their CRA ratings. The Bank received a “satisfactory” rating in its most recent CRA examination for the evaluation period ending June 30, 2013. The federal banking agencies adopted regulations implementing the requirements under the Gramm-Leach-Bliley Act that insured depository institutions publicly disclose certain agreements that are in fulfillment of the CRA. The Bank has no such agreements in place at this time.
Loans to One Borrower. Generally, national banks may not make a loan or extend credit, including credit associated with derivatives and securities financing transactions, to a single or related group of borrowers in excess of 15% of the institution’s unimpaired capital and surplus. Additional amounts may be loaned, not in excess of 10% of unimpaired capital and surplus, if such loans or extensions of credit are secured by readily-marketable collateral. The Bank is in compliance with applicable loans to one borrower limitations.
Nontraditional Mortgage Products. The federal banking agencies have issued guidance for institutions that originate or service nontraditional or alternative mortgage products, defined to include all residential mortgage loan products that allow borrowers to defer repayment on principal or interest, such as interest-only mortgages and payment option adjustable-rate mortgages. A portion of the Bank’s adjustable-rate residential mortgage loans represent interest-only residential mortgage loans. None of these loans permit negative amortization or optional payment amounts.
Recognizing that alternative mortgage products expose institutions to increased risks as compared to traditional loans where payments amortize or reduce the principal amount, the guidance requires increased scrutiny for alternative mortgage products. Institutions that originate or service alternative mortgages should have: (i) strong risk management practices that include maintenance of capital levels and allowance for loan losses commensurate with the risk; (ii) prudent lending policies and underwriting standards that address a borrower’s repayment capacity; and (iii) programs and practices designed to ensure that consumers receive clear and balanced information to assist in making informed decisions about mortgage products. The guidance also recommends heightened controls and safeguards when an institution combines an alternative mortgage product with features that compound risk, such as a simultaneous second-lien or the use of reduced documentation to evaluate a loan application. The Bank complies with the guidance on non-traditional mortgage products as it is interpreted and applied by the OCC.
Liquidity. The Bank maintains sufficient liquidity to ensure its safe and sound operation, in accordance with applicable OCC regulations.
Assessments. The OCC charges assessments to recover the cost of examining national banks and their affiliates. These assessments are based on three components: (i) the size of the institution on which the basic assessment is based; (ii) the institution’s supervisory condition, which results in an additional assessment based on a percentage of the basic assessment for any savings institution with a composite rating of 3, 4 or 5 in its most recent safety and soundness examination; and (iii) the complexity of the institution’s operations, which results in an additional assessment based on a percentage of the basic assessment for any savings institution that managed over $1 billion in trust assets, serviced for others loans aggregating more than $1 billion, or had certain off-balance-sheet assets aggregating more than $1 billion.
Branching. Under OCC branching regulations, the Bank is generally authorized to open branches nationwide. The Bank is required to submit an application to the OCC and publish a public notice prior to establishing a new branch or relocating an existing branch. OCC authority preempts any state law purporting to regulate branching by national banks.
Anti-Money Laundering and Customer Identification. The Bank is subject to OCC and Financial Crimes Enforcement Network regulations implementing the Bank Secrecy Act, as amended by the USA PATRIOT Act. The USA PATRIOT Act gives the federal government powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among banks, regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative reporting obligations on a broad range of financial institutions, including national banks like the Bank.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank (the “FHLB”) system, which consists of twelve regional FHLBs, each subject to supervision and regulation by the Federal Housing Finance Agency. The FHLB system provides a central credit facility primarily for member institutions as well as other entities involved in home mortgage lending. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLBs. It makes loans or advances to members in accordance with policies and procedures, including collateral requirements, established by the respective boards of directors of the FHLBs. These policies and procedures are subject to the regulation and oversight of the Federal Housing Finance Agency, which has also established standards of community or investment service that members must meet to maintain access to long-term advances.
The Bank, as a member of the FHLB of Boston, is currently required to purchase and hold shares of capital stock in the FHLB of Boston in an amount equal to 0.35% of the Bank’s Membership Stock Investment Base plus an Activity Based Stock Investment Requirement. The Activity Based Stock Investment Requirement is equal to 3.0% of any outstanding principal for overnight advances, 4.0% of any outstanding principal for term advances with an original term of two days to three months and 4.5% of any outstanding principal for term advances with an original term greater than three months. The Bank is in compliance with these requirements. As a result of its acquisition of the Bank of Smithtown, the Bank also holds shares of capital stock in the FHLB of New York. The Bank, as a member of the Federal Reserve Bank system, is currently required to purchase and hold shares of capital stock in the Federal Reserve Bank of New York (the “FRB-NY”) in an amount equal to 6% of its capital and surplus.
Reserve Requirements. FRB reserve regulations require banks to maintain reserves against their transaction accounts (primarily negotiable order of withdrawal and demand deposit accounts). Institutions must maintain a reserve of 3% against aggregate transaction account balances between $15.5 million and $115.1 million (subject to adjustment by the FRB) plus a reserve of 10% (subject to adjustment by the FRB within specific limits) against that portion of total transaction account balances in excess of $115.1 million. The first $15.5 million of otherwise reservable balances is exempt from the reserve requirements. The Bank is in compliance with the foregoing requirements. The required reserves must be maintained in the form of vault cash, or an interest-bearing account at a Federal Reserve Bank, or a pass-through account as defined by the FRB.
Market Area and Competition
People’s United’s primary market areas are New England and southeastern New York, with Connecticut, New York, Massachusetts and Vermont having the largest concentration of its loans, deposits and branches. At December 31, 2016, 26%, 19%, 18% and 6% of the Company’s loans by outstanding principal amount were to customers located within Connecticut, New York, Massachusetts and Vermont, respectively. Loans to customers located in the New England states as a group represented 59% of total loans at December 31, 2016. However, substantially the entire equipment financing portfolio (96% at December 31, 2016) was to customers located outside of New England. At December 31, 2016, 29% of the equipment financing portfolio was to customers located in Texas, California and New York, and no other state exposure was greater than 5%.
As of June 30, 2016, People’s United had: (i) the largest market share of deposits in Fairfield County, Connecticut; (ii) the second largest market share of deposits in the state of Connecticut; and (iii) the largest market share of deposits in the state of Vermont. People’s United competes for deposits, loans and financial services with commercial banks, savings institutions, commercial and consumer finance companies, mortgage banking companies, insurance companies, credit unions and a variety of other institutional lenders and securities firms.
As People’s United’s predominant market, Connecticut is one of the most attractive banking markets in the U.S. With a total population of approximately 3.6 million and a median household income of $73,077, Connecticut ranks fourth in the U.S., well above the U.S. median household income of $57,462, according to U.S. Census data and SNL Financial. The median household income in New York, which has the Company’s second highest number of branches, was $62,222, according to U.S. Census data and SNL Financial. The median household income in Massachusetts and Vermont, which have the Company’s third and fourth highest number of branches, was $72,859 and $58,767, respectively, according to U.S. Census data and SNL Financial.
The principal basis of competition for deposits is the interest rate paid for those deposits and related fees, the convenience of access to services through traditional and non-traditional delivery alternatives, and the quality of services to customers. The principal basis of competition for loans is through the interest rates and loan fees charged and the development of relationships based on the efficiency, convenience and quality of services provided to borrowers. Further competition has been created through the rapid acceleration of commerce conducted over the Internet. This has enabled institutions, including People’s United, to compete in markets outside their traditional geographic boundaries.
Personnel
As of December 31, 2016, People’s United had 4,749 full-time and 424 part-time employees.
Access to Information
As a public company, People’s United is subject to the informational requirements of the Exchange Act, as amended and, in accordance therewith, files reports, proxy and information statements and other information with the SEC. Such reports, proxy and information statements and other information can be inspected and copied at prescribed rates at the public reference room maintained by the SEC at 100 F Street N.E., Washington, D.C. 20549 and are available on the SEC’s EDGAR database on the internet at www.sec.gov. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. People’s United’s common stock is listed on the NASDAQ Global Select Market under the symbol “PBCT.”
Copies of many of these reports are also available through People’s United’s website at www.peoples.com.
People’s United currently provides website access to the following reports:
Form 10-K (most recent filing and any related amendments)
Form 10-Q (four most recent filings and any related amendments)
Form 8-K (all filings in most recent 12 months and any related amendments)
Annual Report to Shareholders (two most recent years)
Proxy Statement for Annual Meeting of Shareholders (two most recent years)
XBRL Interactive Data (most recent 12 months)
Item 1A. Risk Factors
Changes in Interest Rates Could Adversely Affect Our Results of Operations and Financial Condition
People’s United makes most of its earnings based on the difference between interest it earns compared to interest it pays. This difference is called the “interest spread.” People’s United earns interest on loans and to a much lesser extent on securities and short-term investments. These are called “interest-earning assets.” People’s United pays interest on some forms of deposits and on funds it borrows from other sources. These are called “interest-bearing liabilities.”
People’s United’s interest spread can change depending on when interest rates earned on interest-earning assets change, compared to when interest rates paid on interest-bearing liabilities change. Some rate changes occur while these assets or liabilities are still on People’s United’s books. Other rate changes occur when these assets or liabilities mature and are replaced by new interest-earning assets or interest-bearing liabilities at different rates. It may be difficult to replace interest-earning assets quickly, since customers may not want to borrow money when interest rates are high, or People’s United may not be able to make loans that meet its lending standards. People’s United interest spread may also change based on the mix of interest-earning assets and interest-bearing liabilities.
People’s United’s interest spread may be lower if the timing of interest rate changes is different for its interest-earning assets compared to its interest-bearing liabilities. For example, if interest rates go down, People’s United could earn less on some of its interest-earning assets while it is still obligated to pay higher rates on some of its interest-bearing liabilities. On the other hand, if interest rates go up, People’s United might have to pay more on some of its interest-bearing liabilities while it continues to receive lower rates on some of its interest-earning assets.
People’s United manages this risk using many different techniques. If unsuccessful in managing this risk, People’s United may be less profitable.
Changes in Our Asset Quality Could Adversely Affect Our Results of Operations and Financial Condition
Asset quality measures the performance of a borrower in repaying a loan, with interest, on time. While we believe we have benefited from relatively stable asset quality, there are elements of our loan portfolio that inherently present greater credit risk, such as interest-only residential mortgage loans, home equity loans and lines with incomplete first lien data, and commercial real estate loans. Each of these portfolio risk elements, where potentially material in the context of our overall loan portfolio, are discussed in greater detail within Management’s Discussion and Analysis-Asset Quality beginning on page 55. While the Company believes that it manages asset quality through prudent underwriting practices and collection operations, it is possible that our asset quality could deteriorate, depending upon economic conditions and other factors.
The Success of Our Stop & Shop Branches Depends on the Success of the Stop & Shop Brand
One element of our strategy is to focus on increasing deposits by providing a wide range of convenient services to our customers. An integral component of this strategy is the Bank’s supermarket banking initiative, pursuant to which, as of December 31, 2016, the Bank has established 146 full-service Stop & Shop branches throughout Connecticut and southeastern New York, most of which are in close proximity to our traditional branches, which provide customers with the convenience of seven-day-a-week banking. At December 31, 2016, 38% of the Bank’s branches were located in Stop & Shop supermarkets and 15% of our total deposits at that date were held in Stop & Shop branches.
The Bank currently has exclusive branching rights in Stop & Shop supermarkets in the state of Connecticut and certain counties in the state of New York, in the form of licensing agreements between The Stop & Shop Supermarket Company and the Bank, which provides for the leasing of space to the Bank within Stop & Shop supermarkets for branch use. The Bank has the exclusive right to branch in these supermarkets until 2027, provided that the Bank does not default on its obligations under the licensing agreement.
Under the terms of the licensing agreements, the Bank has the obligation to open branches in new Stop & Shop locations, even if Stop & Shop’s market share declines or the value of the Stop & Shop brand is diminished. The licensing agreements do not stipulate the number of branch openings per year but, rather, apply only to those new Stop & Shop locations that meet or exceed specified thresholds as to size (square footage) and/or customer traffic. Based on our experience, we would expect the application of these thresholds to result in the opening of approximately 4-6 new branches per year in Stop & Shop locations.
Stop & Shop is a leading grocery store in Connecticut. The success of the Bank’s supermarket branches is dependent, in part, on the success of the Stop & Shop supermarkets in which they are located. A drop in Stop & Shop’s market share, a decrease in the number of Stop & Shop locations or customers, or a decline in the overall quality of Stop & Shop supermarkets could result in decreased business for the Stop & Shop branches, in the form of fewer loan originations, lower deposit generation and fewer overall branch transactions, and could influence market perception of the Bank’s Stop & Shop supermarket branches as convenient banking locations.
We Depend on Our Executive Officers and Key Personnel to Continue Implementing Our Long-Term Business Strategy and Could Be Harmed by the Loss of Their Services
We believe that our continued growth and future success will depend in large part upon the skills of our management team. The competition for qualified personnel in the financial services industry can be intense, and the loss of our key personnel or an inability to continue to attract, retain and motivate key personnel could adversely affect our business.
Our Business Is Affected by the International, National, Regional and Local Economies in Which We Operate
Changes in international, national, regional and local economic conditions affect our business. If economic conditions change significantly or quickly, our business operations could suffer, and we could become weaker financially as a result.
As a result of the financial crisis that existed for much of the period from 2008 through 2012, the housing and real estate markets, as well as the broader economy, experienced declines, both nationally and locally. Housing market conditions in the New England region, where much of our lending activity occurs, were adversely impacted, leading to a reduced level of sales, increasing inventories of houses on the market, declining house prices and an increase in the length of time houses remained on the market. No assurance can be given that these conditions will not be repeated or that such conditions will not result in a decrease in our interest income, an increase in our non-performing loans, an increase in our provision for loan losses or an adverse impact on our loan losses.
Significant volatility in the financial and capital markets during this time led to credit and liquidity concerns, a recessionary economic environment and, in turn, weakness within the commercial sector. Our loan portfolio is not immune to potential negative consequences arising as a result of general economic weakness and, in particular, a prolonged downturn in the housing market on a national scale. Decreases in real estate values could adversely affect the value of property used as collateral for loans. In addition, adverse changes in the economy could have a negative effect on the ability of borrowers to make scheduled loan payments, which would likely have an adverse impact on earnings. Further, an increase in loan delinquencies may serve to decrease interest income and adversely impact loan loss experience, resulting in an increased provision and allowance for loan losses.
International economic uncertainty continues to have an impact on the U.S. financial markets, potentially suppressing stock prices and adding to volatility. Our foreign country exposure, which is defined as the aggregation of exposure maintained with financial institutions, companies or individuals in a given country outside of the U.S., is minimal and indirect, with the majority of such exposure comprised of corporate debt securities. Our sovereign credit exposure is comprised of an immaterial amount of government bonds issued by a single non-European sovereign.
The Geographic Concentration of Our Loan Portfolio Could Make Us Vulnerable to a Downturn in the Economies in Which We Operate
At December 31, 2016, 26%, 19% and 18% of the Company’s loans by outstanding principal amount were to customers located within Connecticut, New York and Massachusetts, respectively. Loans to people and businesses located in the New England states as a group represented 59% of total loans at that date. How well our business performs depends very much on the health of these regional and local economies. We could experience losses in our real estate-related loan portfolios if the prices for housing and other kinds of real estate decreased significantly in New England or southeastern New York.
If the economic environment deteriorates, or negative trends emerge with respect to the financial markets, the New England and southeastern New York economies could suffer more than the national economy. This would be especially likely in Fairfield County, Connecticut (where the Company is headquartered) as well as the suburban communities of New York City and Boston as a result of the significant number of people living in these areas who also work in the financial services industry.
In addition, our ability to continue to originate real estate loans may be impaired by adverse changes in the local and regional economic conditions in these real estate markets. Decreases in real estate values could adversely affect the value of property used as collateral for our loans. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which would have an adverse impact on our earnings. In addition, if poor economic conditions result in decreased demand for real estate loans, our profits may decrease because our alternative investments may earn less income for us than real estate loans.
Our equipment financing business, which operates nationally, could be negatively affected by adverse changes in the national economy, even if those changes have no significant effect on the local and regional economies in which our other businesses operate.
No assurance can be given that such conditions will not occur or that such conditions will not result in a decrease in our interest income, an increase in our non-performing loans, an increase in our provision for loan losses or an adverse impact on our loan losses.
In Response to Competitive Pressures, Our Costs Could Increase if We Were Required to Increase Our Service and Convenience Levels or Our Margins Could Decrease if We Were Required to Increase Deposit Rates or Lower Interest Rates on Loans
People’s United faces significant competition for deposits and loans. In deciding where to deposit their money, many people look first at the interest rate they will earn. They also might consider whether a bank offers other kinds of services they might need and, if they have been a customer of a bank before, what their experience was like. People also like convenience, so the number of offices and banking hours may be important. Some people also prefer the availability of on-line services.
People’s United competes with other banks, credit unions, brokerage firms and money market funds for deposits. Some people may decide to buy bonds or similar kinds of investments issued by companies or by federal, state and local governments and agencies, instead of opening a deposit account.
In making decisions about loans, many people consider the interest rate they will have to pay. They also consider any extra fees they might have to pay in order to get the loan. Many business loans are more complicated because there may not be a standard type of loan that meets all of the customer’s needs. Business borrowers consider many different factors that are not all financial in nature, including the type and amount of security the lender wants and other terms of the loan that do not involve the interest rate.
People’s United competes with other banks, credit unions, credit card issuers, finance companies, mortgage lenders and mortgage brokers for loans. Insurance companies also compete with People’s United for some types of commercial loans.
Several of People’s United’s competitors have branches in the same market area as it does, some of which are much larger than it is. The New England region, including Connecticut, which is People’s United’s predominant market, and specifically Fairfield County, where People’s United is headquartered, is an attractive banking market. As locally-based banks continue to be acquired by large regional and national companies, there are not as many bank competitors in our market as there used to be, but the remaining ones are usually larger and have more resources than the banks they acquired.
People’s United also has competition from outside its own market area. A bank that does not have any branches in our primary markets can still have customers there by providing banking services on-line. It costs money to set up and maintain a branch system. Banks that do not spend as much money as People’s United does on branches might be more profitable than it is, even if they pay higher interest on deposits and charge lower interest on loans.
Changes in Federal and State Regulation Could Adversely Affect Our Results of Operations and Financial Condition
The banking business is heavily regulated by the federal and state governments. Banking laws and rules are for the most part intended to protect depositors, not stockholders.
Banking laws and rules can change at any time. The government agencies responsible for supervising People’s United’s businesses can also change the way they interpret these laws and rules, even if the rules themselves do not change. We need to make sure that our business activities comply with any changes in these rules or the interpretation of the rules. We might be less profitable if we have to change the way we conduct business in order to comply. Our business might suffer in other ways as well.
Changes in state and federal tax laws or the accounting standards we are required to follow can make our business less profitable. Changes in the government’s economic and monetary policies may hurt our ability to compete for deposits and loans. Changes in these policies can also make it more expensive for us to do business.
The government agencies responsible for supervising our business can take drastic action if they think we are not conducting business safely or are too weak financially. They can force People’s United to hold additional capital, pay higher deposit insurance premiums, stop paying dividends, stop making certain kinds of loans or stop offering certain kinds of deposits. If the agencies took any of these steps or other similar steps, it would probably make our business less profitable.
Enactment of the DFA has resulted in significant changes in the financial regulatory landscape, many of which affect us. Among the more significant provisions of the DFA, as well as their actual or anticipated impact, if quantifiable, are:
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Changes to the regulatory landscape, including:
(i) creation of the CFPB, which is empowered to promulgate new consumer protection regulations and revise existing regulations in many areas of consumer protection, and exercise exclusive authority over our consumer compliance examinations; and
(ii) restrictions on the ability of federal bank regulatory authorities to preempt the application of state consumer protection laws and regulations.
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Limitations on the amount of interchange fees that an issuer of debit cards may charge or receive:
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The DFA limits the amount of interchange fee that an issuer of debit cards may charge or receive to an amount that is “reasonable and proportional” to the cost of the transaction. The DFA further provides that a debit card issuer may not restrict the number of payment card networks on which a debit card transaction may be processed to a single network or limit the ability of a merchant to direct the routing of debit card payments for processing.
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Changes impacting the financial products and services we offer to our customers:
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All federal prohibitions on the ability of financial institutions to pay interest on demand deposit accounts were repealed as part of the DFA. As of December 31, 2016, the Bank’s non-interest bearing deposits totaled $6.7 billion, or 22% of total deposits. The Company’s interest expense may increase and net interest margin may decrease if it begins to offer higher rates of interest than are currently offered on demand deposits.
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Stricter capital requirements for bank holding companies:
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The DFA imposes stringent capital requirements on bank holding companies by, among other things, imposing leverage ratios on holding companies and prohibiting the inclusion of new trust preferred issuances in Tier I capital. The DFA also increases regulation of derivatives and hedging transactions, which could limit the ability of People’s United to enter into, or increase the costs associated with, interest rate and other hedging transactions.
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Mortgage rules promulgated by the CFPB:
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The CFPB has issued a series of final rules to implement provisions in the DFA related to mortgage origination and mortgage servicing. These rules, which went into effect in January 2014 and which may increase the cost of originating and servicing residential mortgage loans, include:
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A rule to implement the requirement that creditors make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling and establish certain protections from liability under this requirement for “qualified mortgages”; and
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A rule addressing mortgage servicers’ obligations to: correct errors asserted by mortgage loan borrowers; provide certain information requested by such borrowers; and provide protections to such borrowers in connection with force-placed insurance. Additionally, this final rule addresses servicers’ obligations to: provide information about mortgage loss mitigation options to delinquent borrowers; establish policies and procedures for providing delinquent borrowers with continuity of contact with servicer personnel capable of performing certain functions; and evaluate borrowers’ applications for available loss mitigation options.
While it is difficult to fully quantify the increase in our regulatory compliance burden, we do believe that costs associated with regulatory compliance will continue to increase. Because certain other provisions of the DFA still require regulatory rulemaking, it is not clear how those new regulations will affect People’s United.
If People’s United’s Allowance for Loan Losses Is Not Sufficient to Cover Actual Loan Losses, Our Earnings Would Decrease
People’s United is exposed to the risk that customers will not be able to repay their loans. This risk is inherent in the lending business. There is also the risk that the customer’s collateral will not be sufficient to cover the balance of their loan, as underlying collateral values fluctuate with market changes. People’s United records an allowance for loan losses to cover probable losses inherent in the existing loan portfolio. The allowance for loan losses is established through provisions for loan losses charged to income. Losses on loans, including impaired loans, are charged to the allowance for loan losses when all or a portion of a loan is deemed to be uncollectible. Recoveries of loans previously charged off are credited to the allowance for loan losses when realized.
People’s United maintains the allowance for loan losses at a level that is deemed to be appropriate to absorb probable losses inherent in the respective loan portfolios, based on a quarterly evaluation of a variety of factors. These factors include, but are not limited to: People’s United’s historical loan loss experience and recent trends in that experience; risk ratings assigned by lending personnel to commercial real estate loans, commercial and industrial loans and equipment financing loans, and the results of ongoing reviews of those ratings by People’s United’s independent loan review function; an evaluation of delinquent and non-performing loans and related collateral values; the probability of loss in view of geographic and industry concentrations and other portfolio risk characteristics; the present financial condition of borrowers; and current economic conditions.
While People’s United seeks to use the best available information to make these evaluations and, at December 31, 2016, believed that the allowance for loan losses was appropriate to cover probable losses inherent in the existing loan portfolio, it is possible that borrower defaults could exceed the current estimates for loan losses, which would reduce earnings. In addition, future increases to the allowance for loan losses may be necessary based on changes in economic conditions, results of regulatory examinations, further information obtained regarding known problem loans, increasing charge-offs of existing problem loans, or the identification of additional problem loans and other factors, which would also reduce earnings. See Note 1 to the Consolidated Financial Statements for additional information concerning People’s United’s allowance for loan losses.
Our Goodwill May be Determined to be Impaired at a Future Date Depending on the Results of Periodic Impairment Evaluations
People’s United evaluates goodwill for impairment on an annual basis (or more frequently, if necessary). According to applicable accounting requirements, acceptable valuation methods include present-value measurements based on multiples of earnings or revenues, or similar performance measures. If the quoted market price for People’s United common stock were to decline significantly, or if it was determined that the carrying amount of our goodwill exceeded its implied fair value, we would be required to write down the asset recorded for goodwill as reflected in the Consolidated Statements of Condition. This, in turn, would result in a charge to earnings and, thus, a reduction in stockholders’ equity. See Notes 1 and 6 to the Consolidated Financial Statements for additional information concerning People’s United’s goodwill and the required impairment test.
People’s United May Fail To Successfully Integrate Acquired Companies and Realize All of the Anticipated Benefits of an Acquisition
The ultimate success of an acquisition will depend, in part, on the ability of People’s United to realize the anticipated benefits from combining the businesses of People’s United with those of an acquired company. If People’s United is not able to successfully combine the businesses, the anticipated benefits of a merger may not be realized fully or at all or may take longer to realize than expected.
A Failure In or Breach Of Our Operational or Security Systems or Infrastructure, or Those of Our Third Party Vendors and Other Service Providers, Including as a Result of Cyber-Attacks, Could Disrupt Our Business, Result in the Disclosure or Misuse of Confidential or Proprietary Information, Damage Our Reputation, Increase Our Costs and Cause Losses
We depend upon our ability to process, record and monitor a large number of customer transactions on a continuous basis. As customer, public and regulatory expectations regarding operational and information security have increased, our operational systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions and breakdowns.
Information security risks for financial institutions, such as ours, have generally increased in recent years in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct financial transactions and the increased sophistication and activities of organized crime, hackers, terrorists, activists and other external parties. As noted above, our operations rely on the secure processing, transmission and storage of confidential information in our computer systems and networks.
Our business operations rely on our digital technologies, computer and email systems, software and networks to conduct their operations. In addition, to access our products and services, our customers may use electronic devices that are beyond our control systems. Although we have information security procedures and controls in place, our technologies, systems, networks and our customers’ devices may become the target of cyber-attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our customers’ confidential, proprietary and other information, or otherwise disrupt our or our customers’ or other third parties’ business operations.
Third parties with whom we do business or that facilitate our business activities, including exchanges, clearing houses, financial intermediaries or vendors that provide services or security solutions for our operations, could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints.
Although to date we have not experienced any material losses relating to cyber-attacks or other information security breaches, there can be no assurance that we will not suffer such losses in the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, the size and scale of People’s United, our plans to continue to implement our internet banking and mobile banking channel strategies and develop additional remote connectivity solutions to serve our customers when and how they want to be served, our expanded geographic footprint, the outsourcing of some of our business operations and the continued uncertain global economic environment. As a result, cybersecurity and the continued development and enhancement of our controls, processes and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access remain a focus for us. As threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate information security vulnerabilities.
Disruptions or failures in the physical infrastructure or operating systems that support our business and customers, or cyber-attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in customer attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect our results of operations or financial condition.
Availability of First Lien Data With Respect to Our Home Equity Loans and Lines of Credit Could Delay Our Response to Any Deterioration in the Borrower’s Credit
We do not currently have statistics for our entire portfolio of home equity loans and lines of credit with respect to first liens serviced by third parties that have priority over our junior liens, as we did not historically capture that data on our loan servicing systems. As a result, we may therefore be unaware that the loan secured by the first lien is not performing, which could delay our response to an apparent deterioration in the borrower’s creditworthiness. As of December 31, 2016, full and complete first lien position data was not readily available for 31% of the home equity portfolio which, in turn, represented 2% of our overall loan portfolio at that date.
We are actively working with a third-party vendor to obtain the missing first lien information and have, in certain cases, obtained the data through information reported to credit bureaus when the borrower defaults. This data collection effort, however, can be more difficult in cases where more than one mortgage is reported in a borrower’s credit report and/or there is not a corresponding property address associated with a reported mortgage, in which case we are often unable to associate a specific first lien with our junior lien. See the discussion in Management’s Discussion and Analysis-Asset Quality-Portfolio Risk Elements-Home Equity Lending beginning on page 57 for more detail, including steps we are taking to otherwise address this issue.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
People’s United’s corporate headquarters is located in Bridgeport, Connecticut. The headquarters building had a net book value of $55 million at December 31, 2016 and People’s United occupies 89% of the building; all other available office space is leased to an unrelated party. People’s United delivers its financial services through a network of 387 branches located throughout Connecticut, southeastern New York, Massachusetts, Vermont, Maine and New Hampshire. People’s United’s branch network is primarily concentrated in Connecticut, where it has 149 offices (including 84 located in Stop & Shop supermarkets). People’s United also has 97 branches in southeastern New York (including 62 located in Stop & Shop supermarkets), 48 branches in Massachusetts, 40 branches in Vermont, 27 branches in Maine and 26 branches in New Hampshire. People’s United owns 106 of its branches, which had an aggregate net book value of $49 million at December 31, 2016. People’s United’s remaining banking operations are conducted in leased locations. Information regarding People’s United’s operating leases for office space and related rent expense appears in Note 20 to the Consolidated Financial Statements.
Item 3. Legal Proceedings
The information required by this item appears in Note 20 to the Consolidated Financial Statements.
Item 4. Mine Safety Disclosures
None.
Part II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The common stock of People’s United is listed on the NASDAQ Global Select Market under the symbol “PBCT”. On February 17, 2017, the closing price of People’s United common stock was $19.19. As of that date, there were approximately 17,300 record holders of People’s United common stock.
Five-Year Performance Comparison
The following graph compares total shareholder return on People’s United common stock over the last five fiscal years with: (i) the Standard & Poor’s 500 Stock Index (the “S & P 500 Stock Index”); (ii) the Russell Midcap Index; and (iii) the SNL Large Cap U.S. Bank & Thrift Index (the “SNL Large Cap Index”). Index values are as of December 31 of the indicated year.
The graph assumes $100 invested on December 31, 2011 in each of People’s United’s common stock, the S&P 500 Stock Index, the Russell Midcap Index and the SNL Large Cap Index. The graph also assumes reinvestment of all dividends.
The Russell Midcap Index is a market-capitalization weighted index comprised of 800 publicly-traded companies which are among the 1,000 largest U.S. companies (by market capitalization) but not among the 200 largest such companies. People’s United is included as a component of the Russell Midcap Index. The SNL Large Cap Index is an index prepared by SNL Securities comprised of 35 financial institutions (including People’s United) located throughout the U.S.
Issuer Purchases of Equity Securities
The following table provides information with respect to purchases made by People’s United of its common stock during the three months ended December 31, 2016:
(1) All shares listed were tendered by employees of People’s United in satisfaction of their related minimum tax withholding obligations upon the vesting of restricted stock awards granted in prior periods and/or in payment of the exercise price and satisfaction of their related minimum tax withholding obligations upon the exercise of stock options granted in prior periods. The average price paid per share is equal to the average of the high and low trading price of People’s United’s common stock on The NASDAQ Global Select Market on the vesting or exercise date or, if no trades took place on that date, the most recent day for which trading data was available. There is no limit on the number of shares that may be tendered by employees of People’s United in the future for these purposes. Shares acquired in payment of the option exercise price or in satisfaction of minimum tax withholding obligations are not eligible for reissuance in connection with any subsequent grants made pursuant to equity compensation plans maintained by People’s United. All shares acquired in this manner are retired by People’s United, resuming the status of authorized but unissued shares of People’s United’s common stock.
Additional information required by this item is included in Part III, Item 12 of this report, and Notes 13 and 26 to the Consolidated Financial Statements.
Item 6. Selected Financial Data
(1) See Non-GAAP Financial Measures and Reconciliation to GAAP.
(2) Includes securities purchased under agreements to resell.
(3) Excludes acquired loans. See Asset Quality.
(4) Total risk-based capital ratios presented are for People’s United Bank. See Regulatory Capital Requirements.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
Periodic and other filings made by People’s United with the SEC pursuant to the Exchange Act may, from time to time, contain information and statements that are forward-looking in nature. Such filings include the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and may include other forms such as proxy statements. Other written or oral statements made by People’s United or its representatives from time to time may also contain forward-looking statements.
In general, forward-looking statements usually use words such as “expect,” “anticipate,” “believe,” “should,” and similar expressions, and include all statements about People’s United’s operating results or financial position for future periods. Forward-looking statements represent management’s beliefs, based upon information available at the time the statements are made, with regard to the matters addressed; they are not guarantees of future performance.
All forward-looking statements are subject to risks and uncertainties that could cause People’s United’s actual results or financial condition to differ materially from those expressed in or implied by such statements. Factors of particular importance to People’s United include, but are not limited to: (1) changes in general, international, national or regional economic conditions; (2) changes in interest rates; (3) changes in loan default and charge-off rates; (4) changes in deposit levels; (5) changes in levels of income and expense in non-interest income and expense related activities; (6) changes in accounting and regulatory guidance applicable to banks; (7) price levels and conditions in the public securities markets generally; (8) competition and its effect on pricing, spending, third-party relationships and revenues; (9) the successful integration of acquisitions; and (10) changes in regulation resulting from or relating to financial reform legislation.
All forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Consequently, no forward-looking statement can be guaranteed. People’s United does not undertake any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
General
People’s United is a bank holding company and a financial holding company, and the Bank is a national banking association. The principal business of People’s United is to provide, through the Bank and its subsidiaries, commercial banking, retail banking and wealth management services to individual, corporate and municipal customers. The Bank, which is headquartered in Bridgeport, Connecticut, had $40.3 billion in total assets as of December 31, 2016. Its deposit accounts are insured up to applicable limits by the FDIC under the DIF. The Bank is subject to regulation, examination, supervision and reporting requirements by the OCC, as its primary regulator, and by the FDIC as the deposit insurer. In addition, the CFPB has responsibility for supervising the Bank’s compliance with designated consumer financial laws.
People’s United’s results of operations are largely dependent upon revenues generated through net interest income and fee-based revenues and, to a much lesser extent, other forms of non-interest income such as gains on asset sales. Sources for these revenues are diversified across People’s United’s three primary operating segments that represent its core businesses: Commercial Banking; Retail Banking; and Wealth Management. People’s United’s results of operations are also significantly affected by the provision for loan losses and the level of non-interest expense. In addition, People’s United’s results of operations may also be affected by general and local economic conditions, changes in market interest rates, government policies and actions of regulatory authorities.
Recent Developments
On June 27, 2016, People’s United announced the signing of a definitive agreement to acquire Suffolk Bancorp (“Suffolk”) based in Riverhead, New York. Under the terms of the definitive agreement, each share of Suffolk common stock will be converted into the right to receive 2.225 shares of People’s United common stock, with a total transaction value, as of December 31, 2016, of approximately $518 million. As disclosed in its Quarterly Report on Form 10-Q as of and for the period ended September 30, 2016, Suffolk reported total assets of $2.2 billion, total deposits of $1.9 billion and operated 27 branches in the greater Long Island area.
The acquisition, which is subject to regulatory approval, was approved by the shareholders of Suffolk on October 13, 2016. People’s United shareholder approval is not required for the acquisition. On February 6, 2017, the Company announced that the OCC approved the merger of Suffolk County National Bank with and into the Bank. The acquisition remains subject to the approval of the FRB. Merger-related expenses recorded in 2016 relating to this transaction totaled $2.8 million.
Critical Accounting Policies
In preparing the consolidated financial statements, management is required to make significant estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from management’s current estimates, as a result of changing conditions and future events.
Several accounting estimates are particularly critical and are susceptible to significant near-term change, including the allowance for loan losses and asset impairment judgments, such as the recoverability of goodwill and other intangible assets.
The judgments used by management in applying critical accounting policies may be affected by economic conditions, which may result in changes to future financial results. For example, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for loan losses in future periods, and the inability to collect outstanding principal may result in increased loan losses. People’s United’s significant accounting policies and critical estimates are summarized in Note 1 to the Consolidated Financial Statements.
The Financial Accounting Standards Board (the “FASB”) has recently issued changes to several accounting standards, some of which govern key aspects of the Company’s financial statements. Most notably, the FASB’s standard on accounting for credit losses removes from U.S. generally accepted accounting principles (“GAAP”) the existing “probable” threshold for recognizing credit losses and, instead, utilizes an “expected credit loss” measurement principle. The model would be applied in the recognition of credit losses for loans, held-to-maturity securities and other receivables at the time the financial asset is originated or acquired and adjusted each period for changes in expected credit losses. This standard represents a significant change in GAAP and may, upon adoption, result in material changes to the Company’s Consolidated Financial Statements (see Note 1 to the Consolidated Financial Statements).
Non-GAAP Financial Measures and Reconciliation to GAAP
In addition to evaluating People’s United’s results of operations in accordance with U.S. GAAP, management routinely supplements its evaluation with an analysis of certain non-GAAP financial measures, such as the efficiency and tangible common equity ratios, tangible book value per common share and operating earnings metrics. Management believes these non-GAAP financial measures provide information useful to investors in understanding People’s United’s underlying operating performance and trends, and facilitates comparisons with the performance of other financial institutions. Further, the efficiency ratio and operating earnings metrics are used by management in its assessment of financial performance, including non-interest expense control, while the tangible common equity ratio and tangible book value per common share are used to analyze the relative strength of People’s United’s capital position.
The efficiency ratio, which represents an approximate measure of the cost required by People’s United to generate a dollar of revenue, is the ratio of (i) total non-interest expense (excluding operating lease expense, goodwill impairment charges, amortization of other acquisition-related intangible assets, losses on real estate assets and non-recurring expenses, which are also excluded in arriving at operating non-interest expense) (the numerator) to (ii) net interest income on a fully taxable equivalent (“FTE”) basis plus total non-interest income (including the FTE adjustment on bank-owned life insurance (“BOLI”) income, the netting of operating lease expense and excluding gains and losses on sales of assets other than residential mortgage loans and acquired loans, and non-recurring income) (the denominator). People’s United generally considers an item of income or expense to be non-recurring if it is not similar to an item of income or expense of a type incurred within the last two years and is not similar to an item of income or expense of a type reasonably expected to be incurred within the following two years.
Operating earnings exclude from net income available to common shareholders those items that management considers to be of such a non-recurring or infrequent nature that, by excluding such items (net of income taxes), People’s United’s results can be measured and assessed on a more consistent basis from period to period. Items excluded from operating earnings, which include, but are not limited to: (i) non-recurring gains/losses; (ii) merger-related expenses, including acquisition integration and other costs; (iii) writedowns of banking house assets and related lease termination costs; (iv) severance-related costs; and (v) charges related to executive-level management separation costs, are generally also excluded when calculating the efficiency ratio. Effective with the quarter ended March 31, 2016, recurring writedowns of banking house assets and certain severance-related costs are no longer considered to be non-operating expenses. Operating earnings per common share (“EPS”) is derived by determining the per share impact of the respective adjustments to arrive at operating earnings and adding (subtracting) such amounts to (from) EPS, as reported. Operating return on average assets is calculated by dividing operating earnings by average total assets. Operating return on average tangible common equity is calculated by dividing operating earnings by average tangible common equity. The operating common dividend payout ratio is calculated by dividing common dividends paid by operating earnings for the respective period.
The tangible common equity ratio is the ratio of (i) tangible common equity (total stockholders’ equity less preferred stock, goodwill and other acquisition-related intangible assets) (the numerator) to (ii) tangible assets (total assets less goodwill and other acquisition-related intangible assets) (the denominator). Tangible book value per common share is calculated by dividing tangible common equity by common shares (total common shares issued, less common shares classified as treasury shares and unallocated Employee Stock Ownership Plan (“ESOP”) common shares).
In light of diversity in presentation among financial institutions, the methodologies used by People’s United for determining the non-GAAP financial measures discussed above may differ from those used by other financial institutions.
The following table summarizes People’s United’s operating non-interest expense and efficiency ratio, as derived from amounts reported in the Consolidated Statements of Income:
(1) Items classified as “other” and deducted from non-interest expense for purposes of calculating the efficiency ratio include, as applicable, certain franchise taxes, real estate owned expenses, contract termination costs and non-recurring expenses.
(2) Items classified as “other” and deducted from total revenues for purposes of calculating the efficiency ratio include, as applicable, asset write-offs and gains associated with the sale of branch locations.
The following table summarizes People’s United’s operating earnings, operating EPS and operating return on average assets:
The following tables summarize People’s United’s operating return on average tangible common equity and operating common dividend payout ratio:
The following tables summarize People’s United’s tangible common equity ratio and tangible book value per common share derived from amounts reported in the Consolidated Statements of Condition:
Economic Environment
People’s United’s results are subject to fluctuations based on economic conditions that can affect interest rates, deposit flows, credit demand and the ability of borrowers to service debt, among others. Throughout 2016, the U.S. economy experienced a modest expansion, with real gross domestic product increasing 1.6% year-over-year, national employment increasing by 2.2 million jobs, the national unemployment rate declining from 5.0% at the end of 2015 to 4.7% as of December 31, 2016, and the yield on the 10-year Treasury note increasing from 2.27% to 2.45%. Inflation increased but remained temperate with the Consumer Price Index (“CPI”) increasing 2.1% (or 2.2% excluding food and energy) over the course of the year. The Personal Consumption Expenditure (“PCE”) price index increased 1.6% (or 1.7% excluding food and energy). After raising the target rate for federal funds to between 0.25% and 0.50% at its December 2015 meeting, the Federal Open Market Committee (the “FOMC”) of the FRB maintained this target rate throughout 2016 before raising it to between 0.50% and 0.75% at its December 2016 meeting.
On balance, the modest expansion in 2016 supported loan and deposit growth and loan performance even as the interest rate environment did not support an expansion of the net interest margin. The Company expects a modest acceleration in economic growth in 2017, which should continue to support loan and deposit growth and loan performance. Although the FOMC indicated at its December 2016 meeting that three additional 0.25% increases in the target federal funds rate would likely occur in 2017, policy uncertainties and concerns about the momentum of the U.S. economy make it unlikely that the target rate will increase by that much. With economic growth and inflation likely to increase only modestly over 2016, the interest rate environment in 2017 will continue to be challenging with respect to the net interest margin.
The New England region and southeastern New York comprise People’s United’s primary market area, with Connecticut, Massachusetts, New York and Vermont having the largest concentration of People’s United’s loans, deposits and branches. While the New England economy experienced a less severe contraction during the last recession than the U.S. as a whole, since the recession ended it has expanded more slowly. Employment growth since 2008 has exceeded the national average only in Massachusetts. As of December 31, 2016, Connecticut and Maine had yet to recover all the jobs lost in the recession, while Vermont and New Hampshire had increased employment but more slowly that the nation overall. The combination of the less severe recession but slower subsequent growth resulted in state unemployment rates that are less than the national rate in all states in the Company’s primary market area except for New York, where the unemployment rate was 4.9% as of December 31, 2016 compared to the national average of 4.7%.
Slow economic growth is expected to continue within People’s United’s primary market area. Although this area does not enjoy the natural resources that have led to strong economic growth in other areas of the nation, its skilled labor force should enable it to be competitive in sectors of the economy with high growth potential, including health care, technology, education and advanced manufacturing.
Financial Overview
Comparison of Financial Condition at December 31, 2016 and 2015. Total assets at December 31, 2016 were $40.6 billion, a $1.7 billion increase from December 31, 2015, reflecting increases of $1.3 billion in total loans and $289 million in total securities, partially offset by a $199 million decrease in short-term investments. The increase in total loans from December 31, 2015 to December 31, 2016 reflects increases of $760 million in residential mortgage loans and $654 million in commercial loans, partially offset by an $81 million decrease in home equity loans. Originated loans increased $1.5 billion from December 31, 2015 to $29.1 billion (commercial loans increased $792 million and retail loans increased $729 million) and acquired loans decreased $186 million. At December 31, 2016, the carrying amount of the acquired loan portfolio totaled $610 million. The increase in total securities primarily reflects net purchases of U.S. Treasury securities and municipal bonds, partially offset by principal repayments and maturities of government sponsored enterprise (“GSEs”) mortgage-backed securities and collateralized mortgage obligations (“CMOs”).
Non-performing assets (excluding acquired non-performing loans) totaled $167.3 million at December 31, 2016, a $14.2 million decrease from year-end 2015, primarily reflecting decreases of $9.8 million in non-performing residential mortgage loans and $7.9 million in non-performing commercial real estate loans, partially offset by an $11.9 million increase in non-performing equipment financing loans. The allowance for loan losses was $229.3 million at December 31, 2016 ($223.0 million on originated loans and $6.3 million on acquired loans) compared to $211.0 million at December 31, 2015 ($202.9 million on originated loans and $8.1 million on acquired loans). At December 31, 2016, the originated allowance for loan losses as a percentage of originated loans was 0.77% and as a percentage of originated non-performing loans was 150.6%, compared to 0.73% and 127.3%, respectively, at December 31, 2015.
At December 31, 2016, total liabilities were $35.5 billion, a $1.3 billion increase from December 31, 2015, reflecting a $1.4 billion increase in total deposits, partially offset by a $251 million decrease in total borrowings.
People’s United’s total stockholders’ equity was $5.1 billion at December 31, 2016, a $410.3 million increase from December 31, 2015. This increase primarily reflects net income in 2016 of $281.0 million, net proceeds from the issuance of preferred stock of $244.1 million and net restricted stock and stock option-related transactions in 2016 totaling $105.0 million, partially offset by common dividends paid in 2016 of $205.7 million. As a percentage of total assets, stockholders’ equity was 12.7% at December 31, 2016 compared to 12.2% at December 31, 2015. Tangible common equity as a percentage of tangible assets was 7.2% at both December 31, 2016 and 2015.
People’s United’s (consolidated) Tier 1 Leverage, CET 1, and Tier 1 and Total risk-based capital ratios were 8.4%, 9.9%, 10.7% and 12.5%, respectively, at December 31, 2016, compared to 8.0%, 9.8%, 9.8% and 11.7%, respectively, at December 31, 2015. The Bank’s Tier 1 Leverage, CET 1, and Tier 1 and Total risk-based capital ratios were 8.9%, 11.3%, 11.3% and 13.3%, respectively, at December 31, 2015, compared to 8.4%, 10.2%, 10.2% and 12.6%, respectively, at December 31, 2015.
Comparison of Results of Operations for the Years Ended December 31, 2016 and 2015. People’s United reported net income of $281.0 million, or $0.92 per diluted common share, for the year ended December 31, 2016, compared to $260.1 million, or $0.86 per diluted common share, for the 2015 period. Included in the 2016 results are merger-related costs totaling $4.7 million ($3.1 million after-tax) or $0.01 per common share. Results for 2015 include a net after-tax gain of $6.1 million ($0.02 per common share) resulting from the sale of the Company’s payroll services business. The results for 2016 reflect continued loan and deposit growth, meaningful cost control and the negative impact of the historically low interest rate environment. People’s United’s return on average assets was 0.71% for both 2016 and 2015. Return on average tangible common equity was 10.2% for 2016 compared to 10.0% for the 2015 period.
FTE net interest income totaled $1.0 billion in 2016, a $47.2 million increase from the year-ago period, and the net interest margin declined eight basis points from 2015 to 2.80%. The decrease in the net interest margin primarily reflects continued pricing pressure within the loan portfolio, which includes the pay-off of higher-yielding loans, partially mitigated by new loan originations at rates higher than the existing portfolio.
Average total earning assets increased $2.7 billion compared to 2015, reflecting increases of $1.5 billion in average total loans and $1.1 billion in average total securities. Average total funding liabilities increased $2.6 billion compared to 2015, reflecting increases of $1.7 billion in average total deposits and $820 million in average total borrowings.
Compared to 2015, total non-interest income decreased $9.7 million and total non-interest expense increased $8.2 million. The efficiency ratio was 60.5% for 2016 compared to 61.5% for the year-ago period. The provision for loan losses in 2016 totaled $36.6 million compared to $33.4 million in the year-ago period. Net loan charge-offs as a percentage of average total loans were 0.06% in 2016 compared to 0.08% in 2015.
Comparison of Financial Condition at December 31, 2015 and 2014. Total assets at December 31, 2015 were $38.9 billion, a $2.9 billion increase from December 31, 2014, reflecting increases of $1.8 billion in total loans and $1.4 billion in total securities, partially offset by decreases of $298 million in cash and cash equivalents and $100 million in securities purchased under agreements to resell. The increase in total loans from December 31, 2014 to December 31, 2015 reflects increases of $1.3 billion in commercial loans and $525 million in residential mortgage loans. Originated loans increased $2.1 billion from December 31, 2014 to $27.6 billion (commercial loans increased $1.5 billion and retail loans increased $583 million) and acquired loans decreased $254 million. At December 31, 2015, the carrying amount of the acquired loan portfolio totaled $797 million. The increase in total securities primarily reflects net purchases of GSE mortgage-backed securities and U.S. Treasury and agency securities. The decrease in cash and cash equivalents reflects a $293 million decrease in interest-bearing deposits at the FRB-NY.
Non-performing assets (excluding acquired non-performing loans) totaled $181.5 million at December 31, 2015, a $42.6 million decrease from year-end 2014, reflecting decreases of $30.0 million in non-performing commercial real estate loans, $12.0 million in real estate owned (“REO”) and $10.9 million in non-performing commercial and industrial loans, partially offset by a $7.0 million increase in repossessed assets. The allowance for loan losses was $211.0 million ($202.9 million on originated loans and $8.1 million on acquired loans) at December 31, 2015 compared to $198.3 million ($188.1 million on originated loans and $10.2 million on acquired loans) at December 31, 2014. At December 31, 2015, the originated allowance for loan losses as a percentage of originated loans was 0.73% and as a percentage of originated non-performing loans was 127.3%, compared to 0.74% and 95.5%, respectively, at December 31, 2014.
At December 31, 2015, total liabilities were $34.2 billion, a $2.9 billion increase from December 31, 2014, reflecting increases of $2.3 billion in total deposits and $616 million in total borrowings. The increase in total borrowings reflects additional funding used to support loan growth and securities purchases.
People’s United’s total stockholders’ equity was $4.7 billion at December 31, 2015, a $98.5 million increase from December 31, 2014. This increase reflects net income in 2015 of $260.1 million and net restricted stock and stock option-related transactions in 2015 totaling $43.2 million, partially offset by common dividends paid in 2015 of $201.2 million. As a percentage of total assets, stockholders’ equity was 12.2% at December 31, 2015 compared to 12.9% at December 31, 2014. Tangible common equity as a percentage of tangible assets was 7.2% at December 31, 2015 compared to 7.5% at December 31, 2014.
People’s United’s (consolidated) Tier 1 Leverage, CET 1, and Tier 1 and Total risk-based capital ratios were 8.0%, 9.8%, 9.8% and 11.7%, respectively, at December 31, 2015 (calculated in accordance with Basel III capital rules), compared to 7.9%, 9.8%, 9.8% and 12.2%, respectively, at December 31, 2014. The Bank’s Tier 1 Leverage, CET 1, and Tier 1 and Total risk-based capital ratios were 8.4%, 10.2%, 10.2% and 12.6%, respectively, at December 31, 2015 (calculated in accordance with Basel III capital rules), compared to 8.5%, 10.5%, 10.5% and 13.0%, respectively, at December 31, 2014.
Comparison of Results of Operations for the Years Ended December 31, 2015 and 2014. People’s United reported net income of $260.1 million, or $0.86 per diluted common share, for the year ended December 31, 2015, compared to $251.7 million, or $0.84 per diluted common share, for the 2014 period. Included in the 2015 results is a net after-tax gain of $6.1 million ($0.02 per share) resulting from the sale of the Company’s payroll services business. Included in the 2014 results is a net after-tax gain of $13.4 million ($0.04 per share) resulting from the formation of a merchant services joint venture. The results for 2015 reflect continued loan and deposit growth, meaningful cost control and the negative impact of the historically low interest rate environment. People’s United’s return on average assets was 0.71% for 2015 compared to 0.75% for 2014. Return on average tangible common equity was 10.0% for both 2015 and 2014.
FTE net interest income totaled $957.3 million in 2015, a $26.2 million increase from the 2014 period, and the net interest margin declined 21 basis points from 2014 to 2.88%. The decrease in the net interest margin primarily reflects continued pricing pressure within the loan portfolio, which includes the pay-off of higher-yielding loans and new loan originations at rates lower than the existing portfolio, and declining interest income on acquired loans.
Average total earning assets increased $3.0 billion compared to 2014, reflecting increases of $2.0 billion in average total loans and $985 million in average total securities. Average total funding liabilities increased $3.0 billion compared to 2014, reflecting increases of $3.2 billion in average total deposits and $200 million in average notes and debentures, partially offset by a $423 million decrease in average total borrowings.
Compared to 2014, total non-interest income increased $1.6 million and total non-interest expense increased $19.1 million. The efficiency ratio was 61.5% for 2015 compared to 62.1% for 2014. The provision for loan losses in 2015 totaled $33.4 million compared to $40.6 million in 2014. Net loan charge-offs as a percentage of average total loans were 0.08% in 2015 compared to 0.12% in 2014.
Segment Results
People’s United’s operations are divided into three primary operating segments that represent its core businesses: Commercial Banking; Retail Banking; and Wealth Management. In addition, the Treasury area manages People’s United’s securities portfolio, short-term investments, brokered deposits, wholesale borrowings and the funding center.
The Company’s operating segments have been aggregated into two reportable segments: Commercial Banking and Retail Banking. These reportable segments have been identified and organized based on the nature of the underlying products and services applicable to each segment, the type of customers to whom those products and services are offered and the distribution channel through which those products and services are made available. With respect to the Company’s traditional wealth management activities, this presentation results in the allocation of the Company’s insurance business and certain trust activities to the Commercial Banking segment, and the allocation of the Company’s brokerage business and certain other trust activities to the Retail Banking segment.
Segment Performance Summary
People’s United uses an internal profitability reporting system to generate information by operating segment, which is based on a series of management estimates and allocations regarding funds transfer pricing (“FTP”), the provision for loan losses, non-interest expense and income taxes. These estimates and allocations, some of which are subjective in nature, are subject to periodic review and refinement. Any changes in estimates and allocations that may affect the reported results of any segment will not affect the consolidated financial position or results of operations of People’s United as a whole. Certain reclassifications have been made to prior period amounts to conform to the current period presentation.
FTP, which is used in the calculation of each operating segment’s net interest income, measures the value of funds used in and provided by an operating segment. The difference between the interest income on earning assets and the interest expense on funding liabilities, and the corresponding FTP charge for interest income or credit for interest expense, results in net spread income (see Treasury). For fixed-term assets and liabilities, the FTP rate is assigned at the time the asset or liability is originated by reference to the Company’s FTP yield curve, which is updated daily. For non-maturity-term assets and liabilities, the FTP rate is determined based upon the underlying characteristics, or behavior, of each particular product and results in the use of a historical rolling average FTP rate determined over a period that is most representative of the average life of the particular asset or liability. While the Company’s FTP methodology serves to remove interest rate risk (“IRR”) from the operating segments and better facilitate pricing decisions, thereby allowing management to more effectively assess the longer-term profitability of an operating segment, it may, in sustained periods of low and/or high interest rates, result in a measure of operating segment net interest income that is not reflective of current interest rates.
During the quarter ended March 31, 2015, the Company modified its FTP methodology relating to certain deposit products that resulted in a reduction in the funding credit recognized within net interest income for Commercial Banking and Retail Banking, with the offset reflected in Treasury. Prior period segment results for this modification have not been adjusted and continue to reflect the previous FTP methodology.
A five-year rolling average net charge-off rate is used as the basis for the provision for loan losses for the respective operating segment in order to present a level of portfolio credit cost that is representative of the Company’s historical experience, without presenting the potential volatility from year-to-year changes in credit conditions. While this method of allocation allows management to more effectively assess the longer-term profitability of a segment, it may result in a measure of segment provision for loan losses that does not reflect actual incurred losses for the periods presented.
People’s United allocates a majority of non-interest expenses to each operating segment using a full-absorption costing process (i.e. all expenses are fully-allocated to the segments). Direct and indirect costs are analyzed and pooled by process and assigned to the appropriate operating segment and corporate overhead costs are allocated to the operating segments. During the quarter ended March 31, 2015, the Company modified its cost allocation methodology with respect to the allocation of branch costs associated with servicing certain customers, which resulted in an increase in non-interest expense for Commercial Banking and Wealth Management, with the offset reflected in Retail Banking. Prior period segment results have not been adjusted and continue to reflect the previous cost allocation methodology. Income tax expense is allocated to each operating segment using a constant rate, based on an estimate of the consolidated effective income tax rate for the year. Average total assets and average total liabilities are presented for each reportable segment due to management’s reliance, in part, on such average balances for purposes of assessing segment performance.
For a more detailed description of the estimates and allocations used to measure segment performance, see Note 23 to the Consolidated Financial Statements.
Commercial Banking consists principally of commercial real estate lending, commercial and industrial lending, and commercial deposit gathering activities. This segment also includes the equipment financing operations of PCLC and PUEFC, as well as cash management, correspondent banking, municipal banking, institutional trust services, corporate trust, insurance services provided through PUIA and private banking.
Commercial Banking’s net income increased $12.6 million in 2016 compared to 2015, reflecting an increase in net interest income, partially offset by a decrease in non-interest income and an increase in non-interest expense. The $14.9 million increase in net interest income primarily reflects the benefit from an increase in average commercial loans, partially offset by increases in interest expense and net FTP funding charges, and continued pricing pressure within the loan portfolio, which includes the pay-off of higher-yielding loans, partially mitigated by new originations at rates higher than the existing portfolio. Non-interest income decreased $5.6 million, primarily reflecting decreases in commercial banking lending fees and operating lease income, partially offset by increases in institutional and corporate trust fees, and insurance revenue. The $9.6 million increase in non-interest expense reflects a higher level of direct expenses. Average total assets increased $1.2 billion and average total liabilities increased $1.3 billion compared to 2015, reflecting loan and deposit growth, respectively.
Commercial Banking’s net income increased $13.8 million in 2015 compared to 2014, reflecting increases in net interest income and non-interest income, partially offset by an increase in non-interest expense. The $35.6 million increase in net interest income primarily reflects the benefit from an increase in average commercial loans and lower net FTP funding charges, partially offset by continued pricing pressure within the loan portfolio, which includes the pay-off of higher-yielding loans and new originations at rates lower than the existing portfolio, and declining interest income on acquired loans. Included in non-interest income in 2015 and 2014 are net gains (losses) on sales of acquired loans totaling $1.7 million and $(0.9) million, respectively. Excluding these net gains (losses), non-interest income increased $18.0 million in 2015, primarily reflecting increases in commercial banking lending fees, customer interest rate swap income and operating lease income resulting from a higher level of equipment leases to PCLC customers. The $37.5 million increase in non-interest expense in 2015 reflects higher levels of direct (including operating lease expense) and allocated expenses. Average total assets increased $2.1 billion and average total liabilities increased $1.2 billion compared to 2014, reflecting loan and deposit growth, respectively. In addition, during the quarter ended March 31, 2015, certain customer loans and deposits were transferred from Retail Banking to Commercial Banking to better align with the Bank’s customer relationship management approach.
Retail Banking includes, as its principal business lines, consumer lending (including residential mortgage and home equity lending) and consumer deposit gathering activities. This segment also includes brokerage, financial advisory services, investment management services and life insurance provided by PSI and non-institutional trust services.
Retail Banking’s net loss decreased $10.4 million in 2016 compared to 2015. The $2.9 million increase in net interest income primarily reflects the benefit from an increase in average residential mortgage loans and a decrease in interest expense, partially offset by lower net FTP funding credits and continued pricing pressure within the loan portfolio, which includes the pay-off of higher-yielding loans, partially mitigated by new originations at rates higher than the existing portfolio. The $11.3 million decrease in non-interest expense reflects lower levels of both direct and allocated expenses. Compared to 2015, average total assets increased $468 million, primarily reflecting loan growth, and average total liabilities decreased $29 million, primarily reflecting a decrease in deposits.
Retail Banking’s net loss in 2015 compared to net income in 2014 primarily reflects a $63.4 million decrease in net interest income. The decrease in net interest income primarily reflects lower net FTP funding credits, continued pricing pressure within the loan portfolio, which includes the pay-off of higher-yielding loans and new originations at rates lower than the existing portfolio, and declining interest income on acquired loans, partially offset by the benefit from an increase in average residential mortgage loans. The $2.3 million increase in non-interest income primarily reflects an increase in net gains on sales of residential mortgages. The $7.8 million decrease in non-interest expense reflects lower levels of both direct and allocated expenses. Average total assets decreased $37 million and average total liabilities increased $127 million compared to 2014. During the quarter ended March 31, 2015, certain customer loans and deposits were transferred from Retail Banking to Commercial Banking to better align with the Bank’s customer relationship management approach.
Treasury encompasses the securities portfolio, short-term investments, brokered deposits, wholesale borrowings and the funding center, which includes the impact of derivative financial instruments used for risk management purposes.
The income or loss for the funding center represents the IRR component of People’s United’s net interest income as calculated by its FTP model in deriving each operating segment’s net interest income. Under this process, the funding center buys funds from liability-generating business lines, such as consumer deposits, and sells funds to asset-generating business lines, such as commercial lending. The price at which funds are bought and sold on any given day is set by People’s United’s Treasury group and is based on the wholesale cost to People’s United of assets and liabilities with similar maturities. Liability-generating businesses sell newly-originated liabilities to the funding center and recognize a funding credit, while asset-generating businesses buy funding for newly-originated assets from the funding center and recognize a funding charge. Once funding for an asset is purchased from or a liability is sold to the funding center, the price that is set by the Treasury group will remain with that asset or liability until it matures or reprices, which effectively transfers responsibility for managing IRR to the Treasury group.
Treasury’s net income increased $13.8 million in 2016 compared to 2015. The $23.2 million increase in net interest income primarily reflects an increase in securities income and lower net FTP funding costs, partially offset by an increase in interest expense. Total non-interest income in 2016 includes $5.9 million in net security losses, primarily resulting from the sale of low-yielding and short maturity U.S. Treasury and CMO securities with a combined amortized cost of $403 million, and income relating to distributions from an acquired equity investment. Total non-interest income also includes BOLI death benefits received totaling $1.4 million and $0.5 million in 2016 and 2015, respectively. The increase in non-interest expense reflects an increase in allocated expenses partially offset by a decrease in direct expenses. Average total assets increased $1.0 billion in 2016 compared to 2015, primarily reflecting an increase in average securities. The $1.4 billion increase in average total liabilities in 2016 compared to 2015 primarily reflects an increase in average borrowings.
Treasury’s net income increased $34.6 million in 2015 compared to 2014. The $53.7 million improvement in net interest income primarily reflects lower net FTP funding costs and an increase in securities income, partially offset by an increase in interest expense. The decrease in non-interest income primarily reflects a decrease in net security gains and BOLI income. The increase in non-interest expense reflects increases in both direct and allocated expenses. Average total assets increased $1.1 billion in 2015 compared to 2014, primarily reflecting increases in average securities and average short-term investments. The $1.8 billion increase in average total liabilities in 2015 compared to 2014 reflects increases in average deposits and average notes and debentures, partially offset by a decrease in average borrowings.
Other includes the residual financial impact from the allocation of revenues and expenses (including the provision for loan losses) and certain revenues and expenses not attributable to a particular segment; assets and liabilities not attributable to a particular segment; reversal of the FTE adjustment since net interest income for each segment is presented on an FTE basis; and the FTP impact from excess capital. Total non-interest income includes certain gains totaling $7.5 million, $9.2 million and $20.6 million in 2016, 2015 and 2014, respectively. Total non-interest expense includes certain charges totaling $4.7 million, $12.9 million and $9.5 million in 2016, 2015 and 2014, respectively.
Net Interest Income
Net interest income and net interest margin are affected by many factors, including changes in average balances; interest rate fluctuations and the slope of the yield curve; sales of loans and securities; residential mortgage loan and mortgage-backed security prepayment rates; product pricing; competitive forces; the relative mix, repricing characteristics and maturity of interest-earning assets and interest-bearing liabilities; non-interest-bearing sources of funds; hedging activities; and asset quality.
Net Interest Margin
Years ended December 31 (percent)
Net Interest Income - FTE
Years ended December 31 (dollars in millions)
In response to signs of a moderately expanding U.S. economy, the FRB has raised the targeted range for the federal funds rate by a total of 50 basis points since December 31, 2015, bringing the targeted range to between 0.50% and 0.75%. Until that date, the FRB had not changed the targeted range of between 0% and 0.25% since December 2008. For 2016, the average effective federal funds rate was 0.39%. In February 2016, the FRB issued an interim final rule, which serves to implement a reduction in the dividend rate paid on Federal Reserve Bank capital stock from an annual fixed-rate of 6% to the lesser of 6% or a rate based on 10-year Treasury notes, for those banks with total assets greater than $10 billion, including the Bank. The Company estimates that dividend income from the FRB-NY capital stock may be reduced by approximately $5 million on an annual basis.
The net interest margin was 2.80% in 2016 compared to 2.88% in 2015. The decline in the net interest margin in 2016 compared to 2015 primarily reflects continued pricing pressure within the loan portfolio, which includes the pay-off of higher-yielding loans, a decline in the yield on the securities portfolio and an increase in average total borrowings balances and rate. The net interest margin continues to be negatively impacted by the historically low interest rate environment where loan repricings are outpacing the Company’s ability to lower deposit costs as well as the continued investment of a portion of the Company’s capital in low-yielding short-term investments.
2016 Compared to 2015
FTE net interest income increased $47.2 million compared to 2015, reflecting a $65.5 million increase in total interest and dividend income, partially offset by an $18.3 million increase in total interest expense, and the net interest margin decreased eight basis points to 2.80%, primarily reflecting an increase in funding costs (five basis points).
Average total earning assets were $35.9 billion in 2016, a $2.7 billion increase from 2015, primarily reflecting increases of $1.5 billion in average total loans and $1.1 billion in average securities. Average total loans, average securities and average short-term investments comprised 80%, 19% and 1%, respectively, of average total earning assets in 2016, compared to 82%, 17% and 1%, respectively, in 2015. In 2016, the yield earned on the total loan portfolio was 3.47% and the yield earned on securities and short-term investments was 2.30%, compared to 3.52% and 2.28%, respectively, in the year-ago period. Excluding adjustable-rate residential mortgage loans, which are mostly of the hybrid variety, 51% of the loan portfolio had floating interest rates at December 31, 2016, compared to 49% at December 31, 2015.
The average total commercial and residential mortgage loan portfolios increased $1.0 billion and $602 million, respectively, compared to 2015, reflecting growth. Average home equity and other consumer loans decreased $29 million compared to 2015, primarily reflecting a $26 million decrease in average home equity loans.
Average total funding liabilities were $34.3 billion in 2016, a $2.6 billion increase from the year-ago period, reflecting increases of $1.7 billion in average total deposits and $820 million in average total borrowings. The increase in average total deposits reflects organic growth, partially offset by a $53 million decrease in average brokered deposits. Excluding brokered deposits, average savings, interest-bearing checking and money market deposits, and average non-interest-bearing deposits increased $1.6 billion and $434 million, respectively, while average time deposits decreased $240 million. Average total deposits comprised 85% and 87% of average total funding liabilities in 2016 and 2015, respectively. The increase in average borrowings reflects the additional funding used to support loan growth and securities purchases.
The two basis point increase to 0.45% from 0.43% in the rate paid on average total funding liabilities in 2016 compared to 2015 primarily reflects an increase in the cost of total borrowings, reflecting the increases in the target federal funds rate discussed above. The rate paid on average total deposits decreased one basis point in 2016, primarily reflecting a $434 million increase in non-interest-bearing deposits. Average savings, interest-bearing checking and money market deposits, and average time deposits comprised 63% and 16%, respectively, of average total deposits in 2016 compared to 60% and 19%, respectively, in 2015.
2015 Compared to 2014
FTE net interest income increased $26.2 million compared to 2014, reflecting a $44.3 million increase in total interest and dividend income partially offset by an $18.1 million increase in total interest expense, and the net interest margin decreased 21 basis points to 2.88%. The decline in the net interest margin reflects new loan volume at rates lower than the existing portfolio (15 basis points) and an increase in average deposit balances (five basis points).
Average total earning assets were $33.2 billion in 2015, a $3.0 billion increase from 2014, primarily reflecting increases of $2.0 billion in average total loans and $985 million in average securities. Average total loans, average securities and average short-term investments comprised 82%, 17% and 1%, respectively, of average total earning assets in 2015, compared to 83%, 16% and 1%, respectively, in 2014. In 2015, the yield earned on the total loan portfolio was 3.52% and the yield earned on securities and short-term investments was 2.28%, compared to 3.74% and 2.15%, respectively, in 2014. Excluding adjustable-rate residential mortgage loans, which are mostly of the hybrid variety, 49% of the loan portfolio had floating interest rates at December 31, 2015 compared to 47% at December 31, 2014.
The average total commercial and residential mortgage loan portfolios increased $1.4 billion and $587 million, respectively, compared to 2014, reflecting growth. Average home equity and other consumer loans increased $20 million compared to 2014, primarily reflecting a $32 million increase in average home equity loans, partially offset by a $10 million decrease in average indirect auto loans.
Average total funding liabilities were $31.8 billion in 2015, a $3.0 billion increase from 2014, reflecting increases of $3.2 billion in average total deposits and $200 million in average notes and debentures, partially offset by a $423 million decrease in average total borrowings. The increase in average total deposits reflects organic growth as well as a $1.2 billion increase in average brokered deposits. Excluding brokered deposits, average savings, interest-bearing checking and money market deposits, average non-interest-bearing deposits and average time deposits increased $1.4 billion, $411 million and $204 million, respectively. Average total deposits comprised 87% and 85% of average total funding liabilities in 2015 and 2014, respectively. The increase in average notes and debentures reflects the issuance of $400 million of subordinated notes in June 2014.
The two basis point increase to 0.43% from 0.41% in the rate paid on average total funding liabilities in 2015 compared to 2014 primarily reflects an increase in market interest rates and the shift in deposit mix as well as continued repricing of higher-yielding deposits assumed in acquisitions. The rate paid on average total deposits increased two basis points in 2015, reflecting an increase of four basis points in time deposits. Average savings, interest-bearing checking and money market deposits, and average time deposits comprised 60% and 19%, respectively, of average total deposits in 2015 compared to 59% and 19%, respectively, in 2014.
Average Balance Sheet, Interest and Yield/Rate Analysis
The table on the following page presents average balance sheets, FTE-basis interest income, interest expense and the corresponding average yields earned and rates paid for the years ended December 31, 2016, 2015 and 2014. The average balances are principally daily averages and, for loans, include both performing and non-performing balances. Interest income on loans includes the effect of deferred loan fees and costs accounted for as yield adjustments, but does not include interest on loans for which People’s United has ceased to accrue interest. Premium amortization and discount accretion (including amounts attributable to purchase accounting adjustments) are also included in the respective interest income and interest expense amounts. The impact of People’s United’s use of derivative instruments in managing IRR is also reflected in the table, classified according to the instrument hedged and the related risk management objective.
Average Balance Sheet, Interest and Yield/Rate Analysis
(1) Includes securities purchased under agreements to resell.
(2) Average balances and yields for securities are based on amortized cost.
(3) The FTE adjustment was $32.3 million, $25.2 million and $19.2 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Volume and Rate Analysis
The following table shows the extent to which changes in interest rates and changes in the volume of average total earning assets and average interest-bearing liabilities have affected People’s United net interest income. For each category of earning assets and interest-bearing liabilities, information is provided relating to: changes in volume (changes in average balances multiplied by the prior year’s average interest rates); changes in rates (changes in average interest rates multiplied by the prior year’s average balances); and the total change. Changes attributable to both volume and rate have been allocated proportionately.
The following table provides the weighted average yields earned and rates paid for each major category of earning assets and funding liabilities as of December 31, 2016:
Non-Interest Income
n/m - not meaningful
Total non-interest income, excluding the effects of the gain on sale of business in both 2015 and 2014 discussed below, decreased $0.5 million in 2016 compared to 2015 and increased $13.0 million in 2015 compared to 2014. The increase in non-interest income in 2015 compared to 2014 primarily reflects increases in commercial banking lending fees and customer interest rate swap income.
Bank service charges continue to be impacted as a result of certain provisions of the DFA as well as lower overdraft fees.
The improvement in investment management fees in both 2016 and 2015 reflects the continued benefits from new revenue initiatives, the acquisition of Gerstein, Fisher & Associates, Inc. in early November 2016 (see Note 2 to the Consolidated Financial Statements), additional personnel in our key markets and a broader suite of product offerings. Assets under administration and those under full discretionary management, neither of which are reported as assets of People’s United, totaled $13.3 billion and $8.0 billion, respectively, at December 31, 2016 compared to $9.9 billion and $5.6 billion, respectively, at December 31, 2015. The decline in brokerage commissions in 2016 and 2015 primarily reflects lower levels of mutual fund and annuity commission income. The level of insurance revenue over the past few years reflects the continued soft commercial insurance market as well as the benefits resulting from the recent acquisitions of Eagle Insurance Group, LLC in April 2016 and Kesten-Brown Insurance, LLC in October 2015 (see Note 2 to the Consolidated Financial Statements).
The increase in net gains on sales of residential mortgage loans in 2016 compared to 2015 primarily reflects an improvement in spreads on pricing, partially offset by a 6% decrease in the volume of residential mortgage loan sales. Loans held for sale at December 31, 2016 and 2015 consisted of newly-originated residential mortgage loans with carrying amounts of $39.3 million and $34.5 million, respectively. The increase in net gains on sales of residential mortgage loans in 2015 compared to 2014 primarily reflects a 51% increase in the volume of residential mortgage loan sales and an improvement in spreads on pricing.
The fluctuation in commercial banking lending fees in both periods is primarily related to the level of prepayment fees collected in each year. The fluctuation in operating lease income in 2016 and 2015 reflects fluctuations in levels of equipment leased to PCLC customers. Net security losses in 2016 primarily reflect the sale of low-yielding and short maturity U.S. Treasury and CMO securities with a combined amortized cost of $403 million in the quarter ended December 31, 2016. Net security gains in 2014 include a $2.3 million gain resulting from the call of a single security acquired in a previous acquisition.
On an FTE basis, BOLI income totaled $8.5 million in 2016, compared to $7.0 million in 2015 and $8.6 million in 2014. The increase in BOLI income in 2016 compared to 2015 primarily reflects death benefits received in 2016 totaling $1.4 million compared to $0.5 million in 2015. The decrease in BOLI income in 2015 compared to 2014 primarily reflects lower average interest rates in 2015 compared to 2014, resulting in a slightly lower crediting rate in 2015. Net gains (losses) on sales of acquired loans in 2015 and 2014 reflect sales of acquired loans with contractual balances of $24.1 million and $10.4 million, respectively (carrying amounts of $22.3 million and $10.3 million, respectively). Included in other non-interest income in 2016 are gains totaling $7.5 million resulting from the sale of an ownership interest in a legacy privately-held investment and an interest in a real estate investment.
During the quarter ended December 31, 2015, the Bank sold its payroll services business to its current payroll software licensor and entered into a long-term referral agreement. A $9.2 million gain (non-operating), net of related expenses, was recognized, which represented the fair value of the Bank’s entire portfolio of payroll services customer contracts that previously had a zero book basis. During the quarter ended June 30, 2014, the Bank formed a joint venture with Vantiv, Inc. to provide a comprehensive suite of payment solutions to businesses throughout the Bank’s footprint. The Bank retained a 49% minority interest in the joint venture and recognized a $20.6 million gain (non-operating), net of related expenses, resulting from the formation of the joint venture. The gain represented the fair value of the Bank’s entire portfolio of merchant contracts that was contributed to the joint venture and which previously had a zero book basis. The investment in the joint venture is accounted for using the equity method of accounting.
Non-Interest Expense
Total non-interest expense increased $8.2 million in 2016 compared to 2015 and $19.1 million in 2015 compared to 2014. Included in total non-interest expense are merger-related expenses totaling $4.7 million in 2016 and certain other charges (described below) totaling $12.9 million in 2015 and $9.5 million in 2014.
The improvement in the efficiency ratio in 2016 compared to 2015 reflects increases in both adjusted total revenues and adjusted total expenses (see Non-GAAP Financial Measures and Reconciliation to GAAP).
Compensation and benefits increased $6.1 million in 2016 compared to 2015 and $13.5 million in 2015 compared to 2014. Compensation and benefits includes severance-related costs totaling $0.7 million in 2016, $2.4 million in 2015 and $3.3 million in 2014. Excluding such costs, compensation and benefits increased $7.8 million, or 1.7%, in 2016 compared to 2015, and $14.4 million, or 3.3%, in 2015 compared to 2014. The increases for both periods primarily reflect normal merit increases, higher incentive-related costs and compensation and benefit costs for additional employees primarily within commercial banking, wealth management and regulatory compliance, partially offset by lower health-care and pension-related costs. Effective January 1, 2016, People’s United changed the method used to estimate the interest cost component of net periodic benefit income for its pension and other postretirement plans. For 2016, pension-related expense declined by $3.1 million as a result of this change in accounting estimate (see Note 17 to the Consolidated Financial Statements).
The increases in occupancy and equipment expense primarily reflects higher equipment-related costs partially offset by the benefits from consolidating branches and other office space over the past few years. In 2016, the Company closed 11 branches compared to 18 branches in 2015 and eight branches in 2014. Since the beginning of 2011, the Company has closed 65 branches, most of which were traditional branches, and opened 27 branches, of which 16 are more cost efficient Stop & Shop locations.
Professional and outside services fees include merger-related expenses totaling $3.9 million in 2016 (none in 2015 and 2014). Excluding such expenses, professional and outside services fess decreased $4.1 million in 2016 compared to 2015 and increased $14.9 million in 2015 compared to 2014. The decrease in professional and outside services fees in 2016 compared to 2015 is primarily related to the timing of certain projects in 2016 as well as a higher level of spending in 2015. The increase in professional and outside services fees in 2015 compared to 2014 is primarily related to costs associated with a number of initiatives focused on enhancing the Company’s product offerings and processes. The fluctuations in operating lease expense primarily relates to the levels of equipment leased to PCLC customers. The decrease in advertising and promotion in both 2016 and 2015 primarily reflects lower levels of spending on certain advertising campaigns.
Regulatory assessments include FDIC insurance premiums that are primarily based on the Bank’s average total assets and average tangible equity, and FDIC-defined risk factors. The actual amount of future regulatory assessments will be dependent on several factors, including: (i) the Bank’s average total assets and average tangible equity; (ii) the Bank’s risk profile; and (iii) whether additional special assessments are imposed in future periods and the manner in which such assessments are determined. The increase in regulatory assessments in 2016 compared to 2015 primarily reflects an increase in the Bank’s average total assets over this period, a $2.4 million benefit recognized in 2015 from the overpayment of FDIC assessments in prior periods, as well as a change in deposit insurance assessments discussed below.
In March 2016, the FDIC issued a final rule that will serve to implement a DFA provision requiring banks with over $10 billion in assets to be responsible for recapitalizing the DIF to 1.35% of insured deposits after it reaches a 1.15% reserve ratio. The rule became effective on July 1, 2016. For banks with over $10 billion in assets, the rule imposes a 4.5 basis point surcharge to bring the DIF’s reserve ratio to 1.35% by the end of 2018. For the surcharge only, the assessment base would be reduced by $10 billion. The Company anticipates the impact of the surcharge may increase regulatory assessment expense by $2.5 million to $3.0 million on an annual basis.
Scheduled amortization expense attributable to other acquisition-related intangible assets for each of the next five years is as follows: $24.7 million in 2017; $13.2 million in 2018; $12.4 million in 2019; $12.0 million in 2020; and $11.7 million in 2021.
Included in other non-interest expense in 2015 and 2014 are expenses totaling $10.5 million and $6.2 million, respectively, relating to charges associated with the writedowns of certain banking house assets and related lease termination costs (none in 2016).
Income Taxes
Income tax expense totaled $128.5 million, $130.4 million and $128.9 million for the years ended December 31, 2016, 2015 and 2014, respectively. People’s United’s effective income tax rate was 31.4%, 33.4% and 33.9% for the respective years. Income tax expense in 2016 includes $5.3 million of federal income tax credits, which relate, primarily, to an increase in tax-advantaged investments (see below). People’s United’s effective income tax rate for 2017 is expected to be approximately 32%.
Differences, if any, arising between People’s United’s effective income tax rate and the U.S. federal statutory rate of 35% are generally attributable to: (i) tax-exempt interest earned on certain investments; (ii) tax-exempt income from BOLI; and (iii) state income taxes.
People’s United holds ownership interests in limited partnerships formed to develop and operate affordable housing units for lower income tenants throughout its franchise area. The underlying partnerships, which are considered variable interest entities, are not consolidated into the Company’s Consolidated Financial Statements. These investments have historically played a role in enabling the Bank to meet its CRA requirements while, at the same time, providing tax benefits, including federal income tax credits. The cost of the Company’s investments is amortized on a straight-line basis over the period during which the related federal income tax credits are realized (generally ten years). Amortization expense, which is now included as a component of income tax expense, totaled $12.6 million, $12.6 million and $10.7 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Income tax expense for all three years reflects the state tax benefit resulting from the formation of People’s Mortgage Investment Company, a wholly owned subsidiary of the Bank. The formation of this subsidiary was a result of Connecticut tax legislation, which became effective on January 1, 1999, that allows for the transfer of mortgage loans to a passive investment subsidiary. The related earnings of the subsidiary, and any dividends it pays to the parent, are not subject to Connecticut income tax. See Note 12 to the Consolidated Financial Statements for additional information concerning income tax expense.
Securities
People’s United strives to maintain an appropriate balance between loan portfolio growth and deposit funding. The Company’s management believes that a large securities portfolio funded with wholesale borrowings provides limited economic value and therefore, at December 31, 2016, the securities portfolio only comprised 16% of total assets.
People’s United has historically utilized the securities portfolio for earnings generation (in the form of interest and dividend income), liquidity, IRR management, asset diversification and tax planning. Securities available for sale are used as part of People’s United’s asset/liability management strategy and may be sold in response to, or in anticipation of, factors such as changes in market conditions and interest rates, changes in security prepayment rates, liquidity considerations and regulatory capital requirements.
The Company invests in debt securities rated in the highest categories assigned by nationally recognized statistical ratings organizations (“NRSRO”) and all credit risk undergoes an internal creditworthiness assessment separate from NRSRO ratings. Management has internal guidelines for the credit quality and duration of People’s United’s debt securities portfolio and monitors these on a regular basis.
At December 31, 2016, the fair value of People’s United’s securities available for sale portfolio totaled $4.41 billion, or 11% of total assets, compared to $4.53 billion, or 12% of total assets, at December 31, 2015 and $3.99 billion, or 11% of total assets, at December 31, 2014. The decrease in the fair value of the securities available for sale in 2016 compared to 2015 primarily reflects: (i) principal repayments and maturities of GSE mortgage-backed securities and CMOs; (ii) the sale of low-yielding and short maturity U.S. Treasury and CMO securities in the quarter ended December 31, 2016; (iii) an increase in the unrealized loss on debt securities; and (iv) purchases of U.S. Treasury securities. The increase in the fair value of the securities available for sale in 2015 compared to 2014 primarily reflects net purchases of GSE mortgage-backed securities and U.S. Treasury and agency securities, partially offset by an increase in the unrealized loss on debt securities. The increases in investment grade state and municipal securities in both 2016 and 2015 reflects the Company’s continued investment in such securities based on their value relative to other securities of comparable duration, yield and credit risk.
At December 31, 2016, 2015 and 2014, the amortized cost exceeded the fair value of the securities available for sale portfolio by $53.3 million, $27.5 million and $6.4 million, respectively.
All unrealized gains and those unrealized losses representing temporary declines in value due to factors other than credit are recorded in stockholders’ equity, net of income taxes. As a result, management anticipates continued fluctuations in stockholders’ equity due to changes in the fair value of these securities, albeit on a relatively modest scale due to the duration of the portfolio. The duration of the debt securities portfolio was approximately 4.7 years, 4.2 years and 4.1 years at December 31, 2016, 2015 and 2014, respectively.
In addition to the held to maturity and available for sale securities discussed above, the Bank holds shares of capital stock in both the FHLB of Boston and New York and the FRB-NY. Dividend income on FHLB capital stock totaled $5.8 million, $4.6 million and $2.8 million for the years ended December 31, 2016, 2015 and 2014, respectively. Dividend income on FRB-NY capital stock totaled $3.1 million for the year ended December 31, 2016 and $7.1 million for approximately 10 months in 2015. On February 18, 2016, the FRB issued an interim final rule, which serves to implement a reduction in the dividend rate paid on Federal Reserve Bank capital stock from an annual fixed-rate of 6% to the lesser of 6% or a rate based on 10-year Treasury notes, for those banks with total assets greater than $10 billion, including the Bank. The Company estimates that dividend income from FRB-NY capital stock may be reduced by approximately $5 million on an annual basis.
Lending Activities
People’s United conducts its lending activities principally through its Commercial Banking and Retail Banking operating segments. The Company’s lending activities consist of originating loans secured by commercial and residential properties, and extending secured and unsecured loans to commercial and consumer customers.
Total loans increased $1.33 billion in 2016 compared to 2015 and increased $1.82 billion in 2015 compared to 2014. Loans acquired in connection with business combinations are referred to as ‘acquired’ loans as a result of the manner in which they are accounted for (see further discussion under ‘Acquired Loans’ in Note 1 to the Consolidated Financial Statements). All other loans are referred to as ‘originated’ loans. At December 31, 2016, 2015 and 2014, the carrying amount of the acquired loan portfolio totaled $610.2 million, $796.6 million, and $1.05 billion, respectively.
The following table summarizes the loan portfolio before deducting the allowance for loan losses:
People’s United’s loan portfolio is primarily concentrated within New England with 59% of the total loan portfolio representing loans to customers located within the New England states at both December 31, 2016 and 2015, and 19% and 20% represents loans to customers located in New York at those dates, respectively.
Total Loans
As of December 31 (dollars in millions)
Contractual Maturity and Interest Rate Sensitivity
The following table presents the contractual maturity of total loans as of December 31, 2016:
The following table presents, as of December 31, 2016, loan amounts due after December 31, 2017, and whether these loans have adjustable or fixed interest rates:
The following tables set forth the contractual maturity (based on final payment date) and interest rate sensitivity (based on next repricing date) of People’s United’s commercial and industrial loans and construction loans:
Commercial Portfolio
The commercial lending businesses include commercial real estate, commercial and industrial lending, and equipment financing.
Commercial Real Estate
People’s United manages the commercial real estate portfolio by limiting the concentration in any particular loan type, term, industry, or to any individual borrower. People’s United’s highest loan concentration in the commercial real estate loan portfolio is in the residential (multi-family) sector, which represented 37% of this loan portfolio at December 31, 2016.
Commercial Real Estate Portfolio
As of December 31 (dollars in millions)
The commercial real estate portfolio increased $219 million in 2016 compared to 2015, reflecting originated loan growth of $316 million, or 3% of the commercial real estate portfolio, partially offset by run-off in the acquired portfolio. The commercial real estate portfolio increased $625 million in 2015 compared to 2014, reflecting originated loan growth of $737 million, or 8% of the commercial real estate portfolio, partially offset by run-off in the acquired portfolio. Included in the commercial real estate portfolio are construction loans totaling $604 million and $631 million at December 31, 2016 and 2015, respectively, net of the unadvanced portion of such loan totaling $243 million and $314 million, respectively. During 2015, the Company sold acquired loans with outstanding principal balances of $24.1 million (carrying amounts of $22.3 million) and recognized net gains on sales totaling $1.7 million (none in 2016).
At December 31, 2016 and 2015, 35% and 36%, respectively, of People’s United’s commercial real estate portfolio was secured by properties located in New York, and 19% was secured by properties located in Connecticut in both years. In addition, 26% of the commercial real estate portfolio was secured by properties located in Massachusetts, Vermont and New Hampshire at both December 31, 2016 and 2015. No other state exposure was greater than 6% at December 31, 2016.
Commercial real estate is dependent on the successful operation of the related income-producing real estate. Accordingly, the income streams generated by this portfolio can be impacted by changes in the real estate market and, to a large extent, the New England and southeastern New York economies. People’s United continues to focus on maintaining strong asset quality standards in a competitive market generally characterized by aggressive pricing and less attractive underwriting terms. The growth and performance of this portfolio is largely dependent on the economic environment and may be adversely impacted if the economy weakens in the future.
Commercial Real Estate Diversification by Property Type
As of December 31, 2016 (percent)
Commercial and Industrial
People’s United provides diversified products and services to its commercial customers, including short-term working capital credit facilities, term financing, asset-based loans, letters of credit, cash management services and commercial deposit accounts.
Commercial and Industrial Portfolio
As of December 31 (dollars in millions)
Commercial products are generally packaged together to create a financing solution specifically tailored to the needs of the customer. Taking a total relationship-focused approach with commercial customers to meet their financing needs has resulted in substantial growth in non-interest-bearing deposits over time, as well as in opportunities to provide other banking services to principals and employees of these commercial customers.
The borrower’s ability to repay a commercial loan is closely tied to the ongoing profitability and cash flow of the borrower’s business. Consequently, a commercial loan tends to be more directly impacted by changes in economic cycles that affect businesses generally and the borrower’s business specifically. The availability of adequate collateral is a factor in commercial loan decisions and loans are generally collateralized and/or guaranteed by third parties.
In 2016, the commercial and industrial portfolio increased $376 million compared to 2015, reflecting originated loan growth of $413 million, or 5% of the commercial and industrial portfolio, partially offset by run-off in the acquired portfolio. In 2015, the commercial and industrial portfolio increased $559 million compared to 2014, reflecting originated loan growth of $635 million, or 9% of the commercial and industrial portfolio, partially offset by run-off in the acquired portfolio.
At December 31, 2016 and 2015, the commercial and industrial portfolio included $596 million and $526 million, respectively, of asset-based lending loans, of which 81% were to customers located within the Company’s geographic footprint at December 31, 2016. The commercial and industrial portfolio also includes $1.1 billion of mortgage warehouse loans at December 31, 2016, compared to $963 million at December 31, 2015. Such loans represent lines of credit extended to a loan originator to fund a mortgage that a borrower initially used to purchase a property. The extension of credit generally lasts from the loan’s point of origination to the point when the mortgage is sold into the secondary market. At December 31, 2016, 12% of the mortgage warehouse loans were to customers located within the Company’s footprint.
At both December 31, 2016 and 2015, 22% of the commercial and industrial loan portfolio consisted of loans to Connecticut-based businesses. Commercial and industrial loan exposure in the states of Vermont, Massachusetts and New Hampshire totaled a combined 38% and 39% at December 31, 2016 and 2015, respectively. No other state exposure was greater than 15%. While People’s United continues to focus on asset quality, the performance of the commercial lending and industrial portfolio may be adversely impacted if the economy weakens in the future.
Commercial and Industrial Diversification by Industry
As of December 31, 2016 (percent)
Equipment Financing
PCLC and PUEFC provide equipment financing for customers in all 50 states, specializing in financing for the: transportation/utility; real estate, rental and leasing; construction; and printing industries. PCLC will buy or sell portions of financing transactions in the secondary market to manage the concentration risk of its overall portfolio. In addition, PCLC provides customers with the option to lease equipment. Substantially the entire equipment financing portfolio (96% and 97% at December 31, 2016 and 2015, respectively) was to customers located outside of New England. At December 31, 2016, 29% of the equipment financing portfolio consisted of loans to customers located in Texas, California and New York, and no other state exposure was greater than 5%.
Equipment Financing Portfolio
As of December 31 (dollars in millions)
The equipment financing portfolio increased $59 million in 2016 compared to 2015, reflecting originated loan growth of $63 million, or 2% of the equipment and financing portfolio, partially offset by run-off in the PUEFC acquired loan portfolio. Operating on a national scale, equipment financing represented 14% of the commercial portfolio at both December 31, 2016 and 2015. While People’s United continues to focus on asset quality, the performance of the equipment financing portfolio may be adversely impacted if the national economy weakens in the future.
Equipment Financing Diversification by Industry
As of December 31, 2016 (percent)
Retail Portfolio
Residential Mortgage Lending
People’s United offers its customers a wide range of residential mortgage loan products. These include conventional fixed-rate loans, jumbo fixed-rate loans (loans with principal balances greater than established Freddie Mac and Fannie Mae limits), adjustable-rate loans, sometimes referred to as ARM loans, interest-only loans (loans where payments made by the borrower consist of only interest for a set period of time, before the payments change to principal and interest), as well as Federal Housing Administration insured loans and various state housing finance authority loans. People’s United originates these loans through its network of retail branches and calling officers, as well as correspondent lenders and mortgage brokers.
At December 31, 2016 and 2015, 82% and 86%, respectively, of the residential mortgage loan portfolio was secured by properties located in New England. At December 31, 2016, the residential mortgage loan portfolio included $1.2 billion of interest-only loans, compared to $1.1 billion at December 31, 2015. See Asset Quality for further discussion of interest-only loans. Also included in residential mortgage loans at December 31, 2016 and 2015 are construction loans totaling $84 million and $106 million, respectively.
People’s United’s residential mortgage originations totaled $2.3 billion in 2016, $2.0 billion in 2015 and $1.6 billion in 2014. The mix and volume of residential mortgage loan originations vary in response to changes in market interest rates and customer preferences. Adjustable-rate residential mortgage loans accounted for 75% of total residential mortgage originations in 2016, compared to 69% in 2015 and 74% in 2014.
Residential Mortgage Originations
Years ended December 31 (dollars in millions)
In 2016, adjustable-rate residential mortgage loans increased $698 million compared to 2015, reflecting originated loan growth of $721 million, or 15% of adjustable-rate residential mortgage loans, partially offset by run-off in the acquired portfolio. In 2015, adjustable-rate residential mortgage loans increased $457 million compared to 2014, reflecting originated loan growth of $479 million, or 11% of adjustable-rate residential mortgage loans, partially offset by run-off in the acquired portfolio. Fixed-rate residential mortgage loans increased $62 million in 2016 compared to 2015 and $68 million in 2015 compared to 2014. The Company currently retains in its portfolio most of its originated adjustable-rate and certain fixed-rate residential mortgage loans.
Residential Mortgage Originations by Product
Year ended December 31, 2016 (percent)
People’s United’s loan loss experience within the residential mortgage portfolio continues to be primarily attributable to a small number of loans. The continued performance of the residential mortgage loan portfolio in the future may be adversely impacted by the level and direction of interest rates, consumer preferences and the regional economy.
Home Equity and Other Consumer Lending
People’s United offers home equity lines of credit (“HELOCs”) and home equity loans, and to a lesser extent, other forms of installment and revolving credit loans. At December 31, 2016, 87% of the consumer loan portfolio was to customers located within the New England states. Future growth of People’s United’s home equity and other consumer loan portfolio is highly dependent upon economic conditions, the interest rate environment and competitors’ strategies.
Asset Quality
Recent Trends
While People’s United continues to adhere to prudent underwriting standards, the loan portfolio is not immune to potential negative consequences arising as a result of general economic weakness and, in particular, a prolonged downturn in the housing market on a national scale as was experienced for much of the period from 2008 to 2012. Decreases in real estate values could adversely affect the value of property used as collateral for loans. In addition, adverse changes in the economy could have a negative effect on the ability of borrowers to make scheduled loan payments, which would likely have an adverse impact on earnings. Further, an increase in loan delinquencies may serve to decrease interest income and adversely impact loan loss experience, resulting in an increased provision and allowance for loan losses.
People’s United actively manages asset quality through its underwriting practices and collection operations. Underwriting practices tend to focus on optimizing the return of a given risk classification while collection operations focus on minimizing losses once an account becomes delinquent. People’s United attempts to minimize losses associated with commercial loans by requiring borrowers to pledge adequate collateral and/or provide for third-party guarantees. Loss mitigation within the residential mortgage loan portfolio is highly dependent on the value of the underlying real estate.
Over the past few years, People’s United experienced an increase in the number of loan modification requests. Certain originated loans whose terms have been modified are considered troubled debt restructurings (“TDRs”). Acquired loans that are modified are not considered for TDR classification provided they are evaluated for impairment on a pool basis. Originated loans are considered TDRs if the borrower is experiencing financial difficulty and is afforded a concession by People’s United, such as, but not limited to: (i) payment deferral; (ii) a reduction of the stated interest rate for the remaining contractual life of the loan; (iii) an extension of the loan’s original contractual term at a stated interest rate lower than the current market rate for a new loan with similar risk; (iv) capitalization of interest; or (v) forgiveness of principal or interest.
OCC guidance requires that loans subject to a borrower’s discharge from personal liability following a Chapter 7 bankruptcy be treated as TDRs, included in non-performing loans and written down to the estimated collateral value, regardless of delinquency status. Included in TDRs at December 31, 2016 are $22.5 million of such loans. Of this amount, $14.8 million, or 65%, were less than 90 days past due on their payments as of that date.
TDRs may either be accruing or placed on non-accrual status (and reported as non-performing loans) depending upon the loan’s specific circumstances, including the nature and extent of the related modifications. TDRs on non-accrual status remain classified as such until the loan qualifies for return to accrual status. Loans qualify for return to accrual status once they have demonstrated performance with the restructured terms of the loan agreement for a minimum of six months in the case of a commercial loan or, in the case of a retail loan, when the loan is less than 90 days past due. Loans may continue to be reported as TDRs after they are returned to accrual status.
During 2016, we performed 91 loan modifications that were not classified as TDRs. The balances of the loans at the time of the respective modifications totaled $153.2 million. In each case, we concluded that the modification did not result in the granting of a concession based on one or more of the following considerations: (i) the receipt of additional collateral (the nature and amount of which was deemed to serve as adequate compensation for other terms of the restructuring) and/or guarantees; (ii) the borrower having access to funds at a market rate for debt with similar risk characteristics as the restructured debt; and (iii) the restructuring resulting in a delay in payment that is insignificant in relation to the other terms of the obligation. See Note 5 to the Consolidated Financial Statements for additional disclosures relating to TDRs.
Portfolio Risk Elements-Residential Mortgage Lending
People’s United does not actively engage in subprime mortgage lending that has, historically, been the riskiest sector of the residential housing market. People’s United has virtually no exposure to subprime loans, or to similarly high-risk Alt-A loans and structured investment vehicles. While no standard definition of “subprime” exists within the industry, the Company has generally defined subprime as borrowers with credit scores of 660 or less, either at or subsequent to origination.
At December 31, 2016, the loan portfolio included $1.2 billion of interest-only residential mortgage loans. People’s United began originating interest-only residential mortgage loans in March 2003. The underwriting guidelines and requirements for such loans are generally more restrictive than those applied to other types of residential mortgage loans. People’s United has not originated interest-only residential mortgage loans that permit negative amortization or optional payment amounts. Amortization of an interest-only residential mortgage loan begins after the initial interest rate changes (e.g. after 5 years for a 5/1 adjustable-rate mortgage). In general, People’s United’s underwriting guidelines for residential mortgage loans require the following: (i) properties must be single-family and owner-occupied primary residences; (ii) lower loan-to-value (“LTV”) ratios (less than 60% on average); (iii) higher credit scores (greater than 700 on average); and (iv) sufficient post-closing reserves.
Updated estimates of property values are obtained from an independent third-party for residential mortgage loans 90 days past due. At December 31, 2016, non-performing residential mortgage loans totaling $0.6 million had current LTV ratios of more than 100%. At December 31, 2016, the weighted average LTV ratio and FICO score for the residential mortgage loan portfolio were 63% and 756, respectively.
The Company continues to monitor its foreclosure policies and procedures to ensure ongoing compliance with applicable industry standards. We believe that our established procedures for reviewing foreclosure affidavits and validating information contained in related loan documentation are sound and consistently applied, and that our foreclosure affidavits are accurate. As a result, People’s United has not found it necessary to interrupt or suspend foreclosure proceedings. We have also considered the effect of representations and warranties that we made to third-party investors in connection with whole loan sales, and believe our representations and warranties were true and correct and do not expose the Company to any material loss.
During 2016, the Company repurchased from GSEs and other parties two residential mortgage loans that we had previously sold to the GSEs and other parties. The balances of the loans at the time of the repurchase totaled $0.6 million and related fees and expenses incurred totaled less than $0.1 million. During that same time period, the Company issued seven investor refunds, totaling less than $0.1 million, under contractual recourse agreements. Based on the limited number of repurchase requests the Company has historically received, the immaterial cost associated with such repurchase requests and management’s view that this past experience is consistent with our current and near-term estimate of such exposure, the Company has established a reserve for such repurchase requests, which totaled $0.2 million as of December 31, 2016.
The aforementioned foreclosure issues and the potential for additional legal and regulatory action could impact future foreclosure activities, including lengthening the time required for residential mortgage lenders, including the Bank, to initiate and complete the foreclosure process. In recent years, foreclosure timelines have increased as a result of, among other reasons: (i) delays associated with the significant increase in the number of foreclosure cases as a result of current economic conditions; (ii) additional consumer protection initiatives related to the foreclosure process; and (iii) voluntary and/or mandatory programs intended to permit or require lenders to consider loan modifications or other alternatives to foreclosure. Further increases in the foreclosure timeline may have an adverse effect on collateral values and our ability to minimize losses.
Portfolio Risk Elements-Home Equity Lending
The majority of our HELOCs have an initial draw period of 9 1/2 years followed by a 20-year repayment phase. During the initial draw period, interest-only payments are required, after which the disbursed balance is fully amortized over a 20-year repayment term. HELOCs carry variable rates indexed to the Prime Rate with a lifetime interest rate ceiling and floor, and are secured by first or second liens on the borrower’s primary residence. The rate used to qualify borrowers is the Prime Rate plus 3.00%, even though the initial rate may be substantially lower. The maximum LTV ratio is 80% on a single-family property, including a condominium, and 70% on a two-family property. Lower LTV ratios are required on larger line amounts. The minimum FICO credit score is 680. The borrower has the ability to convert the entire balance or a portion of the balance to a fixed-rate term loan during the draw period. There is a limit of three term loans that must be fully amortized over a term not to exceed the original HELOC maturity date.
A smaller portion of our HELOC portfolio has an initial draw period of 10 years with a variable-rate interest-only payment, after which there is a 5-year amortization period. An additional small portion of our HELOC portfolio has a 5-year draw period which, at our discretion, may be renewed for an additional 5-year interest-only draw period.
The following table sets forth, as of December 31, 2016, the committed amount of HELOCs scheduled to have the draw period end during the years shown:
Approximately 90% of our HELOCs are presently in their draw period. Although converted amortizing payment loans represent only a small portion of the portfolio, our default and delinquency statistics indicate a higher level of occurrence for such loans when compared to HELOCs that are still in the draw period.
Delinquency statistics for the HELOC portfolio as of December 31, 2016 are as follows:
For the three months ended December 31, 2016, 38% of our borrowers with balances outstanding under HELOCs paid only the minimum amount due.
The majority of home equity loans fully amortize over terms ranging from 5 to 20 years. Home equity loans are limited to first or second liens on a borrower’s primary residence. The maximum LTV ratio is 80% on a single-family property, including a condominium, and 70% on a two-family property. Lower LTV ratios are required on larger line amounts.
We are not able, at this time, to develop statistics for the entire home equity portfolio (both HELOCs and home equity loans) with respect to first liens serviced by third parties that have priority over our junior liens, as lien position data has not historically been captured on our loan servicing systems. As of December 31, 2016, full and complete first lien position data was not readily available for 31% of the home equity portfolio. Effective January 2011, we began tracking lien position data for all new originations and our collections department continues to add lien position data once a loan reaches 75 days past due in connection with our updated assessment of combined loan-to-value (“CLTV”) exposure, which takes place for loans 90 days past due. In addition, when we are notified that the holder of a superior lien has commenced a foreclosure action, our home equity account is identified in the collections system for ongoing monitoring of the legal action. As of December 31, 2016, the portion of the home equity portfolio more than 90 days past due with a CLTV greater than 80% was $4.2 million.
As of December 31, 2016, full and complete first lien position data was readily available for 69%, or $1.4 billion, of the home equity portfolio. Of that total, 39%, or $546.9 million, are in a junior lien position. We estimate that of those junior liens, 35%, or $191.4 million, are held or serviced by others.
When the first lien is held by a third party, we can, in some cases, obtain an indication that a first lien is in default through information reported to credit bureaus. However, because more than one mortgage may be reported in a borrower’s credit report and there may not be a corresponding property address associated with reported mortgages, we are often unable to associate a specific first lien with our junior lien. As of December 31, 2016, there were 21 loans totaling $3.6 million for which we have received notification that the holder of a superior lien has commenced foreclosure action. For 15 of the loans (totaling $2.5 million), our second lien position was performing at the time such foreclosure action was commenced. The total estimated loss related to those 15 loans was $0.1 million as of December 31, 2016. It is important to note that the percentage of new home equity originations for which we hold the first lien has increased steadily from approximately 40% in 2009 to approximately 65% as of December 31, 2016.
We believe there are several factors that serve to mitigate the potential risk associated with the limitations on available first lien data. Most importantly, our underwriting guidelines for home equity loans, which have been, and continue to be, consistently applied, generally require the following: (i) properties located within our geographic footprint; (ii) lower LTV ratios; and (iii) higher credit scores. Notwithstanding the maximum LTV ratios and minimum FICO scores discussed previously, actual LTV ratios at origination were less than 60% on average and current FICO scores of our borrowers are greater than 750 on average. In addition, as of December 31, 2016, 93% of the portfolio balance relates to originations that occurred since 2005, which is generally recognized as the peak of the last housing bubble. We believe these factors are a primary reason for the portfolio’s relatively low level of non-performing loans and net loan charge-offs, both in terms of absolute dollars and as a percentage of average total loans.
Each month, all home equity and second mortgage loans greater than 180 days past due (regardless of our lien position) are analyzed in order to determine the amount by which the balance outstanding (including any amount subject to a first lien) exceeds the underlying collateral value. To the extent a shortfall exists, a charge-off is recognized. This charge-off activity is reflected in our established allowance for loan losses for home equity and second mortgage loans as part of the component attributable to historical portfolio loss experience, which considers losses incurred over the most recent 12-month period. While the limitations on available first lien data could impact the accuracy of our loan loss estimates, we believe that our methodology results in an allowance for loan losses that appropriately estimates the inherent probable losses within the portfolio, including those loans originated prior to January 2011 for which certain lien position data is not available.
As of December 31, 2016, the weighted average CLTV ratio and FICO score for the home equity portfolio were 57% and 759, respectively.
Portfolio Risk Elements-Commercial Real Estate Lending
In general, construction loans originated by People’s United are used to finance improvements to commercial, industrial or residential property. Repayment is typically derived from the sale of the property as a whole, the sale of smaller individual units or by a take-out from a permanent mortgage. The term of the construction period generally does not exceed two years. Loan commitments are based on established construction budgets that represent an estimate of total costs to complete the proposed project, including both hard (direct) costs (building materials, labor, etc.) and soft (indirect) costs (legal and architectural fees, etc.). In addition, project costs may include an appropriate level of interest reserve to carry the project through to completion. If established, such interest reserves are determined based on: (i) a percentage of the committed loan amount; (ii) the loan term; and (iii) the applicable interest rate. Regardless of whether a loan contains an interest reserve, the total project cost statement serves as the basis for underwriting and determining which items will be funded by the loan and which items will be funded through borrower equity.
Construction loans are funded, at the request of the borrower, not more than once per month, based on the extent of work completed, and are monitored, throughout the life of the project, by an independent professional construction engineer and the Company’s commercial real estate lending department. Interest is advanced to the borrower upon request, based on the progress of the project toward completion. The amount of interest advanced is added to the total outstanding principal under the loan commitment. Should the project not progress as scheduled, the adequacy of the interest reserve necessary to carry the project through to completion is subject to close monitoring by management. Should the interest reserve be deemed to be inadequate, the borrower is required to fund the deficiency. Similarly, once a loan is fully funded, the borrower is required to fund all interest payments.
People’s United’s construction loan portfolio totaled $604.1 million (2% of total loans) at December 31, 2016. The total committed amount at that date, including both the outstanding balance and the unadvanced portion of such loans, was $847.2 million. In some cases, a portion of the total committed amount includes an accompanying interest reserve. At December 31, 2016, construction loans totaling $272.5 million had remaining available interest reserves of $18.6 million. At that date, the Company had no construction loans with interest reserves that were on non-accrual status and included in non-performing loans.
Recent economic conditions have resulted in an increase in the number of extension requests for commercial real estate and construction loans, some of which have related repayment guarantees. Modifications of originated commercial real estate loans involving maturity extensions are evaluated according to the Company’s normal underwriting standards and are classified as TDRs if the borrower is experiencing financial difficulty and is afforded a concession by People’s United similar to those discussed previously. People’s United had $8.9 million of restructured construction loans at December 31, 2016.
An extension may be granted to allow for the completion of the project, marketing or sales of completed units, or to provide for permanent financing, and is based on a re-underwriting of the loan and management’s assessment of the borrower’s ability to perform according to the agreed-upon terms. Typically, at the time of an extension, borrowers are performing in accordance with contractual loan terms. Extension terms generally do not exceed 12 to 18 months and typically require that the borrower provide additional economic support in the form of partial repayment, additional collateral or guarantees. In cases where the fair value of the collateral or the financial resources of the borrower are deemed insufficient to repay the loan, reliance may be placed on the support of a guarantee, if applicable. However, such guarantees are never considered the sole source of repayment.
People’s United evaluates the financial condition of guarantors based on the most current financial information available. Most often, such information takes the form of (i) personal financial statements of net worth, cash flow statements and tax returns (for individual guarantors) and (ii) financial and operating statements, tax returns and financial projections (for legal entity guarantors). The Company’s evaluation is primarily focused on various key financial metrics, including net worth, leverage ratios and liquidity. It is the Company’s policy to update such information annually, or more frequently as warranted, over the life of the loan.
While People’s United does not specifically track the frequency with which it has pursued guarantor performance under a guarantee, the Company’s underwriting process, both at origination and upon extension, as applicable, includes an assessment of the guarantor’s reputation, creditworthiness and willingness to perform. Historically, when the Company has found it necessary to seek performance under a guarantee, it has been able to effectively mitigate its losses.
In considering the impairment status of such loans, an evaluation is made of the collateral and future cash flow of the borrower as well as the anticipated support of any repayment guarantor. In the event that the guarantor is unwilling or unable to perform, a legal remedy is pursued. When performance under the loan terms is deemed to be uncertain, including performance of the guarantor, all or a portion of the loan may be charged-off, typically based on the fair value of the collateral securing the loan.
Allowance and Provision for Loan Losses
The allowance for loan losses is established through provisions for loan losses charged to income. Losses on loans, including impaired loans, are charged to the allowance for loan losses when all or a portion of a loan is deemed to be uncollectible. Recoveries of loans previously charged off are credited to the allowance for loan losses when realized.
People’s United maintains the allowance for loan losses at a level that is deemed to be appropriate to absorb probable losses inherent in the respective loan portfolios, based on a quarterly evaluation of a variety of factors. These factors include, but are not limited to: (i) People’s United’s historical loan loss experience and recent trends in that experience; (ii) risk ratings assigned by lending personnel to commercial real estate loans, commercial and industrial loans, and equipment financing loans, and the results of ongoing reviews of those ratings by People’s United’s independent loan review function; (iii) an evaluation of delinquent and non-performing loans and related collateral values; (iv) the probability of loss in view of geographic and industry concentrations and other portfolio risk characteristics; (v) the present financial condition of borrowers; and (vi) current economic conditions.
For a more detailed discussion of the Company’s allowance for loan losses methodology and related policies, see Note 1 to the Consolidated Financial Statements.
Acquired loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that all contractually required payments will not be collected are initially recorded at fair value without recording an allowance for loan losses. Fair value of the loans is determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected, as adjusted for an estimate of future credit losses and prepayments, and then applying a market-based discount rate to those cash flows. Acquired loans are generally accounted for on a pool basis, with pools formed based on the loans’ common risk characteristics, such as loan collateral type and accrual status. Each pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows.
Under the accounting model for acquired loans, the excess of cash flows expected to be collected over the carrying amount of the loans, referred to as the “accretable yield”, is accreted into interest income over the life of the loans in each pool using the effective yield method. Accordingly, acquired loans are not subject to classification as non-accrual in the same manner as originated loans. Rather, acquired loans are considered to be accruing loans because their interest income relates to the accretable yield recognized at the pool level and not to contractual interest payments at the loan level. The difference between contractually required principal and interest payments and the cash flows expected to be collected, referred to as the “nonaccretable difference”, includes estimates of both the impact of prepayments and future credit losses expected to be incurred over the life of the loans in each pool. As such, charge-offs on acquired loans are first applied to the nonaccretable difference and then to any allowance for loan losses recognized subsequent to acquisition. A decrease in expected cash flows in subsequent periods may indicate that the loan pool is impaired, which would require the establishment of an allowance for loan losses by a charge to the provision for loan losses. At December 31, 2016 and 2015, the allowance for loan losses on acquired loans was $6.3 million and $8.1 million, respectively.
Selected asset quality metrics presented below distinguish between the ‘originated’ portfolio and the ‘acquired’ portfolio. All loans acquired in connection with acquisitions comprise the acquired loan portfolio; all other loans of the Company comprise the originated portfolio, including originations subsequent to the respective acquisition dates.
The following table presents the activity in the allowance for loan losses and ratios:
The provision for loan losses on originated loans totaled $37.0 million in 2016, reflecting net loan charge-offs of $16.9 million and an increase in the originated allowance for loan losses in response to portfolio-specific risk factors and loan growth. The provision for loan losses on originated loans totaled $35.5 million in 2015, reflecting net loan charge-offs of $20.7 million and an increase in the originated allowance for loan losses in response to growth in both the commercial and residential mortgage loan portfolios. The originated allowance for loan losses as a percentage of originated loans was 0.77% at December 31, 2016 and 0.73% at December 31, 2015.
The provision for loan losses on acquired loans in 2016 reflects net loan charge-offs of $1.4 million and an allowance reversal, while the provision for loan losses on acquired loans in the year-ago period reflects an allowance reversal.
Loan Charge-Offs
The Company’s charge-off policies, which comply with standards established by banking regulators, are consistently applied from period to period. Charge-offs are recorded on a monthly basis. Partially charged-off loans continue to be evaluated on a monthly basis and additional charge-offs or loan loss provisions may be recorded on the remaining loan balance based on the same criteria.
For unsecured consumer loans, charge-offs are generally recorded when the loan is deemed to be uncollectible or 120 days past due, whichever occurs first. For consumer loans secured by real estate, including residential mortgage loans, charge-offs are generally recorded when the loan is deemed to be uncollectible or 180 days past due, whichever occurs first, unless it can be clearly demonstrated that repayment will occur regardless of the delinquency status. Factors that demonstrate an ability to repay may include: (i) a loan that is secured by adequate collateral and is in the process of collection; (ii) a loan supported by a valid guarantee or insurance; or (iii) a loan supported by a valid claim against a solvent estate.
For commercial loans, a charge-off is recorded when the Company determines that it will not collect all amounts contractually due based on the fair value of the collateral less cost to sell, or the present value of expected future cash flows.
The decision whether to charge-off all or a portion of a loan rather than to record a specific or general loss allowance is based on an assessment of all available information that aids in determining the loan’s net realizable value. Typically this involves consideration of both (i) the fair value of any collateral securing the loan, including whether the estimate of fair value has been derived from an appraisal or other market information and (ii) other factors affecting the likelihood of repayment, including the existence of guarantees and insurance. If the amount by which the Company’s recorded investment in the loan exceeds its net realizable value is deemed to be a confirmed loss, a charge-off is recorded. Otherwise, a specific or general reserve is established, as applicable. The comparatively low level of net loan charge-offs in recent years, in terms of absolute dollars and as a percentage of average total loans, may not be sustainable in the future.
The following table summarizes net loan charge-offs by loan portfolio class and total net loan charge-offs to total average loans:
The following table presents, by class of loan, the allocation of the allowance for loan losses on originated loans and the percent of loans in each class to total loans:
The allocation of the allowance for loan losses on originated loans at December 31, 2016 reflects management’s assessment of credit risk and probable loss within each portfolio. This assessment is based on a variety of internal and external factors including, but not limited to, the likelihood and severity of loss, portfolio growth and related risk characteristics, and current economic conditions. With respect to the originated portfolio, an allocation of a portion of the allowance to one loan segment does not preclude its availability to absorb losses in another loan segment. Management believes that the level of the allowance for loan losses at December 31, 2016 is appropriate to cover probable losses.
Non-Performing Assets
A loan is generally considered “non-performing” when it is placed on non-accrual status. A loan is generally placed on non-accrual status when it becomes 90 days past due as to interest or principal payments. Past due status is based on the contractual payment terms of the loan. A loan may be placed on non-accrual status before it reaches 90 days past due if such loan has been identified as presenting uncertainty with respect to the collectability of interest and principal. A loan past due 90 days or more may remain on accruing status if such loan is both well secured and in the process of collection.
All previously accrued but unpaid interest on non-accrual loans is reversed from interest income in the period in which the accrual of interest is discontinued. Interest payments received on non-accrual loans (including impaired loans) are generally applied as a reduction of principal if future collections are doubtful, although such interest payments may be recognized as income. A loan remains on non-accrual status until the factors that indicated doubtful collectability no longer exist or until a loan is determined to be uncollectible and is charged off against the allowance for loan losses. There were no loans past due 90 days or more and still accruing interest at December 31, 2016 or 2015.
People’s United’s non-performing assets are summarized as follows:
(1) Reported net of government guarantees totaling $13.1 million, $16.9 million, $17.6 million, $19.4 million and $9.7 million at December 31, 2016, 2015, 2014, 2013 and 2012, respectively. These government guarantees relate, almost entirely, to guarantees provided by the Small Business Administration as well as selected other Federal agencies and represent the carrying value of the loans that are covered by such guarantees, the extent of which (i.e. full or partial) varies by loan. At December 31, 2016, the principal loan classes to which these government guarantees relate are commercial and industrial loans (99%) and commercial real estate loans (1%).
The table above excludes acquired loans that are (i) accounted for as purchased credit impaired loans or (ii) covered by an FDIC loss-share agreement (“LSA”) totaling: $21.6 million and $3.1 million, respectively, at December 31, 2016; $27.7 million and $2.3 million, respectively, at December 31, 2015; $100.6 million and $3.0 million, respectively, at December 31, 2014; $138.0 million and $4.5 million, respectively, at December 31, 2013; $173.6 million and $8.0 million, respectively, at December 31, 2012. Such loans otherwise meet People’s United’s definition of a non-performing loan but are excluded because the loans are included in loan pools that are considered performing and/or credit losses are covered by an FDIC LSA. The discounts arising from recording these loans at fair value were due, in part, to credit quality. The acquired loans are generally accounted for on a pool basis and the accretable yield on the pools is being recognized as interest income over the life of the loans based on expected cash flows at the pool level.
Total non-performing assets decreased $14.2 million from December 31, 2015 and equaled 0.57% of originated loans, REO and repossessed assets at December 31, 2016. The decrease in total non-performing assets from December 31, 2015 primarily reflects decreases of $9.8 million in non-performing residential mortgage loans and $7.9 million in non-performing commercial real estate loans, partially offset by an increase of $11.9 million in non-performing equipment financing loans.
All loans and REO acquired in the Butler Bank acquisition are subject to an FDIC LSA, which provides for coverage by the FDIC, up to certain limits, on all such ‘covered assets’. The FDIC is obligated to reimburse the Company for 80% of any future losses on covered assets up to $34 million. The Company will reimburse the FDIC for 80% of recoveries with respect to losses for which the FDIC paid the Company 80% reimbursement under the loss-sharing coverage.
In addition to the originated non-performing loans discussed above, People’s United has also identified $532.0 million in originated potential problem loans at December 31, 2016. Originated potential problem loans represent loans that are currently performing, but for which known information about possible credit deterioration on the part of the related borrowers causes management to have concerns as to the ability of such borrowers to comply with contractual loan repayment terms and which may result in the disclosure of such loans as non-performing at some time in the future. The originated potential problem loans are generally loans that, although performing, have been classified as “substandard” in accordance with People’s United’s loan rating system, which is consistent with guidelines established by banking regulators.
At December 31, 2016, originated potential problem loans consisted of equipment financing loans ($264.9 million), commercial and industrial loans ($201.1 million) and commercial real estate loans ($66.0 million). Such loans are closely monitored by management and have remained in performing status for a variety of reasons including, but not limited to, delinquency status, borrower payment history and fair value of the underlying collateral. Management cannot predict the extent to which economic conditions may worsen or whether other factors may adversely impact the ability of these borrowers to make payments. Accordingly, there can be no assurance that originated potential problem loans will not become 90 days or more past due, be placed on non-accrual status, be restructured, or require additional provisions for loan losses.
The levels of non-performing assets and potential problem loans are expected to fluctuate in response to changing economic and market conditions, and the relative sizes of the respective loan portfolios, along with management’s degree of success in resolving problem assets. While management takes a proactive approach with respect to the identification and resolution of problem loans, the level of non-performing assets may increase in the future.
Off-Balance-Sheet Arrangements
Detailed discussions pertaining to People’s United’s off-balance-sheet arrangements are included in the following sections: Funding, Liquidity, Stockholders’ Equity and Dividends, and Market Risk Management.
Funding
People’s United’s primary funding sources are deposits and stockholders’ equity, which represent 86% of total assets at December 31, 2016. Borrowings and notes and debentures also are available sources of funding.
Deposits
People’s United’s strategy is to focus on increasing deposits by providing a wide range of convenient services to commercial, retail, business and wealth management customers. People’s United provides customers access to their deposits through 387 branches, including 146 full-service Stop & Shop supermarket branches, 593 ATMs, telephone banking and an Internet banking site.
Deposits equaled 74%, 73% and 73% of total assets at December 31, 2016, 2015 and 2014, respectively. Deposits and stockholders’ equity constituted 87%, 86% and 87% of People’s United’s funding base at December 31, 2016, 2015 and 2014, respectively.
The expansion of People’s United’s branch network and its commitment to developing full-service relationships with its customers are integral components of People’s United’s strategy to leverage the success of its supermarket banking initiative, expand market share and continue growing deposits. At December 31, 2016, People’s United’s network of Stop & Shop branches held $4.3 billion in total deposits and deposits in supermarket branches open for more than one year averaged $30 million per store.
Non-interest-bearing deposits are an important source of low-cost funding and fee income for People’s United. In addition, People’s United believes that checking accounts represent one of the core relationships between a financial institution and its customers, and it is from these relationships that cross-selling of other financial services can be achieved. Non-interest-bearing deposits equaled 22%, 22% and 23% of total deposits at December 31, 2016, 2015 and 2014, respectively. Time deposits of $100,000 or more totaled $2.0 billion at December 31, 2016, of which $374 million mature within three months, $359 million mature after three months but within six months, $378 million mature after six months but within one year and $870 million mature after one year. Included in total deposits at December 31, 2016 are $2.6 billion of brokered deposits, comprised of interest-bearing checking ($1.6 billion), money market ($505 million) and time deposits ($541 million). See Note 9 to the Consolidated Financial Statements for additional information concerning deposits.
Total Deposits
As of December 31 (dollars in millions)
The following table presents People’s United’s time deposits by rate category:
The following table presents, by rate category, the remaining period to maturity of time deposits outstanding:
Borrowings
People’s United’s primary source for borrowings are advances from the FHLB of Boston, which provides credit for member institutions within its assigned region, and federal funds purchased, which are typically unsecured overnight loans among banks. Customer repurchase agreements primarily consist of transactions with commercial and municipal customers.
At December 31, 2016, the Bank’s total borrowing capacity from (i) the FHLB of Boston and the FRB-NY for advances and (ii) repurchase agreements was $11.6 billion based on the level of qualifying collateral available for these borrowings. In addition, the Bank had unsecured borrowing capacity of $1.0 billion at that date. FHLB advances are secured by the Bank’s investment in FHLB stock and by a security agreement that requires the Bank to maintain, as collateral, sufficient qualifying assets not otherwise pledged (principally single-family residential mortgage loans, home equity lines of credit and loans, and commercial real estate loans).
At December 31, 2016, total borrowings equaled 10% of total assets, compared to 11% at December 31, 2015 and 10% at December 31, 2014. FHLB advances, federal funds purchased and customer repurchase agreements represented 8%, 2% and 1% of total assets at December 31, 2016, respectively. At December 31, 2016, other borrowings consisted of cash collateral received from institutional counterparties for certain derivative positions. See Note 10 to the Consolidated Financial Statements for additional information concerning borrowings.
Notes and Debentures
Notes and debentures totaled $1.0 billion at December 31, 2016, 2015 and 2014, and equaled 3% of total assets at each respective date. On February 14, 2017, the Company repaid the $125 million 5.80% fixed-rate/floating-rate subordinated notes. Concurrent with the repayment, the interest rate swap designated to these subordinated notes matured. See Notes 11 and 21 to the Consolidated Financial Statements for additional information concerning notes and debentures and interest rate swaps.
Contractual Cash Obligations
The following table is a summary of People’s United’s contractual cash obligations, other than deposit liabilities. Additional information concerning the Company’s contractual cash obligations is included in Notes 9, 10, 11 and 20 to the Consolidated Financial Statements. Purchase obligations included in the table below represent those agreements to purchase goods or services that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transactions. A substantial majority of People’s United’s purchase obligations are renewable on a year-to-year basis. As such, the purchase obligations included in this table only reflect the contractual commitment.
(1) Interest payments on floating-rate borrowings and notes and debentures are not included in the table above as the timing and amount of such payments is uncertain. See Notes 10 and 11 to the Consolidated Financial Statements.
Future contingent commitments totaling $92.5 million at December 31, 2016, related to limited partnership affordable housing investments, are not included in the table above as the timing of the related capital calls cannot be estimated. Similarly, income tax liabilities totaling $2.8 million, including related interest and penalties, are not included in the table above as the timing of their resolution cannot be estimated. See Note 12 to the Consolidated Financial Statements.
Also not included in the table above are expected future net benefit payments related to the Company’s pension and other postretirement plans that are due as follows: $25.5 million in less than one year; $46.1 million in one to three years; $49.0 million in four to five years; and $140.6 million after five years. See Note 17 to the Consolidated Financial Statements.
Liquidity
Liquidity is defined as the ability to generate sufficient cash flows to meet all present and future funding requirements at reasonable costs. Liquidity management addresses both People’s United’s and the Bank’s ability to fund new loans and investments as opportunities arise, to meet customer deposit withdrawals and to repay borrowings and subordinated notes as they mature. People’s United’s, as well as the Bank’s, liquidity positions are monitored daily by management. The Asset and Liability Management Committee (“ALCO”) of the Bank has been authorized by the Board of Directors of People’s United to set guidelines to ensure maintenance of prudent levels of liquidity for People’s United as well as for the Bank. ALCO reports to the Treasury and Finance Committee of the Board of Directors of People’s United.
Asset liquidity is provided by: cash; short-term investments and securities purchased under agreements to resell; proceeds from maturities, principal repayments and sales of securities; and proceeds from scheduled principal collections, prepayments and sales of loans. In addition, certain securities may be used to collateralize borrowings under repurchase agreements. The Consolidated Statements of Cash Flows present data on cash provided by and used in People’s United’s operating, investing and financing activities. At December 31, 2016, People’s United (parent company) liquid assets included $309 million in cash and $75 million in debt securities available for sale while the Bank’s liquid assets included $4.3 billion in debt securities available for sale and $305 million in cash and cash equivalents. Securities available for sale with a fair value of $1.83 billion at December 31, 2016 were pledged as collateral for public deposits and for other purposes.
Liability liquidity is measured by both People’s United’s and the Bank’s ability to obtain deposits and borrowings at cost-effective rates that are diversified with respect to markets and maturities. Deposits, which are considered the most stable source of liability liquidity, totaled $29.9 billion at December 31, 2016 and represented 74% of total funding (the sum of total deposits, total borrowings, notes and debentures, and stockholders’ equity). Borrowings are used to diversify People’s United’s funding mix and to support asset growth. Borrowings and notes and debentures totaled $4.1 billion and $1.0 billion, respectively, at December 31, 2016, representing 10% and 3%, respectively, of total funding at that date.
The Bank’s current available sources of borrowings include: federal funds purchased, advances from the FHLB of Boston and the FRB-NY, and repurchase agreements. At December 31, 2016, the Bank’s total borrowing capacity from (i) the FHLB of Boston and the FRB-NY for advances and (ii) repurchase agreements was $11.6 billion based on the level of qualifying collateral available for these borrowings. In addition, the Bank had unsecured borrowing capacity of $1.0 billion at that date.
Earning Asset Mix
Funding Base
$36.7 billion as of December 31, 2016 (percent)
$40.1 billion as of December 31, 2016 (percent)
At December 31, 2016, the Bank had outstanding commitments to originate loans totaling $1.5 billion and approved, but unused, lines of credit extended to customers totaling $6.3 billion (including $2.1 billion of HELOCs).
The sources of liquidity discussed above are deemed by management to be sufficient to fund outstanding loan commitments and to meet both People’s United’s and the Bank’s other obligations.
Stockholders’ Equity and Dividends
People’s United’s total stockholders’ equity was $5.14 billion at December 31, 2016, a $410.3 million increase from December 31, 2015. This increase primarily reflects net income in 2016 of $281.0 million, net proceeds from the issuance of preferred stock of $244.1 million and net restricted stock and stock option-related transactions in 2016 totaling $105.0 million, partially offset by common dividends paid in 2016 of $205.7 million. As a percentage of total assets, stockholders’ equity was 12.7% at December 31, 2016 compared to 12.2% at December 31, 2015. Tangible common equity as a percentage of tangible assets was 7.2% at both December 31, 2016 and 2015.
On October 31, 2016, People’s United issued 10.0 million shares of fixed-to-floating rate non-cumulative perpetual preferred stock, Series A, with a par value of $0.01 per share and a liquidation preference of $25.00 per share. Proceeds from the issuance are presented in the Consolidated Statements of Condition net of issuance costs totaling $5.9 million. Dividends on the preferred stock are based on the liquidation preference amount and, when and if declared, will be payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year, beginning on December 15, 2016.
People’s United’s total stockholders’ equity was $4.73 billion at December 31, 2015, a $98.5 million increase from December 31, 2014. This increase primarily reflects net income in 2015 of $260.1 million and net restricted stock and stock option-related transactions totaling $43.2 million in 2015, partially offset by dividends paid in 2015 of $201.2 million. Stockholders’ equity equaled 12.2% of total assets at December 31, 2015 compared to 12.9% at December 31, 2014. Tangible common equity equaled 7.2% of tangible assets at December 31, 2015 compared to 7.5% at December 31, 2014.
Common dividends declared and paid per common share totaled $0.6775, $0.6675 and $0.6575 for the years ended December 31, 2016, 2015 and 2014, respectively. People’s United’s common dividend payout ratio (common dividends paid as a percentage of net income available to common shareholders) for the years ended December 31, 2016, 2015 and 2014 was 73.7%, 77.3% and 78.2%, respectively. The Company’s Board of Directors declared a quarterly dividend on its common stock of $0.17 per share in January 2017, which was paid on February 15, 2017 to shareholders of record on February 1, 2017.
The Bank paid cash dividends totaling $271 million, $245 million and $244 million to People’s United (parent company) in 2016, 2015 and 2014, respectively, and $69 million in February 2017.
Regulatory Capital Requirements
On January 1, 2015, both People’s United and the Bank became subject to new capital rules (the “Basel III capital rules”) issued by U.S. banking agencies. When fully phased-in on January 1, 2019, the Basel III capital rules will require U.S. financial institutions to maintain: (i) a minimum ratio of CET 1 capital to total risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET 1 risk-based capital ratio as that buffer is phased-in beginning in 2016, effectively resulting in a minimum CET 1 risk-based capital ratio of 7.0% upon full implementation); (ii) a minimum ratio of Tier 1 capital to total risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 risk-based capital ratio as that buffer is phased-in beginning in 2016, effectively resulting in a minimum Tier 1 risk-based capital ratio of 8.5% upon full implementation); (iii) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to total risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% Total risk-based capital ratio as that buffer is phased-in beginning in 2016, effectively resulting in a minimum Total risk-based capital ratio of 10.5% upon full implementation); and (iv) a minimum Tier 1 Leverage capital ratio of at least 4.0%, calculated as the ratio of Tier 1 capital to average total assets, as defined.
In order to avoid limitations on distributions, including dividend payments, and certain discretionary bonus payments, a financial institution must hold a capital conservation buffer above its minimum risk-based capital requirements. For 2016, the capital conservation buffer is 0.625%. The capital conservation buffer increases for each year during the phase-in period as follows: 1.25% in 2017; 1.875% in 2018; and 2.5% in 2019.
The following summary compares People’s United’s and the Bank’s regulatory capital amounts and ratios under the Basel III capital rules. The minimum capital required amounts as of December 31, 2016 are based on the capital conservation buffer phase-in provisions of the Basel III capital rules. In connection with the adoption of the Basel III capital rules, both the Company and the Bank elected to opt-out of the requirement to include most components of AOCL in CET 1 capital. At December 31, 2016, People’s United’s and the Bank’s total risk-weighted assets, as defined, were both $30.5 billion.
(1) Tier 1 Leverage Capital ratio represents CET 1 Capital plus Additional Tier 1 Capital instruments (together, “Tier 1 Capital”) divided by Average Total Assets (less goodwill, other acquisition-related intangibles and other deductions from CET 1 Capital).
(2) CET 1 Risk-Based Capital ratio represents equity capital, as defined, less: (i) after-tax net unrealized gains (losses) on certain securities classified as available for sale; (ii) after-tax net unrealized gains (losses) on securities transferred to held to maturity; (iii) goodwill and other acquisition-related intangible assets; and (iv) the amount recorded in AOCL relating to pension and other postretirement benefits divided by Total Risk-Weighted Assets.
(3) Tier 1 Risk-Based Capital ratio represents Tier 1 Capital divided by Total Risk-Weighted Assets.
(4) Total Risk-Based Capital ratio represents Tier 1 Capital plus subordinated notes and debentures, up to certain limits, and the allowance for loan losses, up to 1.25% of Total Risk-Weighted Assets, divided by Total Risk-Weighted Assets.
Management currently estimates that, as of December 31, 2016, both the Company’s and the Bank’s risk-based capital ratios could be negatively impacted by as much as 10-20 basis points on a “fully phased-in” basis as compared to the risk-based capital ratios at December 31, 2016. See Note 14 to the Consolidated Financial Statements for additional information concerning both the Company’s and the Bank’s regulatory capital amounts and ratios.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Management
Market risk represents the risk of loss to earnings, capital and the economic values of certain assets and liabilities resulting from changes in interest rates, equity prices and foreign currency exchange rates. The only significant market risk exposure for People’s United at this time is IRR, which is a result of the Company’s core business activities of making loans and accepting deposits.
Interest Rate Risk
The effective management of IRR is essential to achieving the Company’s financial objectives. Responsibility for overseeing management of IRR resides with ALCO. The goal of ALCO is to generate a stable net interest margin over entire interest rate cycles regardless of changes in either short- or long-term interest rates. Generating earnings by taking excessive IRR is prohibited by the IRR limits established by the Company’s Board of Directors. ALCO manages IRR by using two primary risk measurement techniques: simulation of net interest income and simulation of economic value of equity. These two measurements are complementary and provide both short-term and long-term risk profiles of the Company.
Net Interest Income at Risk Simulation is used to measure the sensitivity of net interest income to changes in market rates over a forward twelve-month period. This simulation captures underlying product behaviors, such as asset and liability re-pricing dates, balloon dates, interest rate indices and spreads, rate caps and floors, as well as other behavioral attributes. The simulation of net interest income also requires a number of key assumptions such as: (i) future balance sheet volume and mix assumptions that are management judgments based on estimates and historical experience; (ii) prepayment projections for loans and securities that are projected under each interest rate scenario using internal and external analytics; (iii) new business loan rates that are based on recent new business origination experience; and (iv) deposit pricing assumptions that are based on historical regression models and management judgment. Combined, these assumptions can be inherently uncertain, and as a result, actual results may differ from simulation forecasts due to the timing, magnitude and frequency of interest rate changes, future business conditions, as well as unanticipated changes in management strategies.
The Company uses two sets of standard scenarios to measure net interest income at risk. Parallel shock scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Internal policy regarding IRR simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net interest income at risk for the subsequent one-year period should not decline by more than: 7% for a 100 basis point shift; 10% for a 200 basis point shift; and 15% for a 300 basis point shift. Yield curve twist scenarios assume the shape of the curve flattens or steepens instantaneously centered on the 18-month point of the curve, thereby segmenting the yield curve into a “short-end” and a “long-end”. Current internal policy specifies that for yield curve twist simulations, estimated net interest income at risk for the subsequent one-year period should not decline by more than 7% for a 100 basis point shift and 10% for a 200 basis point shift.
The following tables set forth the estimated percent change in the Company’s net interest income at risk over one-year simulation periods beginning December 31, 2016 and 2015. Given the interest rate environment at December 31, 2016, simulations for interest rate declines of more than 75 basis points were not modeled for parallel shook scenarios.
The net interest income at risk simulation results indicate that at both December 31, 2016 and 2015, the Company is asset sensitive over the twelve-month forecast horizon (i.e. net interest income will increase if market rates rise). This is primarily due to (i) approximately 87% of the Company’s loan portfolio being funded by less rate-sensitive core deposits and (ii) approximately 44% of the Company’s loan portfolio being comprised of Prime and one-month Libor-based loans.
The increase in the Company’s asset sensitivity since December 31, 2015 primarily reflects (i) increases in one-month Libor-based loans and core deposits; (ii) fewer loans with “in the money floors” as both the Prime rate and one-month Libor rate have risen; and (iii) less reliance on short-term borrowings. The Company is more asset sensitive when the “long-end” rises compared to increases in the “short-end” due primarily to the limited amount of long-term liabilities funding long-term assets. Based on the Company’s IRR position at December 31, 2016, an immediate 100 basis point parallel increase in interest rates translates to an approximate $42 million increase in net interest income on an annualized basis.
Economic Value of Equity at Risk Simulation is conducted in tandem with net interest income simulations, to ascertain a longer term view of the Company’s IRR position by capturing longer-term re-pricing risk and options risk embedded in the balance sheet. It measures the sensitivity of economic value of equity to changes in interest rates. Economic value of equity at risk simulation values only the current balance sheet and does not incorporate the growth assumptions used for income simulations. As with net interest income modeling, this simulation captures product characteristics such as loan resets, re-pricing terms, maturity dates, rate caps and floors. Key assumptions include loan prepayment speeds, deposit pricing elasticity and non-maturity deposit attrition rates. These assumptions can have significant impacts on valuation results as the assumptions remain in effect for the entire life of each asset and liability. The Company conducts core deposit behavior studies on a periodic basis to support deposit assumptions used in the valuation process. All key assumptions are subject to periodic review.
Base case economic value of equity at risk is calculated by estimating the net present value of all future cash flows from existing assets and liabilities using current interest rates. The current spot interest rate curve is shocked up and down to generate new spot interest rate curves for parallel rate shock scenarios. These new spot curves are then used to re-calculate economic value of equity at risk for these rate shock scenarios. Internal policy currently limits the exposure to a decrease in economic value of equity at risk resulting from instantaneous parallel shifts of the yield curve in the following manner: 7% for a 100 basis point shift; 10% for a 200 basis point shift; and 15% for a 300 basis point shift.
The following table sets forth the estimated percent change in the Company’s economic value of equity at risk, assuming various instantaneous parallel shocks in interest rates. Given the interest rate environment at December 31, 2016, simulations for interest rate declines of more than 75 basis points were not modeled.
The Company’s economic value of equity at risk profile indicates that at December 31, 2016, the Company’s economic value of equity is moderately liability sensitive in a rising rate environment. The slight increase since December 31, 2015 reflects increases in the balances and duration of mortgage-backed securities and the residential loan portfolio, as well as a decrease in the weighted average life of non-maturity deposits driven, in part, by higher long-term interest rates.
People’s United’s IRR position at December 31, 2016, as set forth in the net interest income at risk and economic value of equity at risk tables above, reflects an asset sensitive net interest income at risk position and a moderately liability sensitive economic value of equity position. From a net interest income perspective, asset sensitivity over the next 12 months is primarily attributable to the effect of the substantial Prime and Libor-based loan balances that are funded mainly by less rate-sensitive deposits. From an economic value of equity perspective, in a rising rate environment, the Company’s assets are more price sensitive than its liabilities due to slightly longer asset duration, which serves to create a moderately liability sensitive risk position. Given the uncertainty of the magnitude, timing and direction of future interest rate movements and the shape of the yield curve, actual results may vary from those predicted by the Company’s models.
Management has established procedures to be followed in the event of an anticipated or actual breach in policy limits. As of December 31, 2016, there were no breaches of the Company’s internal policy limits with respect to either IRR measure. Management utilizes both interest rate measures in the normal course of measuring and managing IRR and believes that each measure is valuable in understanding the Company’s IRR position.
People’s United uses derivative financial instruments, including interest rate swaps, as components of its market risk management (principally to manage IRR). Certain other derivatives are entered into in connection with transactions with commercial customers. Derivatives are not used for speculative purposes. At December 31, 2016, People’s United used interest rate swaps to manage IRR associated with certain interest-bearing liabilities.
People’s United has entered into a pay fixed/receive floating interest rate swap to hedge the LIBOR-based floating interest rate payments on the Company’s $125 million subordinated notes (such payments began in February 2012). These notes had a fixed interest rate of 5.80% until February 2012, at which time the interest rate converted to three-month LIBOR plus 68.5 basis points. People’s United has agreed with the swap counterparty to exchange, at specified intervals, the difference between fixed-rate (1.99%) and floating-rate interest amounts calculated based on a notional amount of $125 million. The floating-rate interest amounts received under the swap are calculated using the same floating-rate paid on these notes. The swap effectively converts the variable-rate subordinated notes to a fixed-rate liability and consequently reduces People’s United’s exposure to increases in interest rates. This swap is accounted for as a cash flow hedge. On February 14, 2017, the Company repaid the $125 million 5.80% fixed-rate/floating-rate subordinated notes. Concurrent with the repayment, the interest rate swap designated to these subordinated notes matured.
The Bank has entered into a pay floating/receive fixed interest rate swap to hedge the change in fair value due to changes in interest rates of the Bank’s $400 million subordinated notes. The Bank has agreed with the swap counterparty to exchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts calculated based on a notional amount of $375 million. The fixed-rate interest payments received on the swap will essentially offset the fixed-rate interest payments made on these notes, notwithstanding the notional difference between these notes and the swap. The floating-rate interest amounts paid under the swap are calculated based on three-month LIBOR plus 126.5 basis points. The swap effectively converts the fixed-rate subordinated notes to a floating-rate liability. This swap is accounted for as a fair value hedge.
People’s United has written guidelines that have been approved by its Board of Directors and ALCO governing the use of derivative financial instruments, including approved counterparties and credit limits. Credit risk associated with these instruments is controlled and monitored through policies and procedures governing collateral management and credit approval.
By using derivatives, People’s United is exposed to credit risk to the extent that counterparties to the derivative contracts do not perform as required. Should a counterparty fail to perform under the terms of a derivative contract, the Company’s counterparty credit risk is equal to the amount reported as a derivative asset in the Consolidated Statements of Condition. In accordance with the Company’s balance sheet offsetting policy (see Note 1 to the Consolidated Financial Statements), amounts reported as derivative assets represent derivative contracts in a gain position, without consideration for derivative contracts in a loss position with the same counterparty (to the extent subject to master netting arrangements) and posted collateral. People’s United seeks to minimize counterparty credit risk through credit approvals, limits, monitoring procedures, execution of master netting arrangements and obtaining collateral, where appropriate. Counterparties to People’s United’s derivatives include major financial institutions and exchanges that undergo comprehensive and periodic internal credit analysis as well as maintain investment grade credit ratings from the major credit rating agencies. As such, management believes the risk of incurring credit losses on derivative contracts with those counterparties is remote and losses, if any, would be immaterial.
Certain of People’s United’s derivative contracts contain provisions establishing collateral requirements (subject to minimum collateral posting thresholds) based on the Company’s external credit rating. If the Company’s senior unsecured debt rating were to fall below the level generally recognized as investment grade, the counterparties to such derivative contracts could require additional collateral on those derivative transactions in a net liability position (after considering the effect of master netting arrangements and posted collateral). The aggregate fair value of derivative instruments with such credit-related contingent features that were in a net liability position at December 31, 2016 was $7.5 million, for which People’s United had posted collateral of $5.4 million in the normal course of business. If the Company’s senior unsecured debt rating had fallen below investment grade as of that date, $2.1 million in additional collateral would have been required.
Foreign Currency Risk
Foreign exchange contracts are commitments to buy or sell foreign currency on a future date at a contractual price. People’s United uses these instruments on a limited basis to eliminate its exposure to fluctuations in currency exchange rates on certain of its commercial loans that are denominated in foreign currencies. Gains and losses on foreign exchange contracts substantially offset the translation gains and losses on the related loans.
Derivative Financial Instruments
The following table summarizes certain information concerning derivative financial instruments utilized by People’s United in its management of IRR and foreign currency risk:
People’s United enters into interest rate swaps with certain of its commercial customers. In order to minimize its risk, these customer derivatives (pay floating/receive fixed) have been offset with essentially matching interest rate swaps with People’s United’s institutional counterparties (pay fixed/receive floating). Hedge accounting has not been applied for these derivatives. Accordingly, changes in the fair value of all such interest rate swaps are recognized in current earnings.
The following table summarizes certain information concerning these interest rate swaps:
See Notes 21 and 22 to the Consolidated Financial Statements for further information relating to derivatives.
Item 8. Financial Statements and Supplementary Data
The information required by this item begins on page.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
People’s United’s management, including the Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of People’s United’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that People’s United’s disclosure controls and procedures are effective, as of December 31, 2016, to ensure that information relating to People’s United, which is required to be disclosed in the reports People’s United files with the Securities and Exchange Commission under the Exchange Act, is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to management, including the principal executive officer and the principal financial officer, as appropriate to allow timely decisions regarding required disclosures.
During the quarter ended December 31, 2016, there has not been any change in People’s United’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, People’s United’s internal control over financial reporting. People’s United’s Management’s Report on Internal Control Over Financial Reporting appears on page 86 and the related Report of Independent Registered Public Accounting Firm appears on page.
Item 9B. Other Information
None.
Part III
Item 10. Directors, Executive Officers and Corporate Governance
Directors of the Corporation
The information required by this item appears under the caption “Nominees for Director” in the People’s United Proxy Statement for the 2017 Annual Meeting of Shareholders, to be filed within 120 days of People’s United’s fiscal year end (the “Proxy Statement”) and is herein incorporated by reference.
Audit Committee Financial Expert
The Board of Directors has determined that William F. Cruger, Jr. and Janet M. Hansen, members of the Audit Committee of the Board, are each an “audit committee financial expert” and are “independent” within the meaning of those terms as used in the instructions to this Item 10.
Executive Officers of the Corporation
The information required by this item appears under the caption “Executive Officers who are not Directors” in the Proxy Statement and is herein incorporated by reference.
People’s United has adopted a Code of Ethics that applies to its Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer. The text of the Code of Ethics is available on People’s United’s website at www.peoples.com, under “Investor Relations-Corporate Governance-Management.”
Additional information required by this item appears under the caption “Board of Directors and Committees” in the Proxy Statement and is herein incorporated by reference.
Item 11. Executive Compensation
The information required by this item appears under the caption “Compensation Discussion and Analysis” in the Proxy Statement and is herein incorporated by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item appears under the caption “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement and is herein incorporated by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item appears under the caption “Transactions with Certain Related Persons” in the Proxy Statement and is herein incorporated by reference.
Item 14. Principal Accountant Fees and Services
The information required by this item appears under the caption “Ratification of the Appointment of Independent Registered Public Accounting Firm” in the Proxy Statement and is herein incorporated by reference.
Part IV
Item 15. Exhibits and Financial Statement Schedules
(a)(1)
The following consolidated financial statements of People’s United Financial, Inc. and the independent registered public accounting firm report thereon are included herein beginning on page:
Consolidated Statements of Condition as of December 31, 2016 and 2015
Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014
Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 2015 and 2014
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2016, 2015 and 2014
Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
(a)(2)
Financial statement schedules have been omitted as they are not applicable or the information is included in the consolidated financial statements or notes thereto.
(a)(3)
Exhibits
The following Exhibits are filed with this Report or are incorporated by reference. Each exhibit identified by an asterisk constitutes a management contract or compensatory plan, contract or arrangement.
Designation
Description
3.1
Third Amended and Restated Certificate of Incorporation of People’s United Financial, Inc. (incorporated by reference to Exhibit 3.1(a) to Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 10, 2016)
3.2
Eight Amended and Restated Bylaws of People’s United Financial, Inc. (incorporated by reference to Exhibit 3.1 to Current Report on Form 8-K filed with the Securities and Exchange Commission on January 24, 2017)
4.1
Form of Stock Certificate of People’s United Financial, Inc. (incorporated by reference to Exhibit 4.1 to Amendment No. 4 to Form S-1 filed with the Securities and Exchange Commission on February 13, 2007 (Registration No. 333-138389))
4.2
Indenture, dated as of February 14, 2007, by and between Chittenden Corporation and The Bank of New York Trust Company, N.A. as Trustee (incorporated by reference to Exhibit 4.2 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2009)
4.3
Form of Global Note, registered in the name of Cede & Co. as nominee (February 17, 2007) (incorporated by reference to Exhibit 4.3 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2009)
4.5
Senior Indenture dated as of December 6, 2012 between People’s United Financial, Inc. and The Bank of New York Mellon as Trustee (incorporated by reference to Exhibit 4.5 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2013)
4.6
Form of Global Note, registered in the name of Cede & Co. as nominee (December 6, 2012) (incorporated by reference to Exhibit 4.6 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2013)
Designation
Description
4.7
Issuing and Paying Agency Agreement dated June 26, 2014 between People’s United Bank as Issuer and Bank of New York Mellon as Agent (incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed with the Securities and Exchange Commission on June 26, 2014)
4.8
Form of Global Subordinated Note, registered in the name of Cede & Co. as nominee (June 26, 2014) (incorporated by reference to Exhibit 4.2 to Current Report on Form 8-K filed with the Securities and Exchange Commission on June 26, 2014)
10.1*
Form of Change in Control Agreement (Senior Executive Vice Presidents) (incorporated by reference to Exhibit 10.2(c) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2012)
10.2*
Short-Term Incentive Plan (incorporated by reference to Exhibit 10.3 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2012)
10.3*
Amended and Restated People’s Bank 1998 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.9 to Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 9, 2007)
10.4*
People’s United Financial, Inc. 2008 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.10 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2010)
10.5*
Form of Stock Option Agreement under 2008 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.7 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2013)
10.6*
Form of Grant Agreement for Restricted Stock under 2008 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.8 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2013)
10.7*
People’s United Financial, Inc. 2014 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.22 to Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 12, 2014)
10.7(a)*
Form of Grant Agreement for Performance Shares under People’s United Financial, Inc. 2014 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.7(a) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2016)
10.7(b)*
Form of Grant Agreement for Stock Options under People’s United Financial, Inc. 2014 Long-Term Incentive Plan
10.7(c)*
Form of Grant Agreement for Restricted Stock under People’s United Financial, Inc. 2014 Long-Term Incentive Plan
10.8*
First Amended and Restated People’s United Bank Cap Excess Plan (incorporated by reference to Exhibit 10.13 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2009)
10.8(a)*
First Amendment to the First Amended and Restated People’s United Bank Cap Excess Plan (incorporated by reference to Exhibit 10.9(a) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2012)
10.9*
The People’s United Bank Enhanced Senior Pension Plan-First Amendment and Restatement (incorporated by reference to Exhibit 10.14 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2009)
10.9(a)*
First Amendment to The People’s United Bank Enhanced Senior Pension Plan (incorporated by reference to Exhibit 10.10(a) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2012)
10.10*
Non-Qualified Pension Trust Agreement, dated as of March 18, 1997, between People’s Bank and Morgan Guaranty Trust Company of New York (incorporated by reference to Exhibit 10.15 to Amendment No. 3 to Form S-1 filed with the Securities and Exchange Commission on February 2, 2007 (Registration No. 333-138389))
Designation
Description
10.10(a)*
Amendment to People’s Bank Non-Qualified Pension Trust Agreement (incorporated by reference to Exhibit 10.15(a) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2008)
10.10(b)*
Trustee Engagement Agreement (Non-Qualified Pension Plans) dated May 21, 2014 between People’s United Bank and First Bankers Trust Services, Inc. (incorporated by reference to Exhibit 10.11(b) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2015)
10.11*
People’s United Bank, N.A. Nonqualified Savings and Retirement Plan (amended and restated as of January 1, 2016) (incorporated by reference to Exhibit 10.11 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2016)
10.12*
People’s Bank Supplemental Savings Plan Non-Qualified Trust Agreement, dated as of July 23, 1998, between People’s Bank and Morgan Guaranty Trust Company of New York (incorporated by reference to Exhibit 10.17 to Amendment No. 3 to Form S-1 filed with the Securities and Exchange Commission on February 2, 2007 (Registration No. 333-138389))
10.12(a)*
Amendment to People’s Bank Supplemental Savings Plan Non-Qualified Trust Agreement (incorporated by reference to Exhibit 10.17(a) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2008)
10.12(b)*
Trustee Engagement Agreement (Nonqualified Savings and Retirement Plan) dated May 21, 2014 between People’s United Bank and First Bankers Trust Services, Inc. (incorporated by reference to Exhibit 10.13(b) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2015)
10.13*
People’s United Financial, Inc. Second Amended and Restated Directors’ Equity Compensation Plan (incorporated by reference to Exhibit 10.14 to Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 12, 2014)
10.14*
People’s Bank Change-in-Control Employee Severance Plan (incorporated by reference to Exhibit 10.25 to Amendment No. 4 to Form S-1 filed with the Securities and Exchange Commission on February 13, 2007 (Registration No. 333-138389))
10.15*
People’s United Financial, Inc. 2007 Recognition and Retention Plan (amended) (incorporated by reference to Exhibit 10.26 to Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 8, 2008)
10.15(a)*
Form of Grant Agreement for Restricted Stock under 2007 Recognition and Retention Plan (incorporated by reference to Exhibit 10.16(d) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2012)
10.16*
People’s United Financial, Inc. 2007 Stock Option Plan (amended) (incorporated by reference to Exhibit 10.27 to Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 8, 2008)
10.16(a)*
Form of Grant Agreement for Stock Options under 2007 Stock Option Plan (incorporated by reference to Exhibit 10.17(d) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2012)
10.17*
Chittenden Corporation Deferred Compensation Plan (incorporated by reference to Exhibit 10.28 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2009)
10.17(a)*
Amendment No. 1 to the Chittenden Corporation Deferred Compensation Plan (incorporated by reference to Exhibit 10.28(a) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2009)
Designation
Description
10.17(b)*
Amendment No. 2 to the Chittenden Corporation Deferred Compensation Plan (incorporated by reference to Exhibit 10.18(b) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2012)
10.17(c)*
Amendment No. 3 to the Chittenden Corporation Deferred Compensation Plan (incorporated by reference to Exhibit 10.18(c) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2012)
10.18*
The Chittenden Corporation Supplemental Executive Savings Plan (incorporated by reference to Exhibit 10.30 to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2009)
10.18(a)*
Amendment No. 1 to the Chittenden Corporation Supplemental Executive Savings Plan (incorporated by reference to Exhibit 10.30(a) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2009)
10.18(b)*
Amendment No. 2 to the Chittenden Corporation Supplemental Executive Savings Plan (incorporated by reference to Exhibit 10.19(b) to Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 29, 2012)
10.19*
Purchase and Assumption Agreement dated as of April 16, 2010 among Federal Deposit Insurance Corporation as Receiver of Butler Bank, Federal Deposit Insurance Corporation, and People’s United Bank (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed with the Securities and Exchange Commission on April 20, 2010)
12.1
Consolidated Ratio of Earnings to Fixed Charges
12.2
Consolidated Combined Ratio of Earnings to Fixed Charges and Preferred Stock Dividend Requirements
Subsidiaries
Consent of KPMG LLP
31.1
Rule 13a-14(a)/15d-14(a) Certifications
31.2
Rule 13a-14(a)/15d-14(a) Certifications
Section 1350 Certifications
99.1
Impact of Inflation
101.1
The following financial information from People’s United Financial, Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016 formatted in XBRL: (i) Consolidated Statements of Condition as of December 31, 2016 and 2015; (ii) Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014; (iii) Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 2015 and 2014; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2016, 2015 and 2014; (v) Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014; and (vi) Notes to Consolidated Financial Statements.
Item 16. Form 10-K Summary
None.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, People’s United Financial, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PEOPLE’S UNITED FINANCIAL, INC.
Date: March 1, 2017
By:
/s/ John P. Barnes
John P. Barnes
President and Chief 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 People’s United Financial, Inc. and in the capacities and on the dates indicated.
Date: March 1, 2017
By:
/s/ John P. Barnes
John P. Barnes
President, Chief Executive Officer and
Director (Principal Executive Officer)
Date: March 1, 2017
By:
/s/ R. David Rosato
R. David Rosato
Senior Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)
Date: March 1, 2017
By:
/s/ Jeffrey A. Hoyt
Jeffrey A. Hoyt
Senior Vice President and
Chief Accounting Officer
(Principal Accounting Officer)
Date: March 1, 2017
By:
/s/ Collin P. Baron
Collin P. Baron
Director
Date: March 1, 2017
By:
/s/ Kevin T. Bottomley
Kevin T. Bottomley
Director
Date: March 1, 2017
By:
/s/ George P. Carter
George P. Carter
Chairman and Director
Date: March 1, 2017
By:
/s/ William F. Cruger, Jr.
William F. Cruger, Jr.
Director
Date: March 1, 2017
By:
/s/ John K. Dwight
John K. Dwight
Director
Date: March 1, 2017
By:
/s/ Jerry Franklin
Jerry Franklin
Director
Date: March 1, 2017
By:
/s/ Janet M. Hansen
Janet M. Hansen
Director
Date: March 1, 2017
By:
/s/ Richard M. Hoyt
Richard M. Hoyt
Director
Date: March 1, 2017
By:
/s/ Nancy McAllister
Nancy McAllister
Director
Date: March 1, 2017
By:
/s/ Mark W. Richards
Mark W. Richards
Director
Date: March 1, 2017
By:
/s/ Kirk W. Walters
Kirk W. Walters
Senior Executive Vice President and
Director
STATEMENT OF MANAGEMENT’S RESPONSIBILITY
Management is responsible for the preparation, content and integrity of the consolidated financial statements and all other information included in this annual report. The consolidated financial statements and related footnotes are prepared in conformity with U.S. generally accepted accounting principles. Management is also responsible for compliance with laws and regulations relating to safety and soundness as designated by the Office of the Comptroller of the Currency.
The Board of Directors has an Audit Committee composed of six outside directors, each of whom meets the criteria for independence as set forth in applicable listing standards. The Audit Committee meets regularly with the independent auditors, the internal auditors and management to ensure that internal control over financial reporting is being properly administered and that financial data is being properly reported. The Audit Committee reviews the scope and timing of internal audits, including recommendations made with respect to internal control over financial reporting. The independent auditors and the internal auditors have free access to the Audit Committee.
MANAGEMENT’S REPORT ON INTERNAL CONTROL
OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining effective internal control over financial reporting for People’s United Financial, Inc. Management maintains a system of internal control over financial reporting, including an internal audit function, which is designed to provide reasonable assurance that assets are safeguarded against loss from unauthorized use or disposition, transactions are properly authorized, and that accounting records are reliable for the preparation of 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 internal control over financial reporting may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In order to evaluate the effectiveness of internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, management has conducted an assessment, including testing, using the criteria in Internal Control-Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on its assessment, management has concluded that People’s United Financial, Inc. maintained effective internal control over financial reporting as of December 31, 2016, based on criteria in Internal Control-Integrated Framework (2013) issued by COSO.
/s/ John P. Barnes
/s/ R. David Rosato
John P. Barnes
R. David Rosato
President and Chief Executive Officer
Senior Executive Vice President
and Chief Financial Officer
Date: March 1, 2017
People’s United Financial, Inc. and Subsidiaries
Index to Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firm
Consolidated Statements of Condition as of December 31, 2016 and 2015
Consolidated Statements of Income for the Years Ended December 31, 2016, 2015 and 2014
Consolidated Statements of Comprehensive Income for the Years Ended
December 31, 2016, 2015 and
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended
December 31, 2016, 2015 and 2014
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of People’s United Financial, Inc.:
We have audited the accompanying consolidated statements of condition of People’s United Financial, Inc. and subsidiaries (“People’s”) as of December 31, 2016 and 2015, 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, 2016. These consolidated financial statements are the responsibility of People’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 People’s United Financial, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, 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), People’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 1, 2017 expressed an unqualified opinion on the effectiveness of People’s internal control over financial reporting.
/s/ KPMG LLP
Stamford, Connecticut
March 1, 2017
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of People’s United Financial, Inc.:
We have audited People’s United Financial, Inc.’s (“People’s”) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). People’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 People’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, People’s maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of condition of People’s United Financial, Inc. and subsidiaries as of December 31, 2016 and 2015, 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, 2016, and our report dated March 1, 2017 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Stamford, Connecticut
March 1, 2017
People’s United Financial, Inc. and Subsidiaries
Consolidated Statements of Condition
See accompanying notes to consolidated financial statements.
People’s United Financial, Inc. and Subsidiaries
Consolidated Statements of Income
See accompanying notes to consolidated financial statements.
People’s United Financial, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
See accompanying notes to consolidated financial statements.
People’s United Financial, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
See accompanying notes to consolidated financial statements.
People’s United Financial, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
See accompanying notes to consolidated financial statements.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 1 - Summary of Significant Accounting Policies
People’s United Financial, Inc. (“People’s United” or the “Company”) is a bank holding company and a financial holding company registered under the Bank Holding Company Act of 1956, as amended, and is incorporated under the state laws of Delaware. People’s United is the holding company for People’s United Bank, National Association (the “Bank”), a national banking association headquartered in Bridgeport, Connecticut. Prior to February 23, 2015, the Company was a savings and loan holding company within the meaning of the Home Owners’ Loan Act and the Bank was a federally-chartered savings bank. The principal business of People’s United is to provide, through the Bank and its subsidiaries, commercial banking, retail banking and wealth management services to individual, corporate and municipal customers.
The Bank provides a full range of traditional banking services, including accepting deposits and originating loans, as well as specialized financial services through its non-bank subsidiaries, including: equipment financing provided through People’s Capital and Leasing Corp. (“PCLC”) and People’s United Equipment Finance Corp. (“PUEFC”); brokerage, financial advisory services, investment management services and life insurance provided through People’s Securities, Inc. (“PSI”); and other insurance services provided through People’s United Insurance Agency, Inc. (“PUIA”). The Company’s overall financial results are particularly dependent on economic conditions in New England and New York, which are its primary markets, although economic conditions elsewhere in the United States affect its equipment financing business. Deposits are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (the “FDIC”).
People’s United is regulated by the Board of Governors of the Federal Reserve System (the “FRB”) and subject to FRB examination, supervision and reporting requirements. The Bank is regulated by the Office of the Comptroller of the Currency (the “OCC”) and subject to OCC examination, supervision and reporting requirements.
Basis of Financial Statement Presentation
The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of People’s United and its subsidiaries. All significant intercompany transactions and balances are eliminated in consolidation. Certain reclassifications have been made to prior year amounts to conform to the current year presentation.
In preparing the consolidated financial statements, management is required to make significant estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from management’s current estimates, as a result of changing conditions and future events.
Several accounting estimates are particularly critical and are susceptible to significant near-term change, including the allowance for loan losses and asset impairment judgments, such as the recoverability of goodwill and other intangible assets. These accounting estimates, which are included in the discussion below, are reviewed with the Audit Committee of the Board of Directors.
The judgments used by management in applying critical accounting policies may be affected by economic conditions, which may result in changes to future financial results. For example, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for loan losses in future periods, and the inability to collect outstanding principal may result in increased loan losses.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
For purposes of the Consolidated Statements of Cash Flows, cash equivalents include highly-liquid instruments, such as: (i) interest-bearing deposits at the Federal Reserve Bank of New York (the “FRB-NY”); (ii) government-sponsored enterprise (“GSE”) debt securities with an original maturity of three months or less (determined as of the date of purchase); (iii) federal funds sold; (iv) commercial paper; and (v) money market mutual funds. These instruments are reported as short-term investments in the Consolidated Statements of Condition at cost or amortized cost, which approximates fair value. GSE debt securities classified as cash equivalents are held to maturity and carry the implicit backing of the U.S. government, but are not direct obligations of the U.S. government.
Securities
Marketable equity and debt securities (other than those reported as short-term investments) are classified as either trading account securities, held to maturity securities (applicable only to debt securities) or available for sale securities. Management determines the classification of a security at the time of its purchase and reevaluates such classification at each balance sheet date.
Securities purchased for sale in the near term as well as those securities held by PSI (in accordance with the requirements for a broker-dealer) are classified as trading account securities and reported at fair value with unrealized gains and losses reported in non-interest income.
Debt securities for which People’s United has the intent and ability to hold to maturity are classified as held to maturity securities and reported at amortized cost. All other securities are classified as available for sale and reported at fair value with unrealized gains and losses reported on an after-tax basis in stockholders’ equity as accumulated other comprehensive income (loss) (“AOCL”). Premiums (discounts) are amortized (accreted) to interest income for debt securities, using the interest method over the remaining period to contractual maturity, adjusted for the effect of actual prepayments in the case of mortgage-backed securities and collateralized mortgage obligations (“CMOs”).
Security transactions are recorded on the trade date. Realized gains and losses are determined using the specific identification method and reported in non-interest income.
Securities transferred from available for sale to held to maturity are recorded at fair value at the date of transfer. The unrealized pre-tax gain or loss resulting from the difference between fair value and amortized cost at the transfer date becomes part of the new amortized cost basis of the securities and remains in AOCL. Such unrealized gains or losses are amortized to interest income as an adjustment to yield over the remaining life of the securities, offset by the amortization (accretion) of the premium (discount) resulting from the transfer at fair value, with no effect to net income.
Management conducts a periodic review and evaluation of the securities portfolio to determine if the decline in fair value of any security is deemed to be other-than-temporary. Other-than-temporary impairment losses are recognized on debt securities when: (i) People’s United has an intention to sell the security; (ii) it is more likely than not that People’s United will be required to sell the security prior to recovery; or (iii) People’s United does not expect to recover the entire amortized cost basis of the security. Other-than-temporary impairment losses on debt securities are reflected in earnings as realized losses to the extent the impairment is related to credit losses of the issuer. The amount of the impairment related to other factors is recognized in other comprehensive income. Management has the ability and intent to hold the securities classified as held to maturity until they mature, at which time People’s United expects to receive full value for the securities.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Both Federal Home Loan Bank (“FHLB”) stock and FRB-NY stock are non-marketable equity securities and are, therefore, reported at their respective costs, which equals par value (the amount at which shares have been redeemed in the past). These investments are periodically evaluated for impairment based on, among other things, the capital adequacy of the applicable FHLB or the FRB-NY and their overall financial condition.
Securities Resale and Securities Repurchase Agreements
In securities resale agreements, a counterparty transfers securities to People’s United (as transferee) and People’s United agrees to resell the same securities to the counterparty at a fixed price in the future. In securities repurchase agreements, which include both retail arrangements with customers and wholesale arrangements with other counterparties, People’s United (as transferor) transfers securities to a counterparty and agrees to repurchase the same securities from the counterparty at a fixed price in the future.
People’s United accounts for securities resale agreements as secured lending transactions and securities repurchase agreements as secured borrowings since the transferor maintains effective control over the transferred securities and the transfer meets the other criteria for such accounting. The securities are pledged by the transferor as collateral and the transferee has the right by contract to repledge that collateral provided the same collateral is returned to the transferor upon maturity of the underlying agreement. The fair value of the pledged collateral approximates the recorded amount of the secured loan or borrowing. Decreases in the fair value of the transferred securities below an established threshold require the transferor to provide additional collateral.
Loans Held for Sale
Loans held for sale are reported at the lower of cost or fair value in the aggregate with any adjustment for net unrealized losses reported in non-interest income. Management identifies and designates as loans held for sale certain newly-originated adjustable-rate and fixed-rate residential mortgage loans that meet secondary market requirements, as these loans are originated with the intent to sell. From time to time, management identifies and designates residential mortgage loans held in the loan portfolio for sale. Such loans are transferred to loans held for sale and adjusted to the lower of cost or fair value with the resulting unrealized loss, if any, reported in non-interest income.
Loans
Loans acquired in connection with business combinations are referred to as ‘acquired’ loans as a result of the manner in which they are accounted for (see further discussion under ‘Acquired Loans’ below). All other loans are referred to as ‘originated’ loans.
Basis of Accounting
Originated loans are reported at amortized cost less the allowance for loan losses. Interest on loans is accrued to income monthly based on outstanding principal balances. Loan origination fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized in interest income as an adjustment of yield. Depending on the loan portfolio, amounts are amortized or accreted using the level yield method over either the actual life or the estimated average life of the loan.
Non-accrual Loans
A loan is generally considered “non-performing” when it is placed on non-accrual status. A loan is generally placed on non-accrual status when it becomes 90 days past due as to interest or principal payments. Past due status is based on the contractual payment terms of the loan. A loan may be placed on non-accrual status before it reaches 90 days past due if such loan has been identified as presenting uncertainty with respect to the collectability of interest and principal. A loan past due 90 days or more may remain on accruing status if such loan is both well secured and in the process of collection. There were no loans past due 90 days or more and still accruing interest at December 31, 2016, 2015 or 2014.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
All previously accrued but unpaid interest on non-accrual loans is reversed from interest income in the period in which the accrual of interest is discontinued. Interest payments received on non-accrual loans (including impaired loans) are generally applied as a reduction of principal if future collections are doubtful, although such interest payments may be recognized as income. A loan remains on non-accrual status until the factors that indicated doubtful collectability no longer exist or until a loan is determined to be uncollectible and is charged off against the allowance for loan losses.
Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impaired loans also include certain originated loans whose terms have been modified in such a way that they are considered troubled debt restructurings (“TDRs”). Originated loans are considered TDRs if the borrower is experiencing financial difficulty and is afforded a concession by People’s United, such as, but not limited to: (i) payment deferral; (ii) a reduction of the stated interest rate for the remaining contractual life of the loan; (iii) an extension of the loan’s original contractual term at a stated interest rate lower than the current market rate for a new loan with similar risk; (iv) capitalization of interest; or (v) forgiveness of principal or interest.
TDRs may either be accruing or placed on non-accrual status (and reported as non-performing loans) depending upon the loan’s specific circumstances, including the nature and extent of the related modifications. TDRs on non-accrual status remain classified as such until the loan qualifies for return to accrual status. Loans qualify for return to accrual status once they have demonstrated performance with the restructured terms of the loan agreement for a minimum of six months in the case of a commercial loan or, in the case of a retail loan, when the loan is less than 90 days past due. Loans may continue to be reported as TDRs after they are returned to accrual status. In accordance with regulatory guidance, residential mortgage and home equity loans restructured in connection with the borrower’s bankruptcy and meeting certain criteria are also required to be classified as TDRs, included in non-performing loans and written down to the estimated collateral value, regardless of delinquency status. Acquired loans that are modified are not considered for TDR classification provided they are evaluated for impairment on a pool basis.
Impairment is evaluated on a collective basis for smaller-balance loans with similar credit risk and on an individual loan basis for other loans. If a loan is deemed to be impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported (net of the allowance) at the present value of expected future cash flows discounted at the loan’s original effective interest rate or at the fair value of the collateral less cost to sell if repayment is expected solely from the collateral. Interest payments on impaired non-accrual loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
Acquired Loans
Acquired loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that all contractually required payments will not be collected are initially recorded at fair value without recording an allowance for loan losses. Fair value of the loans is determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected, as adjusted for an estimate of future credit losses and prepayments, and then applying a market-based discount rate to those cash flows. Acquired loans are generally accounted for on a pool basis, with pools formed based on the loans’ common risk characteristics, such as loan collateral type and accrual status. Each pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Under the accounting model for acquired loans, the excess of cash flows expected to be collected over the carrying amount of the loans, referred to as the “accretable yield”, is accreted into interest income over the life of the loans in each pool using the effective yield method. Accordingly, acquired loans are not subject to classification as non-accrual in the same manner as originated loans. Rather, acquired loans are considered to be accruing loans because their interest income relates to the accretable yield recognized at the pool level and not to contractual interest payments at the loan level. The difference between contractually required principal and interest payments and the cash flows expected to be collected, referred to as the “nonaccretable difference”, includes estimates of both the impact of prepayments and future credit losses expected to be incurred over the life of the loans in each pool. As such, charge-offs on acquired loans are first applied to the nonaccretable difference and then to any allowance for loan losses recognized subsequent to acquisition.
Subsequent to acquisition, actual cash collections are monitored relative to management’s expectations and revised cash flow forecasts are prepared, as warranted. These revised forecasts involve updates, as necessary, of the key assumptions and estimates used in the initial estimate of fair value. Generally speaking, expected cash flows are affected by:
•
Changes in the expected principal and interest payments over the estimated life - Updates to changes in expected cash flows are driven by the credit outlook and actions taken with borrowers. Changes in expected future cash flows resulting from loan modifications are included in the assessment of expected cash flows;
•
Changes in prepayment assumptions - Prepayments affect the estimated life of the loans which may change the amount of interest income, and possibly principal, expected to be collected; and
•
Changes in interest rate indices for variable rate loans - Expected future cash flows are based, as applicable, on the variable rates in effect at the time of the assessment of expected cash flows.
A decrease in expected cash flows in subsequent periods may indicate that the loan pool is impaired, which would require the establishment of an allowance for loan losses by a charge to the provision for loan losses. An increase in expected cash flows in subsequent periods serves, first, to reduce any previously established allowance for loan losses by the increase in the present value of cash flows expected to be collected, and results in a recalculation of the amount of accretable yield for the loan pool. The adjustment of accretable yield due to an increase in expected cash flows is accounted for as a change in estimate. The additional cash flows expected to be collected are reclassified from the nonaccretable difference to the accretable yield, and the amount of periodic accretion is adjusted accordingly over the remaining life of the loans in the pool.
An acquired loan may be resolved either through receipt of payment (in full or in part) from the borrower, the sale of the loan to a third party or foreclosure of the collateral. In the event of a sale of the loan, a gain or loss on sale is recognized and reported within non-interest income based on the difference between the sales proceeds and the carrying amount of the loan. In other cases, individual loans are removed from the pool based on comparing the amount received from its resolution (fair value of the underlying collateral less costs to sell in the case of a foreclosure) with its outstanding balance. Any difference between these amounts is absorbed by the nonaccretable difference established for the entire pool. For loans resolved by payment in full, there is no adjustment of the nonaccretable difference since there is no difference between the amount received at resolution and the outstanding balance of the loan. In these cases, the remaining accretable yield balance is unaffected and any material change in remaining effective yield caused by the removal of the loan from the pool is addressed in connection with the subsequent cash flow re-assessment for the pool. Acquired loans subject to modification are not removed from the pool even if those loans would otherwise be deemed TDRs as the pool, and not the individual loan, represents the unit of account.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Allowance and Provision for Loan Losses
The allowance for loan losses is established through provisions for loan losses charged to income. Losses on loans, including impaired loans, are charged to the allowance for loan losses when all or a portion of a loan is deemed to be uncollectible. Recoveries of loans previously charged off are credited to the allowance for loan losses when realized.
People’s United maintains the allowance for loan losses at a level that is deemed to be appropriate to absorb probable losses inherent in the respective loan portfolios, based on a quarterly evaluation of a variety of factors. These factors include, but are not limited to: (i) People’s United’s historical loan loss experience and recent trends in that experience; (ii) risk ratings assigned by lending personnel to commercial real estate loans, commercial and industrial loans, and equipment financing loans, and the results of ongoing reviews of those ratings by People’s United’s independent loan review function; (iii) an evaluation of delinquent and non-performing loans and related collateral values; (iv) the probability of loss in view of geographic and industry concentrations and other portfolio risk characteristics; (v) the present financial condition of borrowers; and (vi) current economic conditions.
The Company’s allowance for loan losses consists of three elements: (i) an allowance for larger-balance, non-homogeneous loans that are evaluated on an individual (loan-by-loan) basis; (ii) an allowance for smaller-balance, homogeneous loans that are evaluated on a collective basis; and (iii) a specific allowance for loans deemed to be impaired, including originated loans classified as TDRs.
Larger-balance, Non-homogeneous Loans. The Company establishes a loan loss allowance for its larger-balance, non-homogeneous loans using a methodology that incorporates (i) the probability of default for a given loan risk rating and (ii) historical loss-given-default data, both derived using an appropriate look back period. In accordance with the Company’s loan risk rating system, each loan, with the exception of those included in large groups of smaller-balance homogeneous loans, is assigned a risk rating (using a nine-grade scale) by the originating loan officer, credit management, internal loan review or loan committee. Loans rated “One” represent those loans least likely to default while loans rated “Nine” represent a loss. The probability of loans defaulting for each risk rating, referred to as default factors, are estimated based on the historical pattern of loans migrating from one risk rating to another and to default status over time as well as the length of time that it takes losses to emerge. Estimated loan default factors, which are updated annually (or more frequently, if necessary), are multiplied by loan balances within each risk-rating category and again multiplied by a historical loss-given-default estimate for each loan type to determine an appropriate level of allowance by loan type. The historical loss-given-default estimates are also updated annually (or more frequently, if necessary) based on actual charge-off experience. This approach is applied to the commercial, commercial real estate and equipment financing components of the loan portfolio.
In establishing the allowance for loan losses for larger-balance, non-homogeneous loans, the Company also gives consideration to certain qualitative factors, including the macroeconomic environment and any potential imprecision inherent in its loan loss model that may result from having limited historical loan loss data which, in turn, may result in inaccurate probability of default and loss-given-default estimates. In this manner, historical portfolio experience, as described above, is not adjusted and the allowance for loan losses always includes a component attributable to qualitative factors, the degree of which may change from period to period as such qualitative factors indicate improving or worsening trends. The Company evaluates the qualitative factors on a quarterly basis in order to conclude that they continue to be appropriate. There were no significant changes in our approach to determining the qualitative component of the related allowance for loan losses during 2016.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Smaller-balance, Homogeneous Loans. Pools of smaller-balance, homogeneous loans with similar risk and loss characteristics are also assessed for probable losses. These loan pools include residential mortgage, home equity and other consumer loans that are not assigned individual loan risk ratings. Rather, the assessment of these portfolios, and the establishment of the related allowance for loan losses, is based upon a consideration of (i) historical loss experience over an appropriate look back period and (ii) certain qualitative factors.
The qualitative component of the allowance for loan losses for smaller-balance, homogenous loans is intended to incorporate risks inherent in the portfolio, economic uncertainties, regulatory requirements and other subjective factors such as changes in underwriting standards. Accordingly, consideration is given to: (i) present and forecasted economic conditions, including unemployment rates; (ii) changes in industry trends, including the impact of new regulations, (iii) trends in property values; (iv) broader portfolio indicators, including delinquencies, non-performing loans, portfolio concentrations, and trends in the volume and terms of loans; and (v) portfolio-specific risk characteristics.
Portfolio-specific risk characteristics include, but are not limited to: (i) collateral values/loan-to value (“LTV”) ratios (above and below 70%); (ii) borrower credit scores under the FICO scoring system (above and below a score of 680); and (iii) other relevant portfolio risk elements such as income verification at the time of underwriting (stated income vs. non-stated income) and the property’s intended use (owner-occupied, non-owner occupied, second home, etc.), the combination of which results in a loan being classified as either “High”, “Moderate” or “Low” risk. These risk classifications are reviewed quarterly to ensure that changes within the portfolio, as well as economic indicators and industry developments, have been appropriately considered in establishing the related allowance for loan losses.
In establishing the allowance for loan losses for smaller-balance, homogeneous loans, the amount reflecting the Company’s consideration of qualitative factors is added to the amount attributable to historical portfolio loss experience. In this manner, historical charge-off data (whether periods or amounts) is not adjusted and the allowance for loan losses always includes a component attributable to qualitative factors, the degree of which may change from period to period as such qualitative factors indicate improving or worsening trends. The Company evaluates the qualitative factors on a quarterly basis in order to conclude that they continue to be appropriate. There were no significant changes in our approach to determining the qualitative component of the related allowance for loan losses during 2016.
Individually Impaired Loans. The allowance for loan losses also includes specific allowances for individually impaired loans. Generally, the Company’s impaired loans consist of (i) classified commercial loans in excess of $750,000 that have been placed on non-accrual status and (ii) originated loans classified as TDRs. Individually impaired loans are measured based upon observable market prices; the present value of expected future cash flows discounted at the loan’s original effective interest rate; or, in the case of collateral dependent loans, fair value of the collateral (based on appraisals and other market information) less cost to sell. If the recorded investment in a loan exceeds the amount measured as described in the preceding sentence, a specific allowance for loan losses would be established as a component of the overall allowance for loan losses or, in the case of a collateral dependent loan, a charge-off would be recorded for the difference between the loan’s recorded investment and management’s estimate of the fair value of the collateral (less cost to sell). It would be rare for the Company to identify a loan that meets the criteria stated above and requires a specific allowance or a charge-off and not deem it impaired solely as a result of the existence of a guarantee.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
People’s United performs an analysis of its impaired loans, including collateral dependent impaired loans, on a quarterly basis. Individually impaired collateral dependent loans are measured based upon the appraised value of the underlying collateral and other market information. Generally, the Company’s policy is to obtain updated appraisals for commercial collateral dependent loans when the loan is downgraded to a risk rating of “substandard” or “doubtful”, and the most recent appraisal is more than 12 months old or a determination has been made that the property has experienced a significant decline in value. Appraisals are prepared by independent, licensed third-party appraisers and are subject to review by the Company’s internal commercial appraisal department or external appraisers contracted by the commercial appraisal department. The conclusions of the external appraisal review are reviewed by the Company’s Chief Commercial Appraiser prior to acceptance. The Company’s policy with respect to impaired loans secured by residential real estate is to receive updated estimates of property values upon the loan being classified as non-performing (typically upon becoming 90 days past due).
In determining the allowance for loan losses, People’s United gives appropriate consideration to the age of appraisals through its regular evaluation of other relevant qualitative and quantitative information. Specifically, between scheduled appraisals, property values are monitored within the commercial portfolio by reference to current originations of collateral dependent loans and the related appraisals obtained during underwriting as well as by reference to recent trends in commercial property sales as published by leading industry sources. Property values are monitored within the residential mortgage and home equity portfolios by reference to available market indicators, including real estate price indices within the Company’s primary lending areas.
In most situations where a guarantee exists, the guarantee arrangement is not a specific factor in the assessment of the related allowance for loan losses. However, the assessment of a guarantor’s credit strength is reflected in the Company’s internal loan risk ratings which, in turn, are an important factor in its allowance for loan loss methodology for loans within the commercial and commercial real estate portfolios.
People’s United did not change its methodologies with respect to determining the allowance for loan losses during 2016. As part of its ongoing assessment of the allowance for loan losses, People’s United regularly makes refinements to certain underlying assumptions used in its methodologies. However, such refinements did not have a material impact on the allowance for loan losses or the provision for loan losses as of or for the year ended December 31, 2016.
While People’s United seeks to use the best available information to make these determinations, future adjustments to the allowance for loan losses may be necessary based on changes in economic conditions, results of regulatory examinations, further information obtained regarding known problem loans, the identification of additional problem loans and other factors.
Loan Charge-Offs
The Company’s charge-off policies, which comply with standards established by banking regulators, are consistently applied from period to period. Charge-offs are recorded on a monthly basis. Partially charged-off loans continue to be evaluated on a monthly basis and additional charge-offs or loan loss provisions may be recorded on the remaining loan balance based on the same criteria.
For unsecured consumer loans, charge-offs are generally recorded when the loan is deemed to be uncollectible or 120 days past due, whichever occurs first. For consumer loans secured by real estate, including residential mortgage loans, charge-offs are generally recorded when the loan is deemed to be uncollectible or 180 days past due, whichever occurs first, unless it can be clearly demonstrated that repayment will occur regardless of the delinquency status. Factors that demonstrate an ability to repay may include: (i) a loan that is secured by adequate collateral and is in the process of collection; (ii) a loan supported by a valid guarantee or insurance; or (iii) a loan supported by a valid claim against a solvent estate.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
For commercial loans, a charge-off is recorded when the Company determines that it will not collect all amounts contractually due based on the fair value of the collateral less cost to sell, or the present value of expected future cash flows.
The decision whether to charge-off all or a portion of a loan rather than to record a specific or general loss allowance is based on an assessment of all available information that aids in determining the loan’s net realizable value. Typically this involves consideration of both (i) the fair value of any collateral securing the loan, including whether the estimate of fair value has been derived from an appraisal or other market information and (ii) other factors affecting the likelihood of repayment, including the existence of guarantees and insurance. If the amount by which the Company’s recorded investment in the loan exceeds its net realizable value is deemed to be a confirmed loss, a charge-off is recorded. Otherwise, a specific or general reserve is established, as applicable.
Wealth Management and Other Fee-Based Revenues
Investment management fees are accrued when earned based on total assets managed and administered, which are not reported as assets of People’s United. Insurance revenue represents commissions earned solely from performing broker- and agency-related services. Insurance commission revenues related to agency-billed policies are recognized at the later of the policy billing date or the policy effective date. Insurance commission revenues on premiums directly billed by insurance carriers are generally recognized as revenue during the period commissions are paid by the insurance carrier. Brokerage commissions are recognized on a trade-date basis. Bank service charges are recorded when earned.
Bank-Owned Life Insurance
Bank-owned life insurance (“BOLI”) represents the cash surrender value of life insurance policies purchased on the lives of certain key executives and former key executives. BOLI funds are generally invested in separate accounts and are supported by a stable wrap agreement to fully insulate the underlying investments against changes in fair value. Increases in the cash surrender value of these policies and death benefits in excess of the related invested premiums are included in non-interest income in the Consolidated Statements of Income. The Company’s BOLI policies have been underwritten by highly-rated third party insurance carriers and the investments underlying these policies are deemed to be of low-to-moderate market risk.
Premises and Equipment
Premises and equipment are reported at cost less accumulated depreciation and amortization, except for land, which is reported at cost. Buildings, data processing and other equipment, computer software, furniture and fixtures are depreciated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the shorter of the remaining lease term, the estimated useful life of the improvements or 10 years. Capitalized software development costs are amortized on a straight-line basis over the estimated useful life of the software. Generally, the estimated useful lives are as follows: buildings - 40 years; data processing and other equipment - 3 to 5 years; computer software - 3 to 5 years; and furniture and fixtures - 10 years.
Goodwill and Other Acquisition-Related Intangible Assets
An acquirer in a business combination is required, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration, if any, is also recognized and measured at fair value on the date of acquisition. In addition, the accounting standards for business combinations require that: (i) acquisition-related transaction costs be expensed as incurred; (ii) specific requirements be met in order to accrue for a restructuring plan as part of the acquisition; (iii) certain pre-acquisition contingencies be recognized at fair value; and (iv) acquired loans be recorded at fair value as of the acquisition date without recognition of an allowance for loan losses.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Intangible assets are recognized in an amount equal to the excess of the consideration transferred over the fair value of the tangible net assets acquired. “Acquisition-related intangible assets” are separately identified, recognized and amortized, where appropriate, for assets such as trade names, certain contractual agreements and the estimated values of acquired core deposits and/or customer relationships. Mutual fund management contract intangibles recognized by People’s United are deemed to have indefinite useful lives and, accordingly, are not amortized. The remaining intangible asset is recognized as goodwill.
Goodwill and indefinite-lived intangible assets are not amortized but, rather, are reviewed for impairment at least annually, with impairment losses recognized as a charge to expense when they occur. Acquisition-related intangible assets other than goodwill and indefinite-lived intangible assets are amortized to expense over their estimated useful lives in a manner consistent with that in which the related benefits are expected to be realized, and are periodically reviewed by management to assess recoverability, with impairment losses recognized as a charge to expense if carrying amounts exceed fair values.
The Company’s trade name intangibles are amortized on either (i) an accelerated basis over a period of approximately 20 years or (ii) a straight-line basis over 5 years. Core deposit intangibles are amortized on an accelerated basis over a period ranging from 7 to 10 years. Customer relationship intangibles are amortized on a straight-line basis over the estimated remaining average life of those relationships, which ranges from 10 to 15 years from the respective acquisition dates. Intangibles stemming from contractual agreements, such as favorable lease and non-compete agreements, are amortized on a straight-line basis over the remaining term of the respective agreements.
Goodwill is evaluated for impairment at the reporting unit level. For the purpose of goodwill impairment evaluations, management has identified reporting units based upon the Company’s three operating segments: Commercial Banking; Retail Banking; and Wealth Management. The impairment evaluation is performed as of an annual date or more frequently if a triggering event indicates that impairment may have occurred.
Entities have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of such events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity is not required to perform the two-step impairment test as described below. People’s United elected to perform this optional qualitative assessment in its evaluation of goodwill impairment as of October 1st (the annual impairment evaluation date) in 2016, and concluded that performance of the two-step impairment test was not required. In both 2015 and 2014, People’s United elected to perform the two-step impairment test.
The first step (“Step 1”) is used to identify potential impairment, and involves comparing each reporting unit’s estimated fair value to its carrying amount, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill is not deemed to be impaired. Should the carrying amount of the reporting unit exceed its estimated fair value, an indicator of potential impairment is deemed to exist and a second step is performed to measure the amount of such impairment, if any. At this time, none of the Company’s identified reporting units are at risk of failing the Step 1 goodwill impairment test.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The second step (“Step 2”) involves calculating the implied fair value of goodwill for each reporting unit for which impairment was indicated in Step 1. The implied fair value of goodwill is determined in a manner similar to how the amount of goodwill is determined in a business combination (i.e. by measuring the excess of the estimated fair value of the reporting unit, as determined in Step 1, over the aggregate estimated fair values of the individual assets, liabilities, and identifiable intangibles applicable to that reporting unit as of the impairment testing date). If the implied fair value of goodwill exceeds the carrying amount of goodwill assigned to the reporting unit, no impairment exists. If the carrying amount of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment loss is recorded in an amount equal to such excess. An impairment loss cannot exceed the carrying amount of goodwill assigned to a reporting unit, and the loss (write-down) establishes a new carrying amount for the goodwill. Subsequent reversals of goodwill impairment losses are not permitted.
The Company estimates the fair value of its reporting units based on an appropriate weighting of values based on (i) a present-value measurement technique (discounted cash flow analysis based on internal forecasts) and (ii) market-based trading and transaction multiples. The discounted cash flow analysis is based on significant assumptions and judgments including future growth rates and discount rates reflecting management’s assessment of market participant views of the risks associated with the projected cash flows of the reporting units. The market-based trading and transaction multiples are derived from the market prices of stocks of companies that are actively traded and engaged in the same or similar businesses as the Company and the respective reporting unit. The derived multiples are then applied to the reporting unit’s financial metrics to produce an indication of value. Differences in the identification of reporting units or in the selection of valuation techniques and related assumptions could result in materially different evaluations of goodwill impairment.
Real Estate Owned
Real estate owned (“REO”) properties acquired through foreclosure or deed-in-lieu of foreclosure are recorded initially at the lower of cost or estimated fair value less costs to sell. Any write-down of the recorded investment in the related loan is charged to the allowance for loan losses upon transfer to REO. Thereafter, an allowance for REO losses is established for any further declines in the property’s value. This allowance is increased by provisions charged to income and decreased by charge-offs for realized losses. Management’s periodic evaluation of the adequacy of the allowance is based on an analysis of individual properties, as well as a general assessment of current real estate market conditions.
Income Taxes
Deferred taxes are recognized for the estimated future tax effects attributable to “temporary differences” and tax loss carryforwards. Temporary differences are differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. A deferred tax liability is recognized for all temporary differences that will result in future taxable income. A deferred tax asset is recognized for all temporary differences that will result in future tax deductions and for all tax loss carryforwards, subject to reduction of the asset by a valuation allowance in certain circumstances. This valuation allowance is recognized if, based on an analysis of available evidence, management determines that it is more likely than not that some portion or all of the deferred tax asset will not be realized. The valuation allowance is subject to ongoing adjustment based on changes in circumstances that affect management’s judgment about the realizability of the deferred tax asset.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to future taxable income. The effect on deferred tax assets and liabilities of a change in tax laws or rates is recognized in income tax expense in the period that includes the enactment date of the change. Tax benefits attributable to deductions in excess of financial statement amounts arising from the exercise of non-statutory stock options are credited to additional paid-in capital.
Individual tax positions taken or expected to be taken on a tax return must satisfy certain criteria in order for some or all of the related tax benefits to be recognized in the financial statements. Specifically, a recognition threshold of more-likely-than-not must be met in order to recognize those tax benefits.
Earnings Per Common Share
Basic earnings per common share (“EPS”) excludes dilution and is computed by dividing earnings attributable to common shareholders by the weighted average number of common shares outstanding for the year. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock options and performance shares) were exercised or converted into additional common shares that would then share in the earnings of the entity. Diluted EPS is computed by dividing earnings attributable to common shareholders by the weighted average number of common shares outstanding for the year, plus an incremental number of common-equivalent shares computed using the treasury stock method.
Unvested share-based payment awards, which include the right to receive non-forfeitable dividends or dividend equivalents, are considered to participate with common shareholders in undistributed earnings for purposes of computing EPS. Companies that have such participating securities, including People’s United, are required to calculate basic and diluted EPS using the two-class method. Restricted stock awards granted by People’s United are considered participating securities. Calculations of EPS under the two-class method (i) exclude from the numerator any dividends paid or owed on participating securities and any undistributed earnings considered to be attributable to participating securities and (ii) exclude from the denominator the dilutive impact of the participating securities.
Derivative Financial Instruments and Hedging Activities
People’s United uses derivative financial instruments as components of its market risk management (principally to manage interest rate risk (“IRR”)). Certain other derivatives are entered into in connection with transactions with commercial customers. Derivatives are not used for speculative purposes.
All derivatives are recognized as either assets or liabilities in the Consolidated Statements of Condition, reported at fair value and presented on a gross basis. Until a derivative is settled, a favorable change in fair value results in an unrealized gain that is recognized as an asset, while an unfavorable change in fair value results in an unrealized loss that is recognized as a liability.
The Company generally applies hedge accounting to its derivatives used for market risk management purposes. Hedge accounting is permitted only if specific criteria are met, including a requirement that a highly effective relationship exist between the derivative instrument and the hedged item, both at inception of the hedge and on an ongoing basis. The hedge accounting method depends upon whether the derivative instrument is classified as a fair value hedge (i.e. hedging an exposure related to a recognized asset or liability, or a firm commitment) or a cash flow hedge (i.e. hedging an exposure related to the variability of future cash flows associated with a recognized asset or liability, or a forecasted transaction). Changes in the fair value of effective fair value hedges are recognized in current earnings (with the change in fair value of the hedged asset or liability also recorded in earnings). Changes in the fair value of effective cash flow hedges are recognized in other comprehensive income (loss) until earnings are affected by the variability in cash flows of the designated hedged item. Ineffective portions of hedge results are recognized in current earnings. Changes in the fair value of derivatives for which hedge accounting is not applied are recognized in current earnings.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
People’s United formally documents at inception all relationships between the derivative instruments and the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transactions. This process includes linking all derivatives that are designated as hedges to specific assets and liabilities, or to specific firm commitments or forecasted transactions. People’s United also formally assesses, both at inception of the hedge and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in the fair values or cash flows of the hedged items. If it is determined that a derivative is not highly effective or has ceased to be a highly effective hedge, People’s United would discontinue hedge accounting prospectively. Gains or losses resulting from the termination of a derivative accounted for as a cash flow hedge remain in AOCL and are amortized to earnings over the remaining period of the former hedging relationship, provided the hedged item continues to be outstanding or it is probable the forecasted transaction will occur.
People’s United uses the dollar offset method, regression analysis and scenario analysis to assess hedge effectiveness at inception and on an ongoing basis. Such methods are chosen based on the nature of the hedge strategy and are used consistently throughout the life of the hedging relationship.
Certain derivative financial instruments are offered to commercial customers to assist them in meeting their financing and investing objectives and for their risk management purposes. These derivative financial instruments consist primarily of interest rate swaps, but also include foreign exchange contracts. The interest rate and foreign exchange risks associated with customer interest rate swaps and foreign exchange contracts are mitigated by entering into similar derivatives having essentially offsetting terms with institutional counterparties.
Interest rate-lock commitments extended to borrowers relate to the origination of residential mortgage loans. To mitigate the IRR inherent in these commitments, People’s United enters into mandatory delivery and best efforts contracts to sell adjustable-rate and fixed-rate residential mortgage loans (servicing released). Forward commitments to sell and interest rate-lock commitments on residential mortgage loans are considered derivatives and their respective estimated fair values are adjusted based on changes in interest rates.
Changes in the fair value of derivatives for which hedge accounting is not applied are recognized in current earnings, including customer derivatives, interest-rate lock commitments and forward sale commitments.
Balance Sheet Offsetting
Assets and liabilities relating to certain financial instruments, including derivatives, may be eligible for offset in the Consolidated Statements of Condition and/or subject to enforceable master netting arrangements or similar agreements. People’s United’s derivative transactions with institutional counterparties are generally executed under International Swaps and Derivative Association (“ISDA”) master agreements, which include “right of set-off” provisions that provide for a single net settlement of all interest rate swap positions, as well as collateral, in the event of default on, or the termination of, any one contract. Nonetheless, the Company does not offset asset and liabilities under such arrangements in the Consolidated Statements of Condition.
Collateral (generally in the form of marketable debt securities) pledged by counterparties in connection with derivative transactions is not reported in the Consolidated Statements of Condition unless the counterparty defaults. Collateral that has been pledged by People’s United to counterparties continues to be reported in the Consolidated Statements of Condition unless the Company defaults.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Fair Value Measurements
Accounting standards related to fair value measurements define fair value, provide a framework for measuring fair value and establish related disclosure requirements. Broadly, fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Accordingly, an “exit price” approach is required in determining fair value. In support of this principle, a fair value hierarchy has been established that prioritizes the inputs used to measure fair value, requiring entities to maximize the use of market or observable inputs (as more reliable measures) and minimize the use of unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs generally require significant management judgment.
The three levels within the fair value hierarchy are as follows:
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Level 1 - Unadjusted quoted market prices for identical assets or liabilities in active markets that the entity has the ability to access at the measurement date (such as active exchange-traded equity securities or mutual funds and certain U.S. and government agency debt securities).
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Level 2 - Observable inputs other than quoted prices included in Level 1, such as:
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quoted prices for similar assets or liabilities in active markets (such as U.S. agency and GSE issued mortgage-backed securities and CMOs);
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quoted prices for identical or similar assets or liabilities in less active markets (such as certain U.S. and government agency debt securities, and corporate and municipal debt securities that trade infrequently); and
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other inputs that (i) are observable for substantially the full term of the asset or liability (e.g. interest rates, yield curves, prepayment speeds, default rates, etc.) or (ii) can be corroborated by observable market data (such as interest rate and currency derivatives and certain other securities).
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Level 3 - Valuation techniques that require unobservable inputs that are supported by little or no market activity and are significant to the fair value measurement of the asset or liability (such as pricing models, discounted cash flow methodologies and similar techniques that typically reflect management’s own estimates of the assumptions a market participant would use in pricing the asset or liability).
People’s United maintains policies and procedures to value assets and liabilities using the most relevant data available.
Stock-Based Compensation
People’s United’s stock-based compensation plans provide for awards of stock options, restricted stock and performance shares to directors, officers and employees. Costs resulting from the issuance of such share-based payment awards are required to be recognized in the financial statements based on the grant date fair value of the award. Stock-based compensation expense is recognized over the requisite service period, which is generally the vesting period.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
New Accounting Standards
Standards effective in 2016
Stock Compensation
In June 2014, the Financial Accounting Standards Board (the “FASB”) amended its standards with respect to stock compensation to require that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. The amendment further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to those periods for which the requisite service has already been rendered. This amendment, which is being applied prospectively, became effective for People’s United on January 1, 2016 and did not have a significant impact on the Company’s Consolidated Financial Statements.
Consolidation
In February 2015, the FASB amended its standards with respect to the analysis that a reporting entity must perform in determining whether certain types of legal entities should be consolidated. The amendment modifies the evaluation of whether limited partnerships or similar legal entities are variable interest entities (“VIEs”) or voting interest entities, eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. This amendment, which is being applied retrospectively, became effective for People’s United on January 1, 2016 and did not have a significant impact on the Company’s Consolidated Financial Statements.
Presentation of Debt Issuance Costs
In April 2015, the FASB amended its standards with respect to the presentation of debt issuance costs by changing the presentation of such costs from an asset on the statement of condition to a deduction from the related debt liability. This amendment, which is being applied retrospectively, became effective for People’s United on January 1, 2016 and did not have a significant impact on the Company’s Consolidated Financial Statements. See Notes 8 and 11.
Retirement Benefits
In April 2015, the FASB amended its standards with respect to the accounting for retirement benefits by providing a practical expedient, for entities with fiscal year-ends that do not coincide with a month-end, permitting such entities to measure defined benefit plan assets and obligations using the month-end that is closest to its fiscal year-end. This practical expedient is to be applied consistently from year to year and to all plans if an entity has more than one plan. Further, in cases where a significant event caused by the entity (such as a plan amendment, curtailment or settlement) that requires the remeasurement of defined benefit plan assets and obligations does not coincide with a month-end, entities may elect to remeasure both plan assets and obligations using the month-end that is closest to the date of the significant event. This amendment, which is being applied prospectively, became effective for People’s United on January 1, 2016 and did not have a significant impact on the Company’s Consolidated Financial Statements.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Business Combinations
In September 2015, the FASB amended its standards with respect to business combinations to eliminate the requirement to restate prior period financial statements for measurement period adjustments. Instead, the amended guidance requires that, during the measurement period, an acquirer recognize adjustments of previously recorded provisional amounts in the reporting period in which such adjustments are determined. In doing so, the acquirer would be required to record the cumulative effect of measurement period adjustments on current and prior period earnings, including the prior period impact on depreciation, amortization or other income statement items. The amended standard also contains additional disclosure requirements with respect to measurement period adjustments. This amendment, which is being applied prospectively, became effective for People’s United on January 1, 2016 and did not have a significant impact on the Company’s Consolidated Financial Statements.
Standards effective in 2017
Derivatives and Hedging
In March 2016, the FASB amended its standards with respect to derivatives and hedging. The first amendment clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument does not, in and of itself, require dedesignation of that hedging relationship and discontinuation of the application of hedge accounting. This amendment does not require additional disclosures beyond disclosure about a change in accounting principle in the period of adoption. The second amendment clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment is required to assess the embedded call (put) options solely in accordance with a four-step decision sequence and no longer is required to assess whether the event that triggers the ability to exercise the option is related to interest rate or credit risk. For public business entities, both of these new amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016 (January 1, 2017 for People’s United) and may be applied either prospectively or on a modified retrospective basis. Earlier application is permitted as of the beginning of an interim or annual reporting period. The adoption of these amendments is not expected to have a significant impact on the Company’s Consolidated Financial Statements.
Investments - Equity Method and Joint Ventures
In March 2016, the FASB amended its standards with respect to the equity method of accounting by eliminating the requirement that, upon an investment qualifying for use of the equity method of accounting as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations and retained earnings retrospectively, as if the equity method of accounting had been in effect during all previous periods that the investment was held. Rather, under the new guidance, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. Instead, any unrealized holding gain or loss is to be recognized through other comprehensive income on the date the investment qualifies for use of the equity method. This amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016 (January 1, 2017 for People’s United) and is to be applied prospectively. The adoption of this amendment is not expected to have a significant impact on the Company’s Consolidated Financial Statements.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Stock Compensation
In March 2016, the FASB amended its standards with respect to certain aspects of the accounting for share-based payment awards, including: (i) the related income tax consequences; (ii) the classification of awards as either equity or liabilities; and (iii) the classification in the statement of cash flows. For public business entities, these amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016 (January 1, 2017 for People’s United) and should be applied prospectively. The adoption of this amendment is not expected to have a significant impact on the Company’s Consolidated Financial Statements.
Standards effective in 2018
Revenue Recognition
In May 2014, the FASB amended its standards with respect to revenue recognition. The amended guidance serves to replace all current U.S. GAAP guidance on this topic and eliminate all industry-specific guidance, providing a unified model to determine when and how revenue is recognized. The underlying principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendments also require enhanced disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. As originally issued, this new guidance, which can be applied retrospectively or through the use of the cumulative effect transition method, was to become effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2016 (January 1, 2017 for People’s United) and early adoption was not permitted.
In July 2015, the FASB approved a one-year deferral of the effective date (now January 1, 2018 for People’s United) with early adoption, as of the original effective date, permitted. In March, April and May 2016, the FASB issued amendments to clarify the implementation guidance and add some practical expedients in certain areas, including: (i) principal versus agent considerations; (ii) the identification of performance obligations; and (iii) certain aspects of the accounting for licensing arrangements. These amendments do not change the core principle of the guidance and are effective for and follow the same transition requirements as the core principle.
The Company will adopt this guidance in the first quarter of 2018 using the modified retrospective method with a cumulative-effect adjustment to opening retained earnings, as appropriate. The Company’s revenue is comprised of net interest income on financial assets and financial liabilities and non-interest income. The scope of the guidance explicitly excludes net interest income as well as other revenues associated with financial assets and liabilities, including loans, leases, securities and derivatives. Accordingly, the majority of the Company’s revenues will not be affected. Other recurring revenue streams are within the scope of the guidance, including revenues associated with certain products and services offered by the Company’s trust and investment management, insurance and brokerage businesses. The Company’s preliminary analysis suggests that adoption of the guidance is not expected to have a material impact on its current accounting policies or the timing or amount of revenue recognized in the Company’s Consolidated Financial Statements. However, the FASB continues to release new accounting guidance related to the adoption of the amended standard which could impact the Company’s preliminary conclusions with respect to materiality.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Presentation of Deferred Taxes
In November 2015, the FASB amended its standards with respect to the presentation of deferred income taxes to eliminate the requirement to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of condition, thereby simplifying the presentation of deferred income taxes. For public business entities, this new amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017 (January 1, 2018 for People’s United) and may be applied either prospectively or retrospectively to all periods presented. Earlier application of the amendment is permitted as of the beginning of an interim or annual reporting period. The adoption of this amendment is not expected to have a significant impact on the Company’s Consolidated Financial Statements.
Recognition and Measurement of Financial Instruments
In January 2016, the FASB amended its standards to address certain aspects of recognition, presentation and disclosure of financial instruments. The amended guidance (i) requires that equity investments be measured at fair value with changes in fair value recognized in net income and (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by permitting a qualitative assessment to identify impairment. The guidance also contains additional disclosure and presentation requirements associated with financial instruments. For public business entities this new guidance is effective in fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017 (January 1, 2018 for People’s United). The cumulative effect transition method will be applied to all outstanding instruments as of the date of adoption, while changes to the accounting for equity investments without readily determinable fair values will be applied prospectively. The Company continues to evaluate the impact of the amended guidance on the Company’s Consolidated Financial Statements.
Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments
In August 2016, the FASB amended its standards to address the classification of certain cash receipts and payments within the statement of cash flows. Specifically, the amended guidance addresses the following: (i) debt prepayment or debt extinguishment costs; (ii) settlement of zero-coupon bonds; (iii) contingent payments made after a business combination; (iv) proceeds from the settlement of insurance claims; (v) proceeds from the settlement of corporate-owned life insurance policies, including BOLI policies; (vi) distributions received from equity method investees; (vii) beneficial interests in securitization transactions; and (viii) separately identifiable cash flows and application of the predominance principle. For public business entities this new guidance is effective in fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017 (January 1, 2018 for People’s United). The retrospective transition method will be applied to all periods presented and early adoption is permitted. An entity that elects early adoption must adopt all of the amendments in the same period. The adoption of this amendment is not expected to have a significant impact on the Company’s Consolidated Financial Statements.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Standards effective in 2019
Accounting for Leases
In February 2016, the FASB amended its standards with respect to the accounting for leases. The amended guidance serves to replace all current U.S. GAAP guidance on this topic and requires that an operating lease be recognized on the statement of condition as a “right-to-use” asset along with a corresponding liability representing the rent obligation. Key aspects of current lessor accounting remain unchanged from existing guidance. This standard is expected to result in an increase to assets and liabilities recognized and, therefore, increase risk-weighted assets for regulatory capital purposes. The guidance requires the use of the modified retrospective transition approach for existing leases that have not expired before the date of initial application and will become effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 (January 1, 2019 for People’s United).
The Company has begun its evaluation of the amended guidance including the potential impact on its Consolidated Financial Statements. To date, the Company has identified several areas that are within the scope of the guidance, including its contracts with respect to leased real estate and office equipment. In addition, operating lease agreements entered into with customers by the Company’s equipment financing businesses are also subject to the new guidance. The Company continues to evaluate the impact of the guidance, including determining whether additional contracts exist that are deemed to be in scope. As such, no conclusions have yet been reached regarding the potential impact of adoption on the Company’s Consolidated Financial Statements. Further, to date, no guidance has been issued by either the Company’s or the Bank’s primary regulator with respect to how the impact of the amended standard is to be treated for regulatory capital purposes.
Standards effective in 2020
Financial Instruments - Credit Losses
In June 2016, the FASB amended its standards with respect to certain aspects of measurement, recognition and disclosure of credit losses on loans and other financial instruments, including available-for-sale debt securities and purchased financial assets with credit deterioration. The amendment is to be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, a modified-retrospective approach). For certain assets (such as debt securities for which an other-than-temporary impairment has been recognized before the effective date and purchased financial assets with credit deterioration), a prospective transition approach is required. For public business entities, this new amendment is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 (January 1, 2020 for People’s United) and earlier application is permitted as of the beginning of an interim or annual reporting period beginning after December 15, 2018.
While early adoption is permitted, the Company does not expect to elect that option. The Company has begun its evaluation of the amended guidance including the potential impact on its Consolidated Financial Statements. As a result of the required change in approach toward determining estimated credit losses from the current “incurred loss” model to one based on estimated cash flows over a loan’s contractual life, adjusted for prepayments (a “life of loan” model), the Company expects the new guidance will result in an increase in the allowance for loan losses, particularly for longer duration portfolios. The Company also expects the new guidance may result in an allowance for debt securities. In both cases, the extent of the change is indeterminable at this time as it will be dependent upon portfolio composition and credit quality at the adoption date, as well as economic conditions and forecasts at that time. Further, to date, no guidance has been issued by either the Company’s or the Bank’s primary regulator with respect to how the impact of the amended standard is to be treated for regulatory capital purposes.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Simplifying the Test for Goodwill Impairment
In January 2017, the FASB amended its standards with respect to goodwill, simplifying how an entity is required to conduct the impairment assessment by eliminating “Step 2”, which requires a hypothetical purchase price allocation, from the goodwill impairment test. Instead, goodwill impairment will now be measured as the amount by which a reporting unit’s carrying amount exceeds its fair value, not to exceed the carrying amount of goodwill. An entity will still have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. For public business entities this new guidance is effective in fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 (January 1, 2020 for People’s United) and is to be applied prospectively. Early adoption is permitted for any impairment tests performed after January 1, 2017. The adoption of this amendment is not expected to have a significant impact on the Company’s Consolidated Financial Statements.
NOTE 2 - Acquisitions
Acquisitions Completed in 2016
Gerstein Fisher
In November 2016, PSI completed its acquisition of Gerstein, Fisher & Associates, Inc. (“Gerstein Fisher”), a $3 billion investment management firm based in New York City, in an all-cash transaction. The acquisition brings People’s United Wealth Management’s total assets under administration to slightly over $21 billion, of which approximately $8 billion are under discretionary management. The fair value of the consideration transferred in the Gerstein Fisher acquisition consisted of $57.4 million in cash and $18.3 million in contingent consideration. The Company’s results of operations for the year ended December 31, 2016 include the results of Gerstein Fisher for November and December 2016.
In connection with the acquisition, the Company recorded: (i) goodwill of $31.7 million; (ii) other acquisition-related intangible assets, representing customer relationships, trade name, and non-compete, favorable lease and fund management contracts, totaling $42.3 million; and (iii) other assets totaling $1.7 million. Merger-related expenses recorded in 2016 relating to this transaction totaled $1.9 million.
Eagle Insurance
In April 2016, PUIA completed its acquisition of Eagle Insurance Group, LLC (“Eagle Insurance”), a Massachusetts-based insurance brokerage firm, focused on commercial insurance, in an all-cash transaction. The fair value of the consideration transferred in the Eagle Insurance acquisition consisted of $2.4 million in cash and $1.5 million in contingent consideration. In connection with the acquisition, the Company recorded (i) goodwill of $2.3 million and (ii) other acquisition-related intangible assets, representing insurance customer relationships, of $1.6 million.
Acquisition Completed in 2015
Kesten-Brown Insurance
In October 2015, PUIA completed its acquisition of Kesten-Brown Insurance, LLC (“Kesten-Brown”), a Connecticut-based insurance brokerage firm that focuses on commercial lines and employee benefits, in an all-cash transaction. The fair value of the consideration transferred in the Kesten-Brown acquisition consisted of $10.2 million in cash and $2.0 million in contingent consideration. In connection with the acquisition, the Company recorded: (i) goodwill of $7.1 million; (ii) other acquisition-related intangible assets, representing insurance customer relationships, of $5.0 million; and (iii) other assets of $0.1 million.
Recent acquisitions have been undertaken with the objective of expanding the Company’s business, both geographically and through product offerings, as well as realizing synergies and economies of scale by combining with the acquired entities. For these reasons, a market-based premium was paid for the acquired entities which, in turn, resulted in the recognition of goodwill, representing the excess of the respective purchase prices over the estimated fair value of the net assets acquired (see Note 6).
All of People’s United’s tax deductible goodwill was created in transactions in which the Company purchased the assets of the target (as opposed to purchasing the issued and outstanding stock of the target). At December 31, 2016 and 2015, tax deductible goodwill totaled $77.9 million and $24.1 million, respectively.
NOTE 3 - Cash and Short-Term Investments
A combination of reserves in the form of deposits with the FRB-NY and vault cash, totaling $91.8 million and $86.0 million at December 31, 2016 and 2015, respectively, were maintained to satisfy federal regulatory requirements. Vault cash is included in cash and due from banks and interest-bearing deposits at the FRB-NY are included in short-term investments in the Consolidated Statements of Condition. These deposits represent an alternative to overnight federal funds sold and had yields of 0.75% and 0.50% at December 31, 2016 and 2015, respectively.
Short-term investments consist of the following cash equivalents:
(1) Includes cash collateral posted for certain derivative positions at December 31, 2015 (none at December 31, 2016).
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 4 - Securities
The amortized cost, gross unrealized gains and losses, and fair value of People’s United’s securities available for sale and securities held to maturity are as follows:
Securities available for sale with a fair value of $1.83 billion and $1.64 billion at December 31, 2016 and 2015, respectively, were pledged as collateral for public deposits and for other purposes.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following table is a summary of the amortized cost, fair value and fully taxable equivalent (“FTE”) yield of debt securities as of December 31, 2016, based on remaining period to contractual maturity. Information for GSE mortgage-backed securities and CMOs is based on the final contractual maturity dates without considering repayments and prepayments.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following tables summarize debt securities with unrealized losses, segregated by the length of time the securities have been in a continuous unrealized loss position at the respective dates. Certain unrealized losses totaled less than $0.1 million.
At December 31, 2016, approximately 36% of the 1,684 securities owned by the Company, consisting of 125 securities classified as available for sale and 482 securities classified as held to maturity, had gross unrealized losses totaling $68.6 million and $26.7 million, respectively. All of the GSE mortgage-backed securities and CMOs had AAA credit ratings and an average contractual maturity of 12 years. The state and municipal securities had an average credit rating of AA and an average maturity of 14 years.
The cause of the gross unrealized losses with respect to all of these securities is directly related to changes in interest rates. At this time, management does not intend to sell such securities nor is it more likely than not, based upon available evidence, that management will be required to sell such securities prior to recovery. As such, management believes that all gross unrealized losses within the securities portfolio at December 31, 2016 are temporary impairments. No other-than-temporary impairment losses were recognized in the Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
People’s United uses the specific identification method to determine the cost of securities sold and records securities transactions on the trade date. In 2016, People’s United sold U.S. Treasury and CMO securities with an amortized cost of $403 million and recorded $6.1 million of gross realized losses. Including other minor gains and losses, net security losses totaled $5.9 million for the year ended December 31, 2016.
The components of net security (losses) gains on debt securities are summarized below. Net gains and losses on trading account securities, which are not included in the table below, totaled less than $0.1 million for each of the years ended December 31, 2016, 2015 and 2014.
The Bank, as a member of the FHLB of Boston, is currently required to purchase and hold shares of capital stock in the FHLB of Boston (total cost of $155.0 million and $154.0 million at December 31, 2016 and 2015, respectively) in an amount equal to its membership base investment plus an activity based investment determined according to the Bank’s level of outstanding FHLB advances. As a result of the Smithtown Bancorp, Inc. acquisition, the Bank acquired shares of capital stock in the FHLB of New York (total cost of $11.3 million at both December 31, 2016 and 2015). Based on the current capital adequacy and liquidity position of both the FHLB of Boston and the FHLB of New York, management believes there is no impairment in the Company’s investment at December 31, 2016 and the cost of the investment approximates fair value. Dividend income on FHLB capital stock totaled $5.8 million, $4.6 million and $2.8 million for the years ended December 31, 2016, 2015 and 2014, respectively.
The Bank, as a member of the Federal Reserve Bank system beginning in 2015, is currently required to purchase and hold shares of capital stock in the FRB-NY (total cost of $149.5 million and $140.1 million at December 31, 2016 and 2015, respectively) in an amount equal to 6% of its capital and surplus. Based on the current capital adequacy and liquidity position of the FRB-NY, management believes there is no impairment in the Company’s investment at December 31, 2016 and the cost of the investment approximates fair value. Dividend income on FRB-NY capital stock totaled $3.1 million and $7.1 million for the years ended December 31, 2016 and 2015, respectively.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 5 - Loans
For purposes of disclosures related to the credit quality of financing receivables and the allowance for loan losses, People’s United has identified two loan portfolio segments, Commercial and Retail, which are comprised of the following loan classes:
•
Commercial Portfolio: commercial real estate; commercial and industrial; and equipment financing.
•
Retail Portfolio: residential mortgage; home equity; and other consumer.
Loans acquired in connection with business combinations are referred to as ‘acquired’ loans as a result of the manner in which they are accounted for (see further discussion under ‘Acquired Loans’ in Note 1). All other loans are referred to as ‘originated’ loans. Accordingly, selected credit quality disclosures that follow are presented separately for the ‘originated’ loan portfolio and the ‘acquired’ loan portfolio.
The following table summarizes People’s United’s loans by loan portfolio segment and class:
Net deferred loan costs, which are included in loans by respective class and accounted for as interest yield adjustments, totaled $69.9 million and $59.8 million at December 31, 2016 and 2015, respectively.
At December 31, 2016, 26%, 19% and 18% of the Company’s loans by outstanding principal amount were to customers located within Connecticut, New York and Massachusetts, respectively. Loans to customers located in the New England states as a group represented 59% of total loans at both December 31, 2016 and 2015, respectively. Substantially the entire equipment financing portfolio (96% and 97% at December 31, 2016 and 2015, respectively) was to customers located outside of New England. At December 31, 2016, 29% of the equipment financing portfolio was to customers located in Texas, California and New York, and no other state exposure was greater than 5%.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Commercial real estate loans include construction loans totaling $604.1 million and $630.6 million at December 31, 2016 and 2015, respectively, net of the unadvanced portion of such loans totaling $243.1 million and $314.1 million, respectively.
At December 31, 2016, residential mortgage loans included $1.2 billion of interest-only loans compared to $1.1 billion at December 31, 2015. People’s United’s underwriting guidelines and requirements for such loans are generally more restrictive than those applied to other types of residential mortgage products. Also included in residential mortgage loans are construction loans totaling $84.2 million and $105.7 million at December 31, 2016 and 2015, respectively, net of the unadvanced portion of such loans totaling $21.4 million and $38.6 million, respectively.
People’s United sells newly-originated residential mortgage loans in the secondary market, without recourse. Net gains on sales of residential mortgage loans totaled $6.3 million, $5.5 million and $2.9 million for the years ended December 31, 2016, 2015 and 2014, respectively. Loans held for sale at December 31, 2016 and 2015 consisted of newly-originated residential mortgage loans with carrying amounts of $39.3 million and $34.5 million, respectively. During 2015 and 2014 (none in 2016), the Company sold acquired loans with outstanding principal balances totaling $24.1 million and $10.4 million, respectively (carrying amounts of $22.3 million and $10.3 million, respectively) and recognized net gains (losses) on sales totaling $1.7 million and $(0.9) million, respectively.
The following table presents a summary, by loan portfolio segment, of activity in the allowance for loan losses for the years ended December 31, 2016, 2015 and 2014. With respect to the originated portfolio, an allocation of a portion of the allowance to one segment does not preclude its availability to absorb losses in another segment.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following is a summary, by loan portfolio segment and impairment methodology, of the allowance for loan losses and related portfolio balances:
The recorded investments, by class of loan, of originated non-performing loans are summarized as follows:
(1) Reported net of government guarantees totaling $13.1 million, $16.9 million and $17.6 million at December 31, 2016, 2015 and 2014, respectively. These government guarantees relate, almost entirely, to guarantees provided by the Small Business Administration as well as selected other Federal agencies and represent the carrying value of the loans that are covered by such guarantees, the extent of which (i.e. full or partial) varies by loan. At December 31, 2016, the principal loan classes to which these government guarantees relate are commercial and industrial loans (99%) and commercial real estate loans (1%).
(2) Includes $9.8 million, $19.9 million and $18.9 million of loans in the process of foreclosure at December 31, 2016, 2015 and 2014, respectively.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The preceding table excludes acquired loans that are (i) accounted for as purchased credit impaired loans or (ii) covered by an FDIC loss-share agreement (“LSA”) totaling $21.6 million and $3.1 million, respectively, at December 31, 2016; $27.7 million and $2.3 million, respectively, at December 31, 2015; and $100.6 million and $3.0 million, respectively, at December 31, 2014. Such loans otherwise meet People’s United’s definition of a non-performing loan but are excluded because the loans are included in loan pools that are considered performing and/or credit losses are covered by an FDIC LSA. The discounts arising from recording these loans at fair value were due, in part, to credit quality. The acquired loans are generally accounted for on a pool basis and the accretable yield on the pools is being recognized as interest income over the life of the loans based on expected cash flows at the pool level.
If interest payments on all originated loans classified as non-performing at December 31, 2016, 2015 and 2014 had been made during the respective years in accordance with the loan agreements, interest income of $14.4 million, $14.1 million and $16.1 million would have been recognized on such loans for the respective years. Interest income actually recognized on originated non-performing loans totaled $1.8 million, $1.6 million and $3.2 million for the years ended December 31, 2016, 2015 and 2014, respectively.
At December 31, 2016 and 2015, People’s United’s recorded investment in originated loans classified as TDRs totaled $189.9 million and $195.7 million, respectively. The related allowance for loan losses was $4.2 million at December 31, 2016 and $5.9 million at December 31, 2015. Interest income recognized on TDRs totaled $4.8 million, $4.6 million and $3.8 million for the years ended December 31, 2016, 2015 and 2014, respectively. Fundings under commitments to lend additional amounts to borrowers with loans classified as TDRs were immaterial for the years ended December 31, 2016, 2015 and 2014. Originated loans that were modified and classified as TDRs during 2016 principally involve reduced payment and/or payment deferral, extension of term (generally no more than two years for commercial loans and nine years for retail loans) and/or a temporary reduction of interest rate (generally less than 200 basis points).
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following tables summarize, by class of loan, the recorded investments in loans modified as TDRs during the years ended December 31, 2016 and 2015. For purposes of this disclosure, recorded investments represent amounts immediately prior to and subsequent to the restructuring.
(1) Represents the following concessions: extension of term (13 contracts; recorded investment of $8.1 million); reduced payment and/or payment deferral (3 contracts; recorded investment of $3.0 million); or a combination of concessions (2 contracts; recorded investment of $17.1 million).
(2) Represents the following concessions: extension of term (32 contracts; recorded investment of $23.4 million); reduced payment and/or payment deferral (10 contracts; recorded investment of $9.9 million); or a combination of concessions (9 contracts; recorded investment of $11.6 million).
(3) Represents the following concessions: extension of term (17 contracts; recorded investment of $6.2 million); reduced payment and/or payment deferral (30 contracts; recorded investment of $17.6 million); or a combination of concessions (14 contracts; recorded investment of $6.9 million).
(4) Represents the following concessions: loans restructured through bankruptcy (21 contracts; recorded investment of $3.7 million); reduced payment and/or payment deferral (13 contracts; recorded investment of $5.8 million); or a combination of concessions (23 contracts; recorded investment of $6.0 million).
(5) Represents the following concessions: loans restructured through bankruptcy (38 contracts; recorded investment of $2.5 million); reduced payment and/or payment deferral (4 contracts; recorded investment of $0.4 million); or a combination of concessions (20 contracts; recorded investment of $1.6 million).
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(1) Represents the following concessions: extension of term (21 contracts; recorded investment of $8.9 million); reduced payment and/or payment deferral (2 contracts; recorded investment of $1.2 million); or a combination of concessions (3 contracts; recorded investment of $5.1 million).
(2) Represents the following concessions: extension of term (35 contracts; recorded investment of $41.1 million); reduced payment and/or payment deferral (20 contracts; recorded investment of $35.9 million); or a combination of concessions (6 contracts; recorded investment of $3.6 million).
(3) Represents the following concessions: extension of term (1 contract; recorded investment of $0.1 million); reduced payment and/or payment deferral (38 contracts; recorded investment of $21.5 million); or a combination of concessions (9 contracts; recorded investment of $6.9 million).
(4) Represents the following concessions: loans restructured through bankruptcy (24 contracts; recorded investment of $5.9 million); reduced payment and/or payment deferral (13 contracts; recorded investment of $4.7 million); temporary rate reduction (2 contracts; recorded investment of $0.3 million); or a combination of concessions (27 contracts; recorded investment of $9.2 million).
(5) Represents the following concessions: loans restructured through bankruptcy (61 contracts; recorded investment of $5.2 million); reduced payment and/or payment deferral (7 contracts; recorded investment of $0.8 million); temporary rate reduction (1 contract; recorded investment of $0.5 million); or a combination of concessions (29 contracts; recorded investment of $3.0 million).
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following is a summary, by class of loan, of information related to TDRs of originated loans completed within the previous 12 months that subsequently defaulted during the years ended December 31, 2016 and 2015. For purposes of this disclosure, the previous 12 months is measured from January 1 of the respective prior year and a default represents a previously-modified loan that became past due 30 days or more during 2016 or 2015.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
People’s United’s impaired loans consist of certain originated loans, including all TDRs. The following table summarizes, by class of loan, information related to individually-evaluated impaired loans within the originated portfolio.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following table summarizes, by class of loan, the average recorded investment and interest income recognized on impaired loans for the periods indicated. The average recorded investment amounts are based on month-end balances.
The following tables summarize, by class of loan, aging information for originated loans:
Included in the “Current” and “30-89 Days” categories above are early non-performing commercial real estate loans, commercial and industrial loans, and equipment financing loans totaling $10.5 million, $24.8 million and $28.4 million, respectively, and $17.6 million of retail loans in the process of foreclosure or bankruptcy. These loans are less than 90 days past due but have been placed on non-accrual status as a result of having been identified as presenting uncertainty with respect to the collectability of interest and principal.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Included in the “Current” and “30-89 Days” categories above are early non-performing commercial real estate loans, commercial and industrial loans, and equipment financing loans totaling $16.0 million, $15.0 million and $20.5 million, respectively, and $21.8 million of retail loans in the process of foreclosure or bankruptcy. These loans are less than 90 days past due but have been placed on non-accrual status as a result of having been identified as presenting uncertainty with respect to the collectability of interest and principal.
Commercial Credit Quality Indicators
The Company utilizes an internal loan risk rating system as a means of monitoring portfolio credit quality and identifying both problem and potential problem loans. Under the Company’s risk rating system, loans not meeting the criteria for problem and potential problem loans as specified below are considered to be “Pass”-rated loans. Problem and potential problem loans are classified as either “Special Mention,” “Substandard” or “Doubtful.” Loans that do not currently expose the Company to sufficient enough risk of loss to warrant classification as either Substandard or Doubtful, but possess weaknesses that deserve management’s close attention, are classified as Special Mention. Substandard loans represent those credits characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful possess all the weaknesses inherent in those classified Substandard with the added characteristic that collection or liquidation in full, on the basis of existing facts, conditions and values, is highly questionable and/or improbable.
Risk ratings on commercial loans are subject to ongoing monitoring by lending and credit personnel with such ratings updated annually or more frequently, if warranted. The Company’s internal Loan Review function is responsible for independently evaluating the appropriateness of those credit risk ratings in connection with its cyclical reviews, the approach to which is risk-based and determined by reference to underlying portfolio credit quality and the results of prior reviews. Differences in risk ratings noted in conjunction with such periodic portfolio loan reviews, if any, are reported to management each month.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Retail Credit Quality Indicators
Pools of smaller-balance, homogeneous loans with similar risk and loss characteristics are also assessed for probable losses. These loan pools include residential mortgage, home equity and other consumer loans that are not assigned individual loan risk ratings. Rather, the assessment of these portfolios is based upon a consideration of recent historical loss experience, broader portfolio indicators, including trends in delinquencies, non-performing loans and portfolio concentrations, and portfolio-specific risk characteristics, the combination of which determines whether a loan is classified as “High”, “Moderate” or “Low” risk.
The portfolio-specific risk characteristics considered include: (i) collateral values/LTV ratios (above and below 70%); (ii) borrower credit scores under the FICO scoring system (above and below a score of 680); and (iii) other relevant portfolio risk elements such as income verification at the time of underwriting (stated income vs. non-stated income) and the property’s intended use (owner occupied, non-owner occupied, second home, etc.). In classifying a loan as either “High”, “Moderate” or “Low” risk, the combination of each of the aforementioned risk characteristics is considered for that loan, resulting, effectively, in a “matrix approach” to its risk classification. These risk classifications are reviewed quarterly to ensure that they continue to be appropriate in light of changes within the portfolio and/or economic indicators as well as other industry developments.
For example, to the extent LTV ratios exceed 70% (reflecting a weaker collateral position for the Company) or borrower FICO scores are less than 680 (reflecting weaker financial standing and/or credit history of the customer), the loans are considered to have an increased level of inherent loss. As a result, a loan with a combination of these characteristics would generally be classified as “High” risk. Conversely, as LTV ratios decline (reflecting a stronger collateral position for the Company) or borrower FICO scores exceed 680 (reflecting stronger financial standing and/or credit history of the customer), the loans are considered to have a decreased level of inherent loss. A loan with a combination of these characteristics would generally be classified as “Low” risk. This analysis also considers (i) the extent of underwriting that occurred at the time of origination (direct income verification provides further support for credit decisions) and (ii) the property’s intended use (owner-occupied properties are less likely to default compared to ‘investment-type’ non-owner occupied properties, second homes, etc.). Loans not otherwise deemed to be “High” or “Low” risk are classified as “Moderate” risk.
LTV ratios and FICO scores are determined at origination and updated periodically throughout the life of the loan. LTV ratios are updated for loans 90 days past due and FICO scores are updated for the entire portfolio quarterly. The portfolio stratification (“High”, “Moderate” and “Low” risk) and identification of the corresponding credit quality indicators also occurs quarterly.
Commercial and Retail loans are also evaluated to determine whether they are impaired loans. Such loans are included in the tabular disclosures of credit quality indicators that follow.
Acquired Loans Credit Quality Indicators
Upon acquiring a loan portfolio, the Company’s internal Loan Review function undertakes the process of assigning risk ratings to all commercial loans in accordance with the Company’s established policy, which may differ in certain respects from the risk rating policy of the predecessor company. The length of time necessary to complete this process varies based on the size of the acquired portfolio, the quality of the documentation maintained in the underlying loan files and the extent to which the predecessor company followed a risk rating approach comparable to People’s United’s. As a result, while acquired loans are risk rated, there are occasions when such ratings may be deemed “preliminary” until the Company’s re-rating process has been completed.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Acquired loans are initially recorded at fair value, determined based upon an estimate of the amount and timing of both principal and interest cash flows expected to be collected and discounted using a market interest rate. The difference between contractually required principal and interest payments at the acquisition date and the undiscounted cash flows expected to be collected at the acquisition date is referred to as the “nonaccretable difference”, which includes an estimate of future credit losses expected to be incurred over the life of the portfolio. A decrease in the expected cash flows in subsequent periods requires the establishment of an allowance for loan losses at that time. At December 31, 2016 and 2015, the allowance for loan losses on acquired loans was $6.3 million and $8.1 million, respectively.
The following tables summarize, by class of loan, credit quality indicators:
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Acquired Loans
At the respective acquisition dates, on an aggregate basis, the acquired loan portfolio had contractually required principal and interest payments receivable of $7.57 billion; expected cash flows of $7.02 billion; and a fair value (initial carrying amount) of $5.36 billion. The difference between the contractually required principal and interest payments receivable and the expected cash flows ($550.9 million) represented the initial nonaccretable difference. The difference between the expected cash flows and fair value ($1.66 billion) represented the initial accretable yield. Both the contractually required principal and interest payments receivable and the expected cash flows reflect anticipated prepayments, determined based on historical portfolio experience. At December 31, 2016, the outstanding principal balance and carrying amount of the acquired loan portfolio were $707.0 million and $610.2 million, respectively ($901.9 million and $796.6 million, respectively, at December 31, 2015).
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following table summarizes activity in the accretable yield for the acquired loan portfolio:
(1) Results in increased interest accretion as a prospective yield adjustment over the remaining life of the corresponding pool of loans.
(2) Represents changes in cash flows expected to be collected due to factors other than credit (e.g. changes in prepayment assumptions and/or changes in interest rates on variable rate loans), as well as loan sales, modifications and payoffs.
FDIC Loss-Share Receivable
On April 16, 2010, the Bank entered into a definitive purchase and assumption agreement (the “Agreement”) with the FDIC pursuant to which the Bank assumed all of the deposits, certain assets and the banking operations of Butler Bank. The Agreement also provides for loss-share coverage by the FDIC, up to certain limits, on all covered assets (loans and REO). The FDIC is obligated to reimburse the Bank for 80% of any future losses on covered assets up to $34.0 million. The Bank will reimburse the FDIC for 80% of recoveries with respect to losses for which the FDIC paid 80% reimbursement under the loss-sharing coverage.
The asset arising from the loss-sharing coverage, referred to as the “FDIC loss-share receivable,” totaled $1.8 million and $3.5 million at December 31, 2016 and 2015, respectively, and is included in other assets in the Consolidated Statements of Condition. The FDIC loss-share receivable is measured separately from the covered loans because the coverage is not contractually embedded in the loans and is not transferable should the Bank choose to dispose of the covered loans. The FDIC loss-share receivable will be reduced as losses are realized on covered assets and as loss-sharing payments are received from the FDIC. Realized losses in excess of the acquisition date estimates will result in an increase in the FDIC loss-share receivable. Conversely, the FDIC loss-share receivable will be reduced if realized losses are less than the estimates at acquisition. The amount ultimately collected for the FDIC loss-share receivable is dependent upon the performance of the underlying covered assets over time and claims submitted to the FDIC. In the event that losses under the loss-share coverage do not reach expected levels, the Bank has agreed to make a cash payment to the FDIC on approximately the tenth anniversary of the Agreement.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 6 - Goodwill and Other Acquisition-Related Intangible Assets
Goodwill
Changes in the carrying amount of People’s United’s goodwill are summarized as follows:
Other Acquisition-Related Intangible Assets
The following is a summary of People’s United’s other acquisition-related intangible assets:
Other acquisition-related intangible assets subject to amortization have an original weighted-average amortization period of 14 years. Amortization expense of other acquisition-related intangible assets totaled $23.6 million, $23.9 million and $24.8 million for the years ended December 31, 2016, 2015 and 2014, respectively. Scheduled amortization expense attributable to other acquisition-related intangible assets for each of the next five years is as follows: $24.7 million in 2017; $13.2 million in 2018; $12.4 million in 2019; $12.0 million in 2020; and $11.7 million in 2021.
There were no impairment losses relating to goodwill or other acquisition-related intangible assets recorded during the years ended December 31, 2016, 2015 and 2014.
NOTE 7 - Premises and Equipment
The components of premises and equipment are summarized below:
Depreciation and amortization expense included in occupancy and equipment expense in the Consolidated Statements of Income totaled $36.9 million, $39.3 million and $39.6 million for the years ended December 31, 2016, 2015 and 2014, respectively.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 8 - Other Assets and Other Liabilities
The components of other assets are as follows:
(1) During the quarter ended June 30, 2014, the Bank formed a joint venture with Vantiv, Inc. to provide a comprehensive suite of payment solutions to businesses throughout the Bank’s footprint. The Bank retained a 49% minority interest in the joint venture and recognized a $20.6 million gain, net of related expenses, resulting from its formation. The gain represented the fair value of the Bank’s entire portfolio of merchant contracts that were contributed to the joint venture and which previously had a zero book basis. The investment in the joint venture is accounted for using the equity method of accounting.
(2) During the quarter ended December 31, 2015, the Bank sold its payroll services business and recognized a $9.2 million gain, net of related expenses. The gain represented the fair value of the Bank’s entire portfolio of payroll services customer contracts, which previously had a zero book basis. In connection with this transaction, the Bank recorded a contingent receivable, which totaled $0.3 million and $2.8 million at December 31, 2016 and 2015, respectively.
(3) As discussed in Notes 1 and 11, debt issuance costs totaling $5.6 million at December 31, 2015, previously included in other assets, are now included as a component of notes and debentures in the Consolidated Statements of Condition.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The components of other liabilities are as follows:
(1) In connection with recent acquisitions, the Company recorded contingent payables, which totaled $21.4 million and $2.0 million at December 31, 2016 and 2015, respectively (see Note 2).
NOTE 9 - Deposits
The following is an analysis of People’s United’s total deposits by product type:
Time deposits issued in amounts of $100,000 or more totaled $2.0 billion and $2.1 billion at December 31, 2016 and 2015, respectively. Overdrafts of non-interest-bearing deposit accounts totaling $1.7 million and $1.6 million at December 31, 2016 and 2015, respectively, have been classified as loans.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Interest expense on deposits is summarized as follows:
NOTE 10 - Borrowings
People’s United’s borrowings are summarized as follows:
At December 31, 2016, the Bank’s total borrowing capacity from (i) the FHLB of Boston and the FRB-NY for advances and (ii) repurchase agreements was $11.6 billion based on the level of qualifying collateral available for these borrowings. In addition, the Bank had unsecured borrowing capacity of $1.0 billion at that date. FHLB advances are secured by the Bank’s investment in FHLB stock and by a security agreement that requires the Bank to maintain, as collateral, sufficient qualifying assets not otherwise pledged (principally single-family residential mortgage loans, home equity lines of credit and loans, and commercial real estate loans).
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Interest expense on borrowings consists of the following:
Information concerning People’s United’s borrowings is presented below:
NOTE 11 - Notes and Debentures
Notes and debentures are summarized as follows:
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The 3.65% senior notes represent fixed-rate unsecured and unsubordinated obligations of People’s United with interest payable semi-annually. The Company may redeem the senior notes at its option, in whole or in part, at any time prior to September 6, 2022, at a redemption price equal to the greater of (i) 100% of the principal amount of the senior notes to be redeemed or (ii) a “make-whole” amount, plus in either case accrued and unpaid interest to the redemption date. In addition, the Company may redeem the senior notes at its option, in whole or in part, at any time on or following September 6, 2022, at a redemption price equal to 100% of the principal amount of the senior notes to be redeemed, plus accrued and unpaid interest to the redemption date.
People’s United assumed the 5.80% fixed-rate/floating-rate subordinated notes in connection with its acquisition of Chittenden Corporation (“Chittenden”). These subordinated notes, which were issued in 2007 and are due in February 2017, represent unsecured general obligations of People’s United with interest payable semi-annually. The notes had a coupon of 5.80% for the first five years and converted to a variable rate in year six that is tied to the three month LIBOR plus 68.5 basis points. At December 31, 2016, the interest rate was 1.59%. In 2011, People’s United entered into an interest rate swap to hedge the LIBOR-based floating rate payments on these subordinated notes, which began in February 2012 (see Note 21). People’s United has the option to redeem the notes, in whole or in part, on any interest payment date at a redemption price of 100% of the principal amount of the redeemed notes, plus any accrued but unpaid interest (see Note 25).
The 4.00% subordinated notes represent fixed-rate unsecured and subordinated obligations of the Bank with interest payable semi-annually. The Bank may redeem the notes, in whole or in part, on or after April 16, 2024 at a redemption price equal to 100% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. The Bank may redeem the notes in whole, but not in part, at its option at a redemption price equal to 100% of the principal amount of the notes together with accrued but unpaid interest to, but excluding, the date fixed for redemption, within 90 days of the occurrence of a “regulatory event” (as defined). Pursuant to capital regulations of the OCC, effective January 1, 2015, the Bank may not redeem the notes prior to maturity without the prior approval of the OCC. The Bank has entered into a pay floating/receive fixed interest rate swap to hedge the change in fair value of the subordinated notes due to changes in interest rates (see Note 21). For regulatory capital purposes, subordinated note issuances qualify, up to certain limits, as Tier 2 capital for both People’s United’s and the Bank’s Total risk-based capital (see Note 14).
As discussed in Note 1, effective January 1, 2016, the Company adopted, with retrospective application, amended standards with respect to the presentation of debt issuance costs by changing the presentation of such costs from an asset on the statement of condition to a deduction from the related debt liability. The adoption of this new guidance did not impact the Company’s results of operations or cash flows. In accordance with the amended standard, debt issuance costs totaling $5.6 million at December 31, 2015, previously included in other assets, are now included as a component of notes and debentures in the Consolidated Statements of Condition.
NOTE 12 - Income Taxes
The following is a summary of total income tax expense:
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The components of income tax expense applicable to pre-tax income are summarized as follows:
(1) Includes the effect of decreases in the valuation allowance for state deferred tax assets of $1.3 million, $0.1 million and $1.2 million in 2016, 2015 and 2014, respectively.
The following is a reconciliation of expected income tax expense, computed at the U.S. federal statutory rate of 35%, to actual income tax expense:
People’s United holds ownership interests in limited partnerships formed to develop and operate affordable housing units for lower income tenants throughout its franchise area. The underlying partnerships, which are considered variable interest entities, are not consolidated into the Company’s Consolidated Financial Statements. These investments have historically played a role in enabling the Bank to meet its Community Reinvestment Act requirements while, at the same time, providing federal income tax credits.
Affordable housing investments, including all legally binding commitments to fund future investments, are included in other assets in the Consolidated Statements of Condition ($195.2 million and $158.4 million at December 31, 2016 and 2015, respectively). Included in other liabilities in the Consolidated Statements of Condition is a liability for all legally binding unfunded commitments to fund future investments ($92.5 million and $74.9 million at those dates). The cost of the Company’s investments is amortized on a straight-line basis over the period during which the related federal income tax credits are realized (generally ten years). Amortization expense, which is included as a component of income tax expense in the Consolidated Statements of Income, totaled $12.6 million, $12.6 million and $10.7 million for the years ended December 31, 2016, 2015 and 2014, respectively.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
In 1998, the Bank formed a passive investment company, People’s Mortgage Investment Company (“PMIC”), in accordance with Connecticut tax laws, which permit transfers of mortgage loans to such subsidiaries on or after January 1, 1999. The related earnings of PMIC, and any dividends it pays to the Bank, are not subject to Connecticut income tax. As a result of the exclusion of such earnings and dividends from Connecticut taxable income beginning in 1999, the Bank has established a valuation allowance for the full amount of its Connecticut deferred tax asset attributable to net temporary differences and state net operating loss carryforwards. Connecticut tax net operating loss carryforwards totaled $1.4 billion at December 31, 2016 and expire between 2020 and 2036.
The tax effects of temporary differences that give rise to People’s United’s deferred tax assets and liabilities are as follows:
Based on People’s United’s recent historical and anticipated future pre-tax earnings and the reversal of taxable temporary differences, management believes it is more likely than not that People’s United will realize its total deferred tax assets, net of the valuation allowance.
People’s United’s current income tax receivable at December 31, 2016 and 2015 totaled $29.9 million and $26.3 million, respectively.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following is a reconciliation of the beginning and ending balances of People’s United’s unrecognized income tax benefits related to uncertain tax positions:
If recognized, the unrecognized income tax benefits at December 31, 2016 would minimally affect People’s United’s annualized income tax rate. Accrued interest expense related to the unrecognized income tax benefits totaled $0.7 million and $0.6 million at December 31, 2016 and 2015, respectively. People’s United recognizes accrued interest related to unrecognized income tax benefits and penalties, if incurred, as components of income tax expense in the Consolidated Statements of Income. The amount of total unrecognized income tax benefits is not expected to change significantly within the next twelve months. People’s United files a consolidated U.S. Federal income tax return and various state income tax returns and is no longer subject to federal or state income tax examinations through 2011.
NOTE 13 - Stockholders’ Equity and Dividends
People’s United is authorized to issue 50.0 million shares of preferred stock, par value of $0.01 per share, of which 10.0 million shares were outstanding as of December 31, 2016, and 1.95 billion shares of common stock, par value of $0.01 per share, of which 405.0 million shares were issued as of December 31, 2016.
On October 31, 2016, People’s United issued 10.0 million shares of fixed-to-floating rate non-cumulative perpetual preferred stock, Series A, with a par value of $0.01 per share and a liquidation preference of $25.00 per share. Proceeds from the issuance are presented in the Consolidated Statements of Condition net of issuance costs totaling $5.9 million. Dividends on the preferred stock are based on the liquidation preference amount and, when and if declared, will be payable quarterly in arrears on March 15, June 15, September 15 and December 15 of each year, beginning on December 15, 2016. Up to and including December 14, 2026, the dividend will be based on a fixed-rate of 5.625% per annum. From and including December 15, 2026, the dividend will be based on a floating-rate equal to three-month LIBOR plus a spread of 4.02% per annum. The Company may redeem the preferred stock at its option, from time to time, on or after December 15, 2026, at a redemption price equal to $25.00 per share.
Treasury stock includes (i) common stock repurchased by People’s United, either directly or through agents, in the open market at prices and terms satisfactory to management in connection with stock repurchases authorized by its Board of Directors (86.4 million shares at December 31, 2016) and (ii) common stock purchased in the open market by a trustee with funds provided by People’s United and originally intended for awards under the People’s United Financial, Inc. 2007 Recognition and Retention Plan (the “RRP”) (2.7 million shares at December 31, 2016). Following shareholder approval of the People’s United Financial, Inc. 2014 Long-Term Incentive Plan (the “2014 Plan”) in the second quarter of 2014, no new awards may be granted under the RRP (see Note 18).
In April 2007, People’s United established an Employee Stock Ownership Plan (the “ESOP”) (see Note 17). At that time, People’s United loaned the ESOP $216.8 million to purchase 10.5 million shares of People’s United common stock in the open market. Shares of People’s United common stock are held by the ESOP and allocated to eligible participants annually based upon a percentage of each participant’s eligible compensation. At December 31, 2016, 7.0 million shares of People’s United common stock, with a contra-equity balance of $144.6 million, have not been allocated or committed to be released.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Common dividends declared and paid per common share totaled $0.6775, $0.6675 and $0.6575 for the years ended December 31, 2016, 2015 and 2014, respectively. People’s United’s common dividend payout ratio (common dividends paid as a percentage of net income available to common shareholders) was 73.7%, 77.3% and 78.2% for the years ended December 31, 2016, 2015 and 2014, respectively.
In the ordinary course of business, People’s United is dependent upon dividends from the Bank to provide funds for the payment of dividends to shareholders and other general corporate purposes. People’s United’s ability to pay cash dividends is governed by federal law, regulations and related guidance. The Bank’s ability to pay cash dividends directly or indirectly to People’s United also is governed by federal law and regulations. These provide that the Bank must receive OCC approval to declare a dividend if the total amount of all dividends (common and preferred), including the proposed dividend, declared by the Bank in any current year exceeds the total of the Bank’s net income for the current year to date, combined with its retained net income for the previous two years, less the sum of any transfers required by the OCC and any transfers required to be made to a fund for the retirement of any preferred stock. The term “retained net income” as defined by federal regulations means the Bank’s net income for a specified period less the total amount of all dividends declared in that period.
The Bank may not pay dividends to People’s United if, after paying those dividends, it would fail to meet the required minimum levels under risk-based capital guidelines or if the OCC has notified the Bank that it is in need of more than normal supervision. See Note 14 for a discussion of regulatory capital requirements. Under the Federal Deposit Insurance Act, an insured depository institution such as the Bank is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is used in the Federal Deposit Insurance Act). Payment of dividends by the Bank also may be restricted at any time at the discretion of the appropriate regulator if it deems the payment to constitute an unsafe and unsound banking practice.
In 2016, 2015 and 2014, the Bank paid a total of $271.0 million, $245.0 million and $244.0 million, respectively, in cash dividends to People’s United (parent company). At December 31, 2016, the Bank’s retained net income, as defined by federal regulations, totaled $42.8 million.
NOTE 14 - Regulatory Capital Requirements
Bank holding companies and banks are subject to various regulations regarding capital requirements administered by U.S. banking agencies. The FRB (in the case of a bank holding company) and the OCC (in the case of a bank) may initiate certain actions if a bank holding company or a bank fails to meet minimum capital requirements. In addition, under its prompt corrective action regulations, the OCC is required to take certain supervisory actions (and may take additional discretionary actions) with respect to an undercapitalized bank. These actions could have a direct material effect on a bank’s financial statements. People’s United and the Bank are subject to regulatory capital requirements administered by the FRB and the OCC, respectively.
On January 1, 2015, both People’s United and the Bank became subject to new capital rules (the “Basel III capital rules”) issued by U.S. banking agencies. The Basel III capital rules, among other things: (i) introduced as a new capital measure “Common Equity Tier 1” (“CET 1”) capital; (ii) specified that Tier 1 capital consists of CET 1 capital and “Additional Tier 1 Capital” instruments meeting specified requirements; (iii) defined CET 1 capital narrowly by requiring that most adjustments to regulatory capital measures be made to CET 1 capital and not to the other components of capital; and (iv) expanded the scope of the adjustments as compared to prior regulations.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
When fully phased-in on January 1, 2019, the Basel III capital rules will require U.S. financial institutions to maintain: (i) a minimum ratio of CET 1 capital to total risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET 1 risk-based capital ratio as that buffer is phased-in beginning in 2016, effectively resulting in a minimum CET 1 risk-based capital ratio of 7.0% upon full implementation); (ii) a minimum ratio of Tier 1 capital to total risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 risk-based capital ratio as that buffer is phased-in beginning in 2016, effectively resulting in a minimum Tier 1 risk-based capital ratio of 8.5% upon full implementation); (iii) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to total risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% Total risk-based capital ratio as that buffer is phased-in beginning in 2016, effectively resulting in a minimum Total risk-based capital ratio of 10.5% upon full implementation); and (iv) a minimum Tier 1 Leverage capital ratio of at least 4.0%, calculated as the ratio of Tier 1 capital to average total assets, as defined.
In order to avoid limitations on distributions, including dividend payments, and certain discretionary bonus payments, a financial institution must hold a capital conservation buffer above its minimum risk-based capital requirements. For 2016, the capital conservation buffer is 0.625%.
The foregoing capital ratios are based in part on specific quantitative measures of assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting guidelines. Capital amounts and classifications are also subject to qualitative judgments by federal regulators about capital components, risk weightings and other factors.
Management believes that, as of December 31, 2016, both People’s United and the Bank met all capital adequacy requirements to which each is subject. Further, the most recent regulatory notification categorized the Bank as a well-capitalized institution under the prompt corrective action regulations. Since that notification, no conditions or events have occurred that have caused management to believe any change in the Bank’s capital classification would be warranted.
The following is a summary of People’s United’s and the Bank’s regulatory capital amounts and ratios under the Basel III capital rules. The improvement in People’s United’s Tier 1 and Total risk-based capital ratios since December 31, 2015 reflects, in part, the issuance of preferred stock in October 2016, which qualifies as a Tier 1 capital instrument (see Note 13). The improvement in the Bank’s capital ratios since December 31, 2015 reflects equity contributions from People’s United (parent company) during 2016. The minimum capital required amounts as of December 31, 2016 and 2015 are based on the capital conservation buffer phase-in provisions of the Basel III capital rules. In connection with the adoption of the Basel III capital rules, both the Company and the Bank elected to opt-out of the requirement to include most components of AOCL in CET 1 capital. At December 31, 2016, People’s United’s and the Bank’s total risk-weighted assets, as defined, were both $30.5 billion, compared to $29.6 billion for both entities at December 31, 2015.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(1) Tier 1 Leverage Capital ratio represents CET 1 Capital plus Additional Tier 1 Capital instruments (together, “Tier 1 Capital”) divided by Average Total Assets (less goodwill, other acquisition-related intangibles and other deductions from CET 1 Capital).
(2) CET 1 Risk-Based Capital ratio represents equity capital, as defined, less: (i) after-tax net unrealized gains (losses) on certain securities classified as available for sale; (ii) after-tax net unrealized gains (losses) on securities transferred to held to maturity; (iii) goodwill and other acquisition-related intangible assets; and (iv) the amount recorded in AOCL relating to pension and other postretirement benefits divided by Total Risk-Weighted Assets.
(3) Tier 1 Risk-Based Capital ratio represents Tier 1 Capital divided by Total Risk-Weighted Assets.
(4) Total Risk-Based Capital ratio represents Tier 1 Capital plus subordinated notes and debentures, up to certain limits, and the allowance for loan losses, up to 1.25% of Total Risk-Weighted Assets, divided by Total Risk-Weighted Assets.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Management currently estimates that, as of December 31, 2016, both the Company’s and the Bank’s risk-based capital ratios could be negatively impacted by as much as 10-20 basis points on a “fully phased-in” basis as compared to the risk-based capital ratios at December 31, 2016.
NOTE 15 - Earnings Per Common Share
The following is an analysis of People’s United’s basic and diluted EPS, reflecting the application of the two-class method, as described in Note 1:
All unallocated ESOP common shares and all common shares accounted for as treasury shares have been excluded from the calculation of basic and diluted EPS. Anti-dilutive equity-based awards totaling 13.6 million shares, 19.7 million shares and 17.7 million shares for the years ended December 31, 2016, 2015 and 2014, respectively, have also been excluded from the calculation of diluted EPS.
NOTE 16 - Comprehensive Income
Comprehensive income represents the sum of net income and items of “other comprehensive income or loss,” including (on an after-tax basis): (i) net actuarial gains and losses, prior service credits and costs, and transition assets and obligations related to People’s United’s pension and other postretirement plans; (ii) net unrealized gains and losses on securities available for sale; (iii) net unrealized gains and losses on securities transferred to held to maturity; and (iv) net unrealized gains and losses on derivatives accounted for as cash flow hedges. People’s United’s total comprehensive income for the years ended December 31, 2016, 2015 and 2014 is reported in the Consolidated Statements of Comprehensive Income.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following is a summary of the changes in the components of AOCL, which are included in People’s United’s stockholders’ equity on an after-tax basis:
(1) See the following table for details about these reclassifications.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following is a summary of the amounts reclassified from AOCL:
(1) Included in the computation of net periodic benefit income (expense) reflected in compensation and benefits expense (see Note 17 for additional details).
(2) Included in non-interest income.
(3) Included in interest and dividend income - securities.
(4) Included in interest expense - notes and debentures.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Deferred income taxes applicable to the components of AOCL are as follows:
The following is a summary of the components of People’s United’s total other comprehensive loss:
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 17 - Employee Benefit Plans
People’s United Employee Pension and Other Postretirement Plans
People’s United maintains a qualified noncontributory defined benefit pension plan (the “People’s Qualified Plan”) that covers substantially all full-time and part-time employees who (i) meet certain age and length of service requirements and (ii) were employed by the Bank prior to August 14, 2006. Benefits are based upon the employee’s years of credited service and either the average compensation for the last five years or the average compensation for the five consecutive years of the last ten years that produce the highest average.
New employees of the Bank starting on or after August 14, 2006 are not eligible to participate in the People’s Qualified Plan. Instead, the Bank makes contributions on behalf of these employees to a qualified defined contribution plan in an annual amount equal to 3% of the employee’s eligible compensation. Employee participation in this plan is restricted to employees who (i) are at least 18 years of age and (ii) worked at least 1,000 hours in a year. Both full-time and part-time employees are eligible to participate as long as they meet these requirements.
In July 2011, the Bank amended the People’s Qualified Plan to “freeze”, effective December 31, 2011, the accrual of pension benefits for People’s Qualified Plan participants. As such, participants will not earn any additional benefits after that date. Instead, effective January 1, 2012, the Bank began making contributions on behalf of these participants to a qualified defined contribution plan in an annual amount equal to 3% of the employee’s eligible compensation.
In addition to the People’s Qualified Plan, People’s United continues to maintain a qualified defined benefit pension plan that covers former Chittenden employees who meet certain eligibility requirements (the “Chittenden Qualified Plan”). Effective December 31, 2005, accrued benefits were frozen based on participants’ then-current service and pay levels. Interest continues to be credited on undistributed balances at a crediting rate specified by the Chittenden Qualified Plan. During April 2010, participants who were in payment status as of April 1, 2010, or whose accrued benefit as of that date was scheduled to be paid in the form of an annuity commencing May 1, 2010 based upon elections made by April 15, 2010, were transferred into the People’s Qualified Plan.
People’s United also maintains (i) unfunded, nonqualified supplemental plans to provide retirement benefits to certain senior officers (the “Supplemental Plans”) and (ii) an unfunded plan that provides retirees with optional medical, dental and life insurance benefits (the “Other Postretirement Plan”). People’s United accrues the cost of these postretirement benefits over the employees’ years of service to the date of their eligibility for such benefit.
An employer is required to recognize an asset or a liability for the funded status of pension and other postretirement plans. The funded status is measured as the difference between the fair value of plan assets and the applicable benefit obligation, which is the projected benefit obligation for a pension plan and the accumulated postretirement benefit obligation for an other postretirement plan. Plan assets and benefit obligations are required to be measured as of the date of the employer’s fiscal year-end.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following table summarizes changes in the benefit obligations and plan assets of the People’s Qualified Plan, the Chittenden Qualified Plan and the Supplemental Plans (together the “Pension Plans”) and the Other Postretirement Plan. The table also shows the funded status (or the difference between benefit obligations and plan assets) recognized in the Consolidated Statements of Condition. All plans have a December 31 measurement date.
(1) Represents the projected benefit obligation for the Pension Plans and the accumulated benefit obligation for the Other Postretirement Plan.
(2) During the quarter ended March 31, 2015, People’s United made voluntary employer contributions of $40.0 million to the People’s Qualified Plan and $10.0 million to the Chittenden Qualified Plan.
Plan assets for the People’s Qualified Plan and the Chittenden Qualified Plan (together the “Qualified Plans”) of $430.4 million and $47.6 million, respectively, as of December 31, 2016 exceeded the related projected benefit obligation ($405.5 million and $43.0 million, respectively) at that date.
Although the Supplemental Plans hold no assets, People’s United has funded a trust to provide benefit payments to the extent such benefits are not paid directly by People’s United. Trust assets of $31.6 million as of December 31, 2016 (which are included in other assets in the Consolidated Statements of Condition) were exceeded by the related projected benefit obligation ($40.8 million) at that date.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following table summarizes the accumulated and projected benefit obligations for the Pension Plans at the respective measurement dates:
Components of net periodic benefit (income) expense and other amounts recognized in other comprehensive loss are as follows:
(1) Settlement charges are a result of lump-sum benefit payments in excess of the sum of a plan’s annual interest and service costs. When an employer settles the full amount of its obligation for vested benefits with respect to some of a plan’s participants, the employer is required to recognize in income a pro-rata portion of the aggregate gain or loss recorded in AOCL.
The pre-tax amounts in AOCL that have not been recognized as components of net periodic benefit (income) expense are as follows:
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The Company uses a corridor approach in the valuation of its Qualified Plans, which results in the deferral of actuarial gains and losses resulting from differences between actual results and actuarial assumptions. Amortization of actuarial gains and losses occurs when the accumulated unrecognized gain or loss balance, as of the beginning of the year, exceeds 10% of the greater of the projected benefit obligation or the market-related value of plan assets. The excess unrecognized gain or loss balance is amortized over the average remaining life expectancy of plan participants for the People’s Qualified Plan (approximately 28 years) and over the average working lifetime of active participants for the Chittenden Qualified Plan (approximately 9 years), both as of December 31, 2016.
In 2017, approximately $6.5 million in net actuarial losses and $0.8 million in prior service credit are expected to be recognized as components of net periodic benefit (income) expense for the Pension Plans and approximately $0.2 million in net actuarial losses is expected to be recognized as a component of net periodic benefit (income) expense for the Other Postretirement Plan.
The following assumptions were used in determining the benefit obligations and net periodic benefit (income) expense as of and for the periods indicated:
n/a - not applicable
(1) Changes in the net periodic benefit (income) expense and the related benefit obligation arising as a result of a one-percentage-point increase or decrease in this assumed trend rate would not be significant.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The discount rates used to determine the benefit obligation of the Supplemental Plans at December 31, 2016 ranged from 3.60% to 4.40% while the discount rate used to determine net periodic benefit (income) expense for 2016 ranged from 3.95% to 4.60%. The discount rates used to determine the benefit obligation of the Supplemental Plans at December 31, 2015 ranged from 3.95% to 4.60% while the discount rate used to determine net periodic benefit (income) expense for 2015 was 4.20%.
The discount rates reflect the then current rates available on long-term high-quality fixed-income debt instruments, and are reset annually on the measurement date. To determine the discount rates, People’s United reviews, along with its independent actuary, spot interest rate yield curves based upon yields from a broad population of high-quality bonds adjusted to match the timing and amounts of expected benefit payments.
Effective January 1, 2016, People’s United changed the method used to estimate the interest cost component of net periodic benefit income for the Pension Plans and the Other Postretirement Plan. Instead of using spot interest rate yield curves as discussed above, People’s United has elected to use a full yield curve approach to estimate this component of benefit income by applying the specific spot rates along the yield curve, used in the determination of the benefit obligations, to the relevant projected cash flows. This change is expected to improve the correlation between projected benefit cash flows and the corresponding yield curve spot rates and to provide a more precise measurement of interest cost. This change did not affect the measurement of People’s United’s total benefit obligations as the change in interest cost is completely offset by the actuarial gain or loss recognized. People’s United considers this a change in accounting estimate and, accordingly, accounted for it prospectively in 2016.
The impact in 2016 of the change in accounting estimate for the Qualified Plans was as follows:
The impact in 2016 of the change in accounting estimate for the Supplemental Plans and the Other Postretirement Plan was $0.3 million.
In developing an expected long-term rate of return on asset assumption for the Qualified Plans for purposes of determining 2016 net periodic benefit income, People’s United considered the historical returns and the future expectations for returns within each asset class, as well as the target asset allocation of the pension portfolio. This resulted in an expected long-term rate of return assumption of 7.25%, which was intended to reflect expected asset returns over the life of the related pension benefits expected to be paid.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
In 2017, $14.3 million in net periodic benefit income is expected to be recognized related to the Qualified Plans. This amount was determined using the following assumptions: (i) an expected long-term rate of return of 7.25%; (ii) discount rates of 4.41% and 4.16% (based on the full yield curve approach discussed above) for the People’s Qualified Plan and the Chittenden Qualified Plan, respectively; and (iii) updated mortality tables issued by the Society of Actuaries in October 2016. The mortality rate is a key assumption used in valuing retirement benefit obligations as it reflects the probability of future benefit payments that are contingent upon the longevity of plan participants and their beneficiaries. Adoption of updated mortality tables resulted in a decrease in the related benefit obligation of $6.0 million for the Qualified Plans.
People’s United’s funding policy is to contribute the amounts required by applicable regulations, although additional amounts may be contributed from time to time. In 2017, no employer contributions are expected to be made for either the People’s Qualified Plan or the Chittenden Qualified Plan. Employer contributions for the Supplemental Plans and the Other Postretirement Plan in 2017 are expected to total $8.1 million, representing net benefit payments expected to be paid under these plans.
Expected future net benefit payments for the Pension Plans as of December 31, 2016 are: $23.0 million in 2017; $20.8 million in 2018; $20.4 million in 2019; $20.3 million in 2020; $23.4 million in 2021; and an aggregate of $125.1 million in 2022 through 2026. Expected future net benefit payments for the Other Postretirement Plan as of December 31, 2016 are: $2.5 million in 2017; $2.7 million in 2018; $2.2 million in 2019; $2.6 million in 2020; $2.7 million in 2021; and an aggregate of $15.5 million in 2022 through 2026.
The investment strategy of the Qualified Plans is to develop a diversified portfolio, representing a variety of asset classes of varying duration, in order to effectively fund expected near-term and long-term benefit payments. All investment decisions are governed by an established policy that contains the following asset allocation guidelines:
Equity securities are required to be diversified among industries and economic sectors and may include convertible securities. Limitations have been established on the overall allocation to any individual security representing more than 3% of the market value of total plan assets. A limit of 50% of equity holdings may be invested in international equities. Short sales, margin purchases and similar speculative transactions are prohibited.
Fixed income securities are oriented toward risk-averse, investment-grade securities rated “A” or higher. A limit of up to 30% of the fixed income holdings may be purchased and held indirectly in issues rated below “Baa” by Moody’s or “BBB” by Standard & Poor’s, if the higher investment risk is compensated for by the prospect of a positive incremental investment return. With the exception of U.S. government securities, in which the Qualified Plans may invest the entire fixed income allocation, fixed income securities require diversification among individual securities and sectors. Limitations have been established on the overall investment in securities of a single issuer to no more than 2.5% of the market value of total plan assets. There is no limit on the maximum maturity of securities held. Short sales, margin purchases and similar speculative transactions are prohibited.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following table summarizes the percentages of fair value for the major categories of assets in the Qualified Plans as of the respective measurement dates:
The following tables present the Qualified Plans’ assets measured at fair value:
Employee Stock Ownership Plan
In April 2007, People’s United established an ESOP. At that time, People’s United loaned the ESOP $216.8 million to purchase 10,453,575 shares of People’s United common stock in the open market. In order for the ESOP to repay the loan, People’s United expects to make annual cash contributions of approximately $18.8 million until 2036. Such cash contributions may be reduced by the cash dividends paid on unallocated ESOP shares, which totaled $5.0 million in 2016, $5.1 million in 2015 and $5.3 million in 2014. At December 31, 2016, the loan balance totaled $184.9 million.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Employee participation in this plan is restricted to those employees who (i) are at least 18 years of age and (ii) worked at least 1,000 hours within 12 months of their hire date or any plan year (January 1 to December 31) after their date of hire. Employees meeting the aforementioned eligibility criteria during the plan year must continue to be employed as of the last day of the plan year in order to receive an allocation of shares for that plan year.
Shares of People’s United common stock are held by the ESOP and allocated to eligible participants annually based upon a percentage of each participant’s eligible compensation. Since the ESOP was established, a total of 3,484,525 shares of People’s United common stock have been allocated or committed to be released to participants’ accounts. At December 31, 2016, 6,969,050 shares of People’s United common stock, with a fair value of $134.9 million at that date, have not been allocated or committed to be released.
Compensation expense related to the ESOP is recognized at an amount equal to the number of common shares committed to be released by the ESOP for allocation to participants’ accounts multiplied by the average fair value of People’s United’s common stock during the reporting period. The difference between the fair value of the shares of People’s United’s common stock committed to be released and the cost of those common shares is recorded as a credit to additional paid-in capital (if fair value exceeds cost) or, to the extent that no such credits remain in additional paid-in capital, as a charge to retained earnings (if fair value is less than cost). Expense recognized for the ESOP totaled $5.5 million, $5.4 million and $5.1 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Employee Savings Plans
People’s United sponsors an employee savings plan that qualifies as a 401(k) plan under the Internal Revenue Code. Employees may contribute up to 50% of their pre-tax compensation up to certain limits, and People’s United makes a matching contribution equal to 100% of a participant’s contributions up to 4% of pre-tax compensation. Participants vest immediately in their own contributions and after one year in People’s United’s contributions. A supplemental savings plan has also been established for certain senior officers and the Company has funded a trust to provide benefit payments to the extent such benefits are not paid directly by People’s United. Trust assets of $8.0 million as of December 31, 2016 (which are included in other assets in the Consolidated Statements of Condition) were exceeded by the related benefit obligation of $27.3 million at that date. Expense recognized for these employee savings plans totaled $22.9 million, $22.1 million and $20.1 million for the years ended December 31, 2016, 2015 and 2014, respectively.
NOTE 18 - Stock-Based Compensation Plans
Long-Term Incentive Plan
People’s United’s 2014 Plan and the predecessor 2008 Long-Term Incentive Plan and the 1998 Long-Term Incentive Plan (together the “Incentive Plans”) provide for awards to officers and employees in the form of: (i) incentive stock options that may afford tax benefits to recipients; (ii) non-statutory stock options that do not afford tax benefits to recipients but may provide tax benefits to People’s United; and (iii) stock appreciation rights, restricted stock and performance shares. A total of 34,000,000 shares of People’s United common stock are reserved for issuance under the 2014 Plan. The number of shares of common stock reserved under the 2014 Plan is depleted by one share for each option or stock appreciation right, by 5.32 shares for each restricted stock award and by 7.98 shares for each performance share. At December 31, 2016, a total of 15,833,453 reserved shares remain available for future awards.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Non-statutory stock options have been granted under the Incentive Plans at exercise prices equal to the fair value of People’s United common stock at the grant dates. Option expiration dates are fixed at the grant date, with a maximum term of ten years. Prior to 2013, options granted under the Incentive Plans generally vested 50% after two years, 75% after three years and 100% after four years. Beginning in 2013, options granted under the Incentive Plans vest 33% after one year, 66% after two years and 100% after three years. Unvested options become fully exercisable in the event of a change of control, as defined in the Incentive Plans.
People’s United has also granted restricted stock awards under the Incentive Plans. Employees become fully vested in these shares generally after a three- or four-year period, with requisite service conditions and no performance-based conditions to such vesting. Unvested restricted stock awards become fully vested in the event of a change in control, as defined in the Incentive Plans. During the vesting period, dividends are paid on the restricted stock and the recipients are entitled to vote these restricted shares. The fair value of all restricted stock awards is measured at the grant date based on quoted market prices.
Beginning in 2016, People’s United granted performance shares under the 2014 Plan. A performance share represents the right to receive a share of People’s United common stock contingent upon the Company achieving certain pre-established performance goals and the employee satisfying requisite service conditions. Employees become fully vested in these performance shares upon completion of a three year performance period beginning with the year in which the performance shares are granted. At the end of the three year performance period, if performance goals have been achieved, the number of performance shares earned by each employee is determined by the level of achievement against the pre-established performance goals. During the performance period, dividend equivalents are accrued to the employees’ benefit. Such dividends are paid out at the end of the performance period based on the number of performance shares earned. Unvested performance shares and dividend equivalents become fully vested in the event of a change in control, as defined in the Incentive Plans.
Performance Shares Awarded
The following is a summary of performance share activity under the 2014 Plan:
Expense related to unvested performance shares is recognized on a straight-line basis, generally over the applicable service period, and totaled $2.1 million for the year ended December 31, 2016. Unamortized cost for unvested performance shares, which reflects an estimated forfeiture rate of 5% per year over the vesting period, totaled $5.3 million at December 31, 2016, and is expected to be recognized over the remaining weighted-average vesting period of 2.2 years. The total fair value of performance shares vested during the year ended December 31, 2016 was immaterial.
Following shareholder approval of the 2014 Plan in the second quarter of 2014, no new awards may be granted under the 2008 Long-Term Incentive Plan, the 2007 Stock Option Plan (the “SOP”) or the RRP (together the “Prior Plans”). All awards granted under the Prior Plans and the 1998 Long-Term Incentive Plan that were unvested (in the case of stock options and restricted stock awards) or unexercised (in the case of stock options) as of the date of shareholder approval of the 2014 Plan continue to be governed by the terms of the plan under which such awards were granted and the applicable grant agreements.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Recognition and Retention Plan and Stock Option Plan
The RRP and SOP (together the “2007 Plans”) provided for awards to directors, officers and employees in the form of: (i) incentive stock options that may afford tax benefits to recipients; (ii) non-statutory stock options that do not afford tax benefits to recipients but may provide tax benefits to People’s United; and (iii) restricted stock. Shares of People’s United common stock were purchased in the open market in October 2007 by a trustee with funds provided by People’s United for the maximum number of shares available to be awarded in the form of restricted stock.
Non-statutory stock options were granted under the SOP at exercise prices equal to the fair value of People’s United’s common stock at the grant date based on quoted market prices. The fair value of all restricted stock awarded under the RRP was measured at the grant date based on quoted market prices. Prior to 2014, most restricted stock awards and stock options granted under the 2007 Plans were scheduled to vest in 20% annual increments over a five-year period with requisite service conditions and no performance-based conditions to such vesting. Beginning in 2014, awards made under the 2007 Plans in 2014 are scheduled to vest in one-third annual increments over a three-year period with requisite service conditions and no performance-based conditions to such vesting. All restricted stock awards and stock options become fully vested and exercisable, respectively, in the event of a change of control, as defined in the 2007 Plans. During the vesting period, dividends are paid on the restricted stock and the recipients are entitled to vote these restricted shares.
Stock Options Granted
People’s United granted a total of 3,187,500 stock options in 2016, 5,221,992 stock options in 2015 and 562,355 stock options in 2014 under the Incentive Plans and 4,391,269 stock options under the SOP in 2014. The estimated weighted-average grant-date fair value of all stock options granted in 2016, 2015 and 2014 was $1.33 per option, $1.46 per option and $1.51 per option, respectively, using the Black-Scholes option-pricing model with assumptions as follows: dividend yield of 4.6% in 2016, 4.4% in 2015 and 4.7% in 2014; expected volatility rate of 20% in both 2016 and 2015 and 22% in 2014; risk-free interest rate of 1.3% in 2016 and 1.6% in both 2015 and 2014; and expected option life of approximately 5 years in 2016, 2015 and 2014.
In arriving at the grant date fair value of stock options using the Black-Scholes option-pricing model, expected volatilities were based on the historical volatilities of People’s United traded common stock. The expected term of stock options represents the period of time that options granted are expected to be outstanding. People’s United used historical data to estimate voluntary suboptimal (early) exercises by continuing employees, and estimates of post-vest option exercise or forfeiture by terminated employees. Suboptimal exercise data and employee termination estimates are incorporated into Monte Carlo simulations of People’s United common stock prices to calculate the expected term. The risk-free interest rate approximated the U.S. Treasury rate curve matched to the expected option term at the time of the grant.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following is a summary of stock option activity under the Incentive Plans and the SOP:
(1) Reflects only those stock options with intrinsic value at December 31, 2016.
Expense relating to stock options granted is recognized on a straight-line basis, generally over the applicable service period, and totaled $5.7 million, $6.8 million and $5.4 million for the years ended December 31, 2016, 2015 and 2014, respectively. Unamortized cost for unvested stock options, which reflects an estimated forfeiture rate of 5.0% per year over the vesting period, totaled $5.3 million at December 31, 2016, and is expected to be recognized over the remaining weighted-average vesting period of 1.4 years. The total intrinsic value of stock options exercised was $15.6 million, $5.1 million and $1.1 million in the years ended December 31, 2016, 2015 and 2014, respectively.
Additional information concerning options outstanding and options exercisable at December 31, 2016 is summarized as follows:
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Restricted Stock Awarded
The following is a summary of restricted stock award activity under the Incentive Plans and the RRP:
Expense relating to unvested restricted stock awards is recognized on a straight-line basis, generally over the applicable service period, and totaled $6.5 million, $9.4 million and $8.7 million for the years ended December 31, 2016, 2015 and 2014, respectively. Unamortized cost for unvested restricted stock awards, which reflects an estimated forfeiture rate of 5.0% per year over the vesting period, totaled $6.4 million at December 31, 2016, and is expected to be recognized over the remaining weighted-average vesting period of 1.3 years. The total fair value of restricted stock awards vested during the years ended December 31, 2016, 2015 and 2014 was $9.8 million, $9.4 million and $10.3 million, respectively.
During 2016, 2015 and 2014, employees of People’s United tendered a total of 289,992 shares, 230,459 shares and 229,635 shares of common stock, respectively, in satisfaction of their related minimum tax withholding obligations upon the vesting of restricted stock awards granted in prior periods and/or in payment of the exercise price and satisfaction of their related minimum tax withholding obligations upon the exercise of stock options granted in prior periods. There is no limit on the number of shares that may be tendered by employees of People’s United in the future for these purposes. Shares acquired in payment of the stock option exercise price or in satisfaction of minimum tax withholding obligations are not eligible for reissuance in connection with any subsequent grants made pursuant to equity compensation plans maintained by People’s United. Rather, all shares acquired in this manner are retired by People’s United, resuming the status of authorized but unissued shares of People’s United’s common stock. The total cost of shares repurchased and retired applicable to restricted stock awards during the years ended December 31, 2016, 2015 and 2014 was $3.4 million, $3.2 million and $3.0 million, respectively.
Directors’ Equity Compensation Plan
The People’s United Financial, Inc. Directors’ Equity Compensation Plan (the “Directors’ Plan”) provides for an annual award of shares of People’s United common stock with a fair value of approximately $95,000 to each non-employee director immediately following each annual meeting of shareholders. Shares of People’s United common stock issued pursuant to the Directors’ Plan are subject to a one-year vesting period, with no post-vesting transfer restrictions. A total of 1,192,500 shares of People’s United common stock are reserved for issuance under the Directors’ Plan.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
In 2016, 2015 and 2014, directors were granted a total of 58,020 shares, 62,690 shares and 57,330 shares, respectively, of People’s United common stock, with grant date fair values of $16.24 per share, $15.23 per share and $14.63 per share, respectively, at those dates. Expense totaling $0.9 million, $0.9 million and $0.8 million was recognized for the years ended December 31, 2016, 2015 and 2014, respectively, for the Directors’ Plan. At December 31, 2016, a total of 193,051 shares remain available for issuance.
NOTE 19 - Fair Value Measurements
Described below are the valuation methodologies used by People’s United and the resulting fair values for those financial instruments measured at fair value on both a recurring and a non-recurring basis, as well as for those financial assets and financial liabilities not measured at fair value but for which fair value is disclosed.
Recurring Fair Value Measurements
Trading Account Securities and Securities Available For Sale
When available, People’s United uses quoted market prices for identical securities received from an independent, nationally-recognized, third-party pricing service (as discussed further below) to determine the fair value of investment securities such as U.S. Treasury and agency securities that are included in Level 1. When quoted market prices for identical securities are unavailable, People’s United uses prices provided by the independent pricing service based on recent trading activity and other observable information including, but not limited to, market interest rate curves, referenced credit spreads and estimated prepayment rates where applicable. These investments include certain U.S. and government agency debt securities, corporate and municipal debt securities, GSE mortgage-backed securities and CMOs, all of which are included in Level 2.
The Company’s available-for-sale securities are primarily comprised of GSE mortgage-backed securities and CMOs. The fair values of these securities are based on prices obtained from the independent pricing service. The pricing service uses various techniques to determine pricing for the Company’s mortgage-backed securities, including option pricing and discounted cash flow analysis. The inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers, reference data, monthly payment information and collateral performance. At both December 31, 2016 and 2015, the entire available-for-sale mortgage-backed securities portfolio was comprised of 10- and 15-year GSE securities. An active market exists for securities that are similar to the Company’s GSE mortgage-backed securities and CMOs, making observable inputs readily available.
Changes in the prices obtained from the pricing service are analyzed from month to month, taking into consideration changes in market conditions including changes in mortgage spreads, changes in U.S. Treasury security yields and changes in generic pricing of securities with similar duration. As a further point of validation, the Company generates its own month-end fair value estimate for all mortgage-backed securities, agency-issued CMOs (also backed by 10- and 15-year mortgage-backed securities), and state and municipal securities. While the Company has not adjusted the prices obtained from the independent pricing service, any notable differences between those prices and the Company’s estimates are subject to further analysis. This additional analysis may include a review of prices provided by other independent parties, a yield analysis, a review of average life changes using Bloomberg analytics and a review of historical pricing for the particular security. Based on management’s review of the prices provided by the pricing service, the fair values incorporate observable market inputs used by market participants at the measurement date and, as such, are classified as Level 2 securities.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Other Assets
As discussed in Note 17, certain unfunded, nonqualified supplemental plans have been established to provide retirement benefits to certain senior officers. People’s United has funded two trusts to provide benefit payments to the extent such benefits are not paid directly by People’s United, the assets of which are included in other assets in the Consolidated Statements of Condition. When available, People’s United determines the fair value of the trust assets using quoted market prices for identical securities received from a third-party nationally recognized pricing service.
Derivatives
People’s United values its derivatives using internal models that are based on market or observable inputs, including interest rate curves and forward/spot prices for selected currencies. Derivative assets and liabilities included in Level 2 represent interest rate swaps, foreign exchange contracts, risk participation agreements, forward commitments to sell residential mortgage loans and interest rate-lock commitments on residential mortgage loans.
The following tables summarize People’s United’s financial instruments that are measured at fair value on a recurring basis:
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(1) As of December 31, 2016 and 2015, the fair value of risk participation agreements totaled less than $0.1 million (see Note 21).
There were no transfers into or out of the Level 1 or Level 2 categories during the years ended December 31, 2016 and 2015.
Non-Recurring Fair Value Measurements
Loans Held for Sale
Residential mortgage loans held for sale are recorded at the lower of cost or fair value and are therefore measured at fair value on a non-recurring basis. When available, People’s United uses observable secondary market data, including pricing on recent closed market transactions for loans with similar characteristics. Accordingly, such loans are classified as Level 2 measurements. When observable data is unavailable, valuation methodologies using current market interest rate data adjusted for inherent credit risk are used, and such loans are included in Level 3.
Impaired Loans
Loan impairment is deemed to exist when full repayment of principal and interest according to the contractual terms of the loan is no longer probable. Impaired loans are reported based on one of three measures: the present value of expected future cash flows discounted at the loan’s original effective interest rate; the loan’s observable market price; or the fair value of the collateral (less estimated cost to sell) if the loan is collateral dependent. Accordingly, certain impaired loans may be subject to measurement at fair value on a non-recurring basis.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
People’s United has estimated the fair values of these assets using Level 3 inputs, such as discounted cash flows based on inputs that are largely unobservable and, instead, reflect management’s own estimates of the assumptions a market participant would use in pricing such loans and/or the fair value of collateral based on independent third-party appraisals for collateral-dependent loans. Such appraisals are based on the market and/or income approach to value and are subject to a discount (to reflect estimated cost to sell) that generally approximates 10%.
REO and Repossessed Assets
REO and repossessed assets are recorded at the lower of cost or fair value, less estimated selling costs, and are therefore measured at fair value on a non-recurring basis. People’s United has estimated the fair values of these assets using Level 3 inputs, such as independent third-party appraisals and price opinions. Such appraisals are based on the market and/or income approach to value and are subject to a discount (to reflect estimated cost to sell) that generally approximates 10%. Assets that are acquired through loan default are recorded as held for sale initially at the lower of the recorded investment in the loan or fair value (less estimated selling costs) upon the date of foreclosure/repossession. Subsequent to foreclosure/repossession, valuations are updated periodically and the carrying amounts of these assets may be reduced further.
The following tables summarize People’s United’s assets that are measured at fair value on a non-recurring basis:
(1) Consists of residential mortgage loans; no fair value adjustments were recorded for the years ended December 31, 2016 and 2015.
(2) Represents the recorded investment in originated impaired loans with a related allowance for loan losses measured in accordance with applicable accounting guidance. The total consists of $40.8 million of Commercial loans and $15.1 million of Retail loans at December 31, 2016. The provision for loan losses on impaired loans totaled $3.8 million and $6.7 million for the years ended December 31, 2016 and 2015, respectively.
(3) Represents: (i) $8.1 million of residential REO; (ii) $4.0 million of commercial REO; and (iii) $7.2 million of repossessed assets at December 31, 2016. Charge-offs to the allowance for loan losses related to loans that were transferred to REO or repossessed assets totaled $3.7 million and $1.8 million for the years ended December 31, 2016 and 2015, respectively. Write downs and net loss on sale of foreclosed/repossessed assets charged to non-interest expense totaled $3.2 million and $2.8 million for the same periods.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Financial Assets and Financial Liabilities Not Measured At Fair Value
As discussed in Note 1, fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date (an “exit price” approach to fair value).
Acceptable valuation techniques (when quoted market prices are not available) that might be used to estimate the fair value of financial instruments include discounted cash flow analyses and comparison to similar instruments. Such estimates are highly subjective and require judgments regarding significant matters such as the amount and timing of future cash flows and the selection of discount rates that appropriately reflect market and credit risks. Changes in these judgments often have a material impact on the fair value estimates. In addition, since these estimates are made as of a specific point in time, they are susceptible to material near-term changes. Fair values estimated in this manner do not reflect any premium or discount that could result from the sale of a large volume of a particular financial instrument, nor do they reflect possible tax ramifications or estimated transaction costs.
The following is a description of the principal valuation methods used by People’s United for those financial instruments that are not measured at fair value either on a recurring or non-recurring basis:
Cash, Short-Term Investments and Securities Purchased Under Agreements to Resell
Cash and due from banks are classified as Level 1. Short-term investments and securities purchased under agreements to resell have fair values that approximate the respective carrying amounts because the instruments are payable on demand or have short-term maturities, and present relatively low credit risk and IRR. As such, these fair values are classified as Level 2.
Securities Held to Maturity
When available, the fair values of investment securities held to maturity are measured based on quoted market prices for identical securities in active markets and, accordingly, are classified as Level 1 assets. When quoted market prices for identical securities are not available, fair values are estimated based on quoted prices for similar assets in active markets or through the use of pricing models containing observable inputs (i.e. market interest rates, financial information and credit ratings of the issuer, etc.). These fair values are included in Level 2. In cases where there may be limited information available and/or little or no market activity for the underlying security, fair value is estimated using pricing models containing unobservable inputs and classified as Level 3.
FHLB and FRB-NY Stock
Both FHLB and FRB-NY stock are non-marketable equity securities classified as Level 2 and reported at cost, which equals par value (the amount at which shares have been redeemed in the past). No significant observable market data is available for either of these securities.
Loans
For valuation purposes, the loan portfolio is segregated into its significant categories, which are commercial real estate, commercial and industrial, equipment financing, residential mortgage, home equity and other consumer. These categories are further segregated, where appropriate, into components based on significant financial characteristics such as type of interest rate (fixed or adjustable) and payment status (performing or non-performing). Fair values are estimated for each component using a valuation method selected by management.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The fair values of performing loans were estimated by discounting the anticipated cash flows from the respective portfolios, assuming future prepayments and using market interest rates for new loans with comparable credit risk. As a result, the valuation method for performing loans, which is consistent with certain guidance provided in accounting standards, does not fully incorporate the “exit price” approach to fair value. The fair values of non-performing loans were based on recent collateral appraisals or management’s analysis of estimated cash flows discounted at rates commensurate with the credit risk involved. The estimated fair values of residential mortgage loans are classified as Level 2 as a result of the observable market inputs (i.e. market interest rates, prepayment assumptions, etc.) available for this loan type. The fair values of all other loan types are classified as Level 3 as the inputs contained within the respective discounted cash flow models are largely unobservable and, instead, reflect management’s own estimates of the assumptions a market participant would use in pricing such loans. The fair value of home equity lines of credit was based on the outstanding loan balances, and therefore does not reflect the value associated with earnings from future loans to existing customers.
Deposit Liabilities
The fair values of time deposits represent contractual cash flows discounted at current rates determined by reference to observable inputs including a LIBOR/swap curve over the remaining period to maturity. As such, these fair values are classified as Level 2. The fair values of other deposit liabilities (those with no stated maturity, such as checking and savings accounts) are equal to the carrying amounts payable on demand. Deposit fair values do not include the intangible value of core deposit relationships that comprise a significant portion of People’s United’s deposit base. Management believes that People’s United’s core deposit relationships provide a relatively stable, low-cost funding source that has a substantial intangible value separate from the deposit balances.
Borrowings and Notes and Debentures
The fair values of federal funds purchased, repurchase agreements and other borrowings are equal to the carrying amounts due to the short maturities (generally overnight). The fair values of FHLB advances represent contractual repayments discounted using interest rates currently available on borrowings with similar characteristics and remaining maturities and are classified as Level 2. The fair values of notes and debentures were based on dealer quotes and are classified as Level 2.
Lending-Related Financial Instruments
The estimated fair values of People’s United’s lending-related financial instruments approximate the respective carrying amounts. Such instruments include commitments to extend credit, unadvanced lines of credit and letters of credit, for which fair values were estimated based on an analysis of the interest rates and fees currently charged to enter into similar transactions, considering the remaining terms of the instruments and the creditworthiness of the potential borrowers.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following tables summarize the carrying amounts, estimated fair values and placement in the fair value hierarchy of People’s United’s financial instruments that are not measured at fair value either on a recurring or non-recurring basis:
(1) Excludes impaired loans totaling $55.9 million measured at fair value on a non-recurring basis.
(1) Excludes impaired loans totaling $49.1 million measured at fair value on a non-recurring basis.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 20 - Legal Proceedings and Lease Commitments
People’s United has various outstanding commitments and contingent liabilities that are not required to be and, therefore, have not been reflected in the consolidated financial statements.
Legal Proceedings
In the normal course of business, People’s United is subject to various legal proceedings. Management has discussed with legal counsel the nature of these legal proceedings and, based on the advice of counsel and the information currently available, believes that the eventual outcome of these legal proceedings will not have a material adverse effect on People’s United’s financial condition, results of operations or liquidity.
Lease Commitments
At December 31, 2016, People’s United was obligated under various noncancelable operating leases for office space, which expire on various dates through 2054. Certain leases contain renewal options and provide for increased rentals based principally on the consumer price index and fair market rental value provisions. Future minimum rental commitments under operating leases in excess of one year at December 31, 2016 were: $58.8 million in 2017; $54.3 million in 2018; $49.5 million in 2019; $45.6 million in 2020; $42.5 million in 2021; and an aggregate of $106.6 million in 2022 through 2054. Rent expense under operating leases included in occupancy and equipment in the Consolidated Statements of Income totaled $59.8 million, $58.9 million and $59.1 million for the years ended December 31, 2016, 2015 and 2014, respectively.
NOTE 21 - Financial Instruments
In the normal course of business, People’s United is a party to both on-balance-sheet and off-balance-sheet financial instruments involving, to varying degrees, elements of credit risk and IRR in addition to the amounts recognized in the Consolidated Statements of Condition. The contractual amounts of off-balance-sheet instruments reflect the extent of People’s United’s involvement in particular classes of financial instruments.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
A summary of the contractual or notional amounts of People’s United’s lending-related and derivative financial instruments follows:
(1) The contractual amounts of these financial instruments represent People’s United’s maximum potential exposure to credit loss, assuming (i) the instruments are fully funded at a later date; (ii) the borrower does not meet contractual repayment obligations; and (iii) any collateral or other security proves to be worthless.
(2) The contractual or notional amounts of these financial instruments are substantially greater than People’s United’s maximum potential exposure to credit loss.
Lending-Related Financial Instruments
The contractual amounts of People’s United’s lending-related financial instruments do not necessarily represent future cash requirements since certain of these instruments may expire without being funded and others may not be fully drawn upon. These instruments are subject to People’s United’s credit approval process, including an evaluation of the customer’s creditworthiness and related collateral requirements. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee by the customer. The geographic distribution of People’s United’s lending-related financial instruments is similar to the distribution of its loan portfolio, as described in Note 5.
People’s United issues both stand-by and commercial letters of credit. Stand-by letters of credit are conditional commitments issued by People’s United to guarantee the performance of a customer to a third party. The letter of credit is generally extended for an average term of one year and is secured in a manner similar to existing extensions of credit. For each letter of credit issued, if the customer fails to perform under the terms of the agreement, People’s United would have to fulfill the terms of the letter of credit. The credit risk involved in issuing stand-by letters of credit is essentially the same as that involved in extending loan facilities to customers.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
A commercial letter of credit is normally a short-term instrument issued by a financial institution on behalf of its customer. The letter of credit authorizes a beneficiary to draw drafts on the financial institution or one of its correspondent banks, provided the terms and conditions of the letter of credit have been met. In issuing a commercial letter of credit, the financial institution has substituted its credit standing for that of its customer. After drafts are paid by the financial institution, the customer is charged or an obligation is created under an existing reimbursement agreement. An advance under a reimbursement agreement is recorded as a loan by the financial institution and is subject to terms and conditions similar to other commercial obligations.
The fair value of People’s United’s obligations relating to its unfunded loan commitments and letters of credit was $2.3 million and $2.5 million at December 31, 2016 and 2015, respectively, and is included in other liabilities in the Consolidated Statements of Condition.
Derivative Financial Instruments and Hedging Activities
People’s United uses derivative financial instruments as components of its market risk management (principally to manage IRR). Certain other derivatives are entered into in connection with transactions with commercial customers. Derivatives are not used for speculative purposes.
By using derivatives, People’s United is exposed to credit risk to the extent that counterparties to the derivative contracts do not perform as required. Should a counterparty fail to perform under the terms of a derivative contract, the Company’s counterparty credit risk is equal to the amount reported as a derivative asset in the Consolidated Statements of Condition. In accordance with the Company’s balance sheet offsetting policy (see Note 1), amounts reported as derivative assets represent derivative contracts in a gain position, without consideration for derivative contracts in a loss position with the same counterparty (to the extent subject to master netting arrangements) and posted collateral. People’s United seeks to minimize counterparty credit risk through credit approvals, limits, monitoring procedures, execution of master netting arrangements and obtaining collateral, where appropriate. Counterparties to People’s United’s derivatives include major financial institutions and exchanges that undergo comprehensive and periodic internal credit analysis as well as maintain investment grade credit ratings from the major credit rating agencies. As such, management believes the risk of incurring credit losses on derivative contracts with those counterparties is remote and losses, if any, would be immaterial.
Certain of People’s United’s derivative contracts contain provisions establishing collateral requirements (subject to minimum collateral posting thresholds) based on the Company’s external credit rating. If the Company’s senior unsecured debt rating were to fall below the level generally recognized as investment grade, the counterparties to such derivative contracts could require additional collateral on those derivative transactions in a net liability position (after considering the effect of master netting arrangements and posted collateral). The aggregate fair value of derivative instruments with such credit-related contingent features that were in a net liability position at December 31, 2016 was $7.5 million, for which People’s United had posted collateral of $5.4 million in the normal course of business. If the Company’s senior unsecured debt rating had fallen below investment grade as of that date, $2.1 million in additional collateral would have been required.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following sections further discuss each class of derivative financial instrument used by People’s United, including management’s principal objectives and risk management strategies.
Interest Rate Swaps
People’s United may, from time to time, enter into interest rate swaps that are used to manage IRR associated with certain interest-earning assets and interest-bearing liabilities.
People’s United has entered into a pay fixed/receive floating interest rate swap to hedge the LIBOR-based floating rate payments on the Company’s $125 million subordinated notes (see Note 11) (such payments began in February 2012). These notes had a fixed interest rate of 5.80% until February 2012, at which time the interest rate converted to the three-month LIBOR plus 68.5 basis points. People’s United has agreed with the swap counterparty to exchange, at specified intervals, the difference between fixed-rate (1.99%) and floating-rate interest amounts calculated based on a notional amount of $125 million. The floating-rate interest amounts received under the swap are calculated using the same floating-rate paid on these notes. The swap effectively converts the variable-rate subordinated notes to a fixed-rate liability and consequently reduces People’s United’s exposure to increases in interest rates. This swap is accounted for as a cash flow hedge (see Note 25).
The Bank has entered into a pay floating/receive fixed interest rate swap to hedge the change in fair value of the Bank’s $400 million subordinated notes (see Note 11) due to changes in interest rates. The Bank has agreed with the swap counterparty to exchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts calculated based on a notional amount of $375 million. The fixed-rate interest payments received on the swap will essentially offset the fixed-rate interest payments made on these notes, notwithstanding the notional difference between these notes and the swap. The floating-rate interest amounts paid under the swap are calculated based on three-month LIBOR plus 126.5 basis points. The swap effectively converts the fixed-rate subordinated notes to a floating-rate liability. This swap is accounted for as a fair value hedge.
Customer Derivatives
People’s United enters into interest rate swaps with certain of its commercial customers. In order to minimize its risk, these customer derivatives (pay floating/receive fixed swaps) have been offset with essentially matching interest rate swaps with People’s United’s institutional counterparties (pay fixed/receive floating swaps). Hedge accounting has not been applied for these derivatives. Accordingly, changes in the fair value of all such interest rate swaps are recognized in current earnings.
Foreign Exchange Contracts
Foreign exchange contracts are commitments to buy or sell foreign currency on a future date at a contractual price. People’s United uses these instruments on a limited basis to (i) eliminate its exposure to fluctuations in currency exchange rates on certain of its commercial loans that are denominated in foreign currencies and (ii) provide foreign exchange contracts on behalf of commercial customers within credit exposure limits. Gains and losses on foreign exchange contracts substantially offset the translation gains and losses on the related loans.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Risk Participation Agreements
People’s United enters into risk participation agreements under which it may either assume or sell credit risk associated with a borrower’s performance under certain interest rate derivative contracts. In those instances in which People’s United has assumed credit risk, it is not a party to the derivative contract and has entered into the risk participation agreement because it is also a party to the related loan agreement with the borrower. In those instances in which People’s United has sold credit risk, it is a party to the derivative contract and has entered into the risk participation agreement because it sold a portion of the related loan. People’s United manages its credit risk under risk participation agreements by monitoring the creditworthiness of the borrower, based on its normal credit review process. The notional amounts of the risk participation agreements reflect People’s United’s pro-rata share of the derivative contracts, consistent with its share of the related loans.
Forward Commitments to Sell Residential Mortgage Loans and Related Interest Rate-Lock Commitments
People’s United enters into forward commitments to sell adjustable-rate and fixed-rate residential mortgage loans (all to be sold servicing released) in order to reduce the market risk associated with originating loans for sale in the secondary market. In order to fulfill a forward commitment, People’s United delivers originated loans at prices or yields specified by the contract. The risks associated with such contracts arise from the possible inability of counterparties to meet the contract terms or People’s United’s inability to originate the necessary loans. Gains and losses realized on the forward contracts are reported in the Consolidated Statements of Income as a component of the net gains on sales of residential mortgage loans. In the normal course of business, People’s United will commit to an interest rate on a mortgage loan application at the time of application, or anytime thereafter. The risks associated with these interest rate-lock commitments arise if market interest rates change prior to the closing of these loans. Both forward sales commitments and interest rate-lock commitments made to borrowers on held-for-sale loans are accounted for as derivatives, with changes in fair value recognized in current earnings.
Interest Rate Locks
In connection with its planned issuance of senior notes in the fourth quarter of 2012, People’s United entered into U.S. Treasury forward interest rate locks (“T-Locks”) to hedge the risk that the 10-year U.S. Treasury yield component of the underlying coupon of the fixed-rate senior notes would rise prior to establishing the fixed interest rate on the senior notes. Upon pricing the senior notes, the T-Locks were terminated and the unrealized gain of $0.9 million was included (on a net-of-tax basis) as a component of AOCL. The gain is being recognized as a reduction of interest expense over the ten-year period during which the hedged item ($500 million senior note issuance) affects earnings. The portion of the unrecognized gain at December 31, 2016 that is expected to be recognized over the next 12 months totals approximately $0.1 million.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The table below provides a summary of the notional amounts and fair values (presented on a gross basis) of derivatives outstanding:
(1) Assets are recorded in other assets and liabilities are recorded in other liabilities.
(2) Fair value totaled less than $0.1 million at both dates.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following table summarizes the impact of People’s United’s derivatives on pre-tax income and AOCL:
(1) Amounts recognized in earnings are recorded in interest income, interest expense or other non-interest income for derivatives designated as hedging instruments and in other non-interest income for derivatives not designated as hedging instruments.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 22 - Balance Sheet Offsetting
The following tables provide a gross presentation, the effects of offsetting, and a net presentation of the Company’s financial instruments that are eligible for offset in the Consolidated Statements of Condition. The collateral amounts in these tables are limited to the outstanding balances of the related asset or liability (after netting is applied) and, therefore, instances of overcollateralization are not presented. The net amounts of the derivative assets and liabilities can be reconciled to the fair value of the Company’s derivative financial instruments in Note 21. The Company’s derivative contracts with commercial customers and customer repurchase agreements are not subject to master netting arrangements and, therefore, have been excluded from the tables below.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 23 - Segment Information
Public companies are required to report (i) certain financial and descriptive information about “reportable operating segments,” as defined, and (ii) certain enterprise-wide financial information about products and services, geographic areas and major customers. Operating segment information is reported using a “management approach” that is based on the way management organizes the segments for purposes of making operating decisions and assessing performance.
People’s United’s operations are divided into three primary operating segments that represent its core businesses: Commercial Banking; Retail Banking; and Wealth Management. In addition, the Treasury area manages People’s United’s securities portfolio, short-term investments, brokered deposits, wholesale borrowings and the funding center.
The Company’s operating segments have been aggregated into two reportable segments: Commercial Banking and Retail Banking. These reportable segments have been identified and organized based on the nature of the underlying products and services applicable to each segment, the type of customers to whom those products and services are offered and the distribution channel through which those products and services are made available. With respect to the Company’s traditional wealth management activities, this presentation results in the allocation of the Company’s insurance business and certain trust activities to the Commercial Banking segment, and the allocation of the Company’s brokerage business and certain other trust activities to the Retail Banking segment.
Commercial Banking consists principally of commercial real estate lending, commercial and industrial lending, and commercial deposit gathering activities. This segment also includes the equipment financing operations of PCLC and PUEFC, as well as cash management, correspondent banking, municipal banking, institutional trust services, corporate trust, insurance services provided through PUIA and private banking.
Retail Banking includes, as its principal business lines, consumer lending (including residential mortgage and home equity lending) and consumer deposit gathering activities. This segment also includes brokerage, financial advisory services, investment management services and life insurance provided by PSI and non-institutional trust services.
People’s United’s segment disclosure is based on an internal profitability reporting system, which generates information by operating segment based on a series of management estimates and allocations regarding funds transfer pricing (“FTP”), the provision for loan losses, non-interest expense and income taxes. These estimates and allocations, some of which are subjective in nature, are subject to periodic review and refinement. Any changes in estimates and allocations that may affect the reported results of any segment will not affect the consolidated financial position or results of operations of People’s United as a whole. Certain reclassifications have been made to prior period segment results to conform to the current period presentation.
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
FTP, which is used in the calculation of each operating segment’s net interest income, measures the value of funds used in and provided by an operating segment. The difference between the interest income on earning assets and the interest expense on funding liabilities, and the corresponding FTP charge for interest income or credit for interest expense, results in net spread income. For fixed-term assets and liabilities, the FTP rate is assigned at the time the asset or liability is originated by reference to the Company’s FTP yield curve, which is updated daily. For non-maturity-term assets and liabilities, the FTP rate is determined based upon the underlying characteristics, or behavior, of each particular product and results in the use of a historical rolling average FTP rate determined over a period that is most representative of the average life of the particular asset or liability. While the Company’s FTP methodology serves to remove IRR from the operating segments and better facilitate pricing decisions, thereby allowing management to more effectively assess the longer-term profitability of an operating segment, it may, in sustained periods of low and/or high interest rates, result in a measure of operating segment net interest income that is not reflective of current interest rates.
During the quarter ended March 31, 2015, the Company modified its FTP methodology relating to certain deposit products that resulted in a reduction in the funding credit recognized within net interest income for Commercial Banking and Retail Banking, with the offset reflected in Treasury. Prior period segment results have not been adjusted and continue to reflect the previous FTP methodology.
A five-year rolling average net charge-off rate is used as the basis for the provision for loan losses for the respective operating segment in order to present a level of portfolio credit cost that is representative of the Company’s historical experience, without presenting the potential volatility from year-to-year changes in credit conditions. While this method of allocation allows management to more effectively assess the longer-term profitability of a segment, it may result in a measure of segment provision for loan losses that does not reflect actual incurred losses for the periods presented.
People’s United allocates a majority of non-interest expenses to each operating segment using a full-absorption costing process (i.e. all expenses are fully-allocated to the segments). Direct and indirect costs are analyzed and pooled by process and assigned to the appropriate operating segment and corporate overhead costs are allocated to the operating segments. During the quarter ended March 31, 2015, the Company modified its cost allocation methodology with respect to the allocation of branch costs associated with servicing certain customers, which resulted in an increase in non-interest expense for Commercial Banking and Wealth Management, with the offset reflected in Retail Banking. Prior period segment results have not been adjusted and continue to reflect the previous cost allocation methodology. Income tax expense is allocated to each operating segment using a constant rate, based on an estimate of the consolidated effective income tax rate for the year. Average total assets and average total liabilities are presented for each reportable segment due to management’s reliance, in part, on such average balances for purposes of assessing segment performance. Average total assets of each reportable segment include allocated goodwill and intangible assets, both of which are reviewed for impairment at least annually.
The “Other” category includes the residual financial impact from the allocation of revenues and expenses (including the provision for loan losses) and certain revenues and expenses not attributable to a particular segment; assets and liabilities not attributable to a particular segment; reversal of the FTE adjustment since net interest income for each segment is presented on an FTE basis; and the FTP impact from excess capital. The “Other” category also includes certain gains totaling $7.5 million, $9.2 million and $20.6 million for the years ended December 31, 2016, 2015 and 2014, respectively (included in total non-interest income), and certain charges totaling $4.7 million, $12.9 million and $9.5 million for the years ended December 31, 2016, 2015 and 2014, respectively (included in total non-interest expense).
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
The following tables provide selected financial information for People’s United’s reportable segments:
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 24 - Parent Company Financial Information
Condensed financial information of People’s United (parent company only) is presented below:
CONDENSED STATEMENTS OF CONDITION
CONDENSED STATEMENTS OF INCOME
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
CONDENSED STATEMENTS OF CASH FLOWS
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 25 - Subsequent Events
Pending Acquisition
On June 27, 2016, People’s United announced the signing of a definitive agreement to acquire Suffolk Bancorp (“Suffolk”) based in Riverhead, New York. Under the terms of the definitive agreement, each share of Suffolk common stock will be converted into the right to receive 2.225 shares of People’s United common stock, with a total transaction value, as of December 31, 2016, of approximately $518 million. As disclosed in its Quarterly Report on Form 10-Q as of and for the period ended September 30, 2016, Suffolk reported total assets of $2.2 billion, total deposits of $1.9 billion and operated 27 branches in the greater Long Island area.
The acquisition, which is subject to regulatory approval, was approved by the shareholders of Suffolk on October 13, 2016. People’s United shareholder approval is not required for the acquisition. On February 6, 2017, the Company announced that the OCC approved the merger of Suffolk County National Bank with and into the Bank. The acquisition remains subject to the approval of the FRB. Merger-related expenses recorded in 2016 relating to this transaction totaled $2.8 million.
Repayment of Subordinated Notes
On February 14, 2017, the Company repaid the $125 million 5.80% fixed-rate/floating-rate subordinated notes (see Note 11). Concurrent with the repayment, the interest rate swap designated to these subordinated notes matured (see Note 21).
People’s United Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
NOTE 26 - Selected Quarterly Financial Data (Unaudited)
The following table presents People’s United’s quarterly financial data for 2016 and 2015:
INDEX TO EXHIBITS
Designation
Description
10.7(b)*
Form of Grant Agreement for Stock Options under People’s United Financial, Inc. 2014 Long-Term Incentive Plan
10.7(c)*
Form of Grant Agreement for Restricted Stock under People’s United Financial, Inc. 2014 Long-Term Incentive Plan
12.1
Consolidated Ratio of Earnings to Fixed Charges
12.2
Consolidated Combined Ratio of Earnings to Fixed Charges and
Preferred Stock Dividend Requirements
Subsidiaries
Consent of KPMG LLP
31.1
Rule 13a-14(a)/15d-14(a) Certifications
31.2
Rule 13a-14(a)/15d-14(a) Certifications
Section 1350 Certifications
99.1
Impact of Inflation
101.1
The following financial information from People’s United Financial, Inc.’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016 formatted in XBRL: (i) Consolidated Statements of Condition as of December 31, 2016 and 2015; (ii) Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014; (iii) Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 2015 and 2014; (iv) Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2016, 2015 and 2014; (v) Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014; and (vi) Notes to Consolidated Financial Statements.
* Each exhibit identified by an asterisk constitutes a management contract or compensatory plan, contract or arrangement.