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| FLIC > SEC Filings for FLIC > Form 10-Q on 10-Nov-2008 | All Recent SEC Filings |
10-Nov-2008
Quarterly Report
The following is management's discussion and analysis of certain significant factors that have affected the Corporation's financial condition and operating results during the periods included in the accompanying consolidated financial statements, and should be read in conjunction with such financial statements. The Corporation's financial condition and operating results principally reflect those of its wholly-owned subsidiary, The First National Bank of Long Island, and subsidiaries wholly-owned by the Bank, either directly or indirectly, The First of Long Island Agency, Inc., FNY Service Corp., and The First of Long Island REIT, Inc. The consolidated entity is referred to as the "Corporation" and the Bank and its subsidiaries are collectively referred to as the "Bank." The Bank's primary service area is Nassau and Suffolk Counties, Long Island, although the Bank has three commercial banking branches in Manhattan and may open additional Manhattan branches in the future.
Overview
Earnings for the first nine months of 2008 were $1.33 per share, up 23 cents, or 21%, over the same period last year. Earnings for the third quarter of 2008 were up 10 cents per share, or 26% over the same quarter last year.
Return on assets ("ROA") and return on equity ("ROE") were 1.12% and 12.96%, respectively, for the first nine months of 2008 compared to 1.15% and 11.61%, respectively, for the same period last year. The improvement in ROE is attributable to increased earnings and share repurchases made pursuant to the Corporation's share repurchase program.
The increase in earnings thus far in 2008 is largely attributable to loan growth. On an average balance basis, total loans grew by $83.1 million, or 17.7%, when comparing the first nine months of 2008 to the same period last year. The growth, which occurred in commercial mortgages, residential mortgages and home equity loans, resulted from management's continued efforts to improve the Bank's current and future earnings prospects by making loans a larger portion of the overall balance sheet. Most of the loan growth was funded by an increase in interest bearing deposits. On an average balance basis, time deposits increased by $36.5 million, or 17.2%, and savings and money market deposits increased by $34.6 million, or 10.7%.
Also contributing to the increase in earnings was a borrowing and investing strategy undertaken in the latter part of 2007 and continued in 2008. This strategy, which accounts for $127 million of the borrowings under repurchase agreements at September 30, 2008, is primarily responsible for the increase in average borrowings of $108.4 million and the increase in average taxable investment securities of $94.1 million when comparing the first nine months of 2008 to the same period last year. The borrowings, some of which included interest rate caps ("caps"), were undertaken to increase current earnings and protect the Bank's future earnings in the event of an increase in interest rates.
A decline in interest rates during the first nine months of 2008 is yet another important factor that contributed to the increase in earnings. Earnings increased because the Bank's interest-bearing deposits are generally shorter in duration than its interest-earning assets and therefore reprice faster in a changing rate environment. In addition, short-term interest rates, which
are the primary driver of the rates paid by the Bank on its deposit products, declined more than intermediate and longer-term interest rates, which are the primary drivers of the yields available to the Bank on the repricing and origination of loans and purchase of securities.
The Corporation lost the tax benefit of its REIT entity as a result of a change in New York State tax law effective January 1, 2008. Under the old law, the Corporation would have derived a tax benefit from its REIT entity during the first nine months of 2008 in the approximate amount of $450,000. Management currently intends to change the ownership of its REIT entity within the consolidated group to once again obtain favorable tax treatment. The timing of this change is currently uncertain.
The credit quality of the Bank's loan portfolio continues to be excellent as evidenced by the low level of nonperforming loans. The Bank has not originated nor does it hold any subprime mortgages in its loan portfolio. In addition, all of the Bank's mortgage securities are backed by mortgages underwritten on conventional terms. The U.S. government guarantees the timely payment of principal and interest on most of the securities and underlying mortgages. Fannie Mae and Freddie Mac guarantee the remainder. Fannie Mae and Freddie Mac have been placed into conservatorship by their primary regulator, the Federal Housing Finance Agency ("FHFA"). The FHFA will act as conservator and will have the indefinite authority to control and oversee these entities in order to return them to a sound and solvent condition.
Deposits declined in the third quarter due to, among other things, the desire of bank customers to obtain, without limitation, insurance coverage on all deposits. Also negatively impacting the flow of deposits was increased price competition. In response to concerns regarding deposit insurance, the FDIC, as part of the Emergency Economic Stabilization Act of 2008, recently increased its deposit insurance limit from $100,000 to $250,000 and, under its Temporary Liquidity Guarantee Program, is now fully insuring checking balances. In addition, the Bank has responded to market concerns about deposit insurance coverage by adopting strategies that allow it to obtain or offer additional deposit insurance for interest-bearing balances held by customers. The actions by the FDIC and the Bank should serve to positively impact the flow of deposits. In addition, the Bank currently expects to open several new branches and convert one of its commercial banking offices to a full service branch in 2009. This should also positively impact the flow of deposits.
In recent months, two major pieces of legislation were enacted; the Housing and Economic Recovery Act of 2008 and the Emergency Economic Stabilization Act of 2008. Both pieces of legislation contain many significant provisions affecting banks, such as the aforementioned change in FDIC insurance coverage. Management is currently analyzing the impact of this legislation on the Bank's current and future operations.
Net Interest Income
Average Balance Sheet; Interest Rates and Interest Differential. The
following table sets forth the average daily balances for each major category of
assets, liabilities and stockholders' equity as well as the amounts and average
rates earned or paid on each major category of interest-earning assets and
interest-bearing liabilities.
Nine Months Ended September 30,
------------------------------------------------------------------------------
2008 2007
- --------- -- -- -------- -- ------ - - ------- -- -- -------- -- ------ -
Average Interest/ Average Average Interest/ Average
Balance Dividends Rate Balance Dividends Rate
- --------- -- -------- ------ - - ------- -- -------- ------ -
(dollars in thousands)
Assets
Federal funds sold and
overnight investments $ 25,842 $ 480 2.48 % $ 29,872 $ 1,165 5.21 %
Investment Securities:
Taxable 376,758 13,810 4.89 282,692 9,746 4.61
Nontaxable (1) 143,735 7,045 6.54 146,992 7,270 6.59
Loans (1) (2) 551,871 24,967 6.04 468,815 23,084 6.58
- --------- -- -------- ------ - ------- -- -------- ------
Total interest-earning
assets 1,098,206 46,302 5.63 928,371 41,265 5.94
-- -------- ------ -- -------- ------
Allowance for loan losses (4,792 ) (4,100 )
- --------- - -------
Net interest-earning assets 1,093,414 924,271
Cash and due from banks 32,643 32,685
Premises and equipment, net 11,351 9,115
Other assets 20,403 19,203
- --------- - -------
$ 1,157,811 $ 985,274
- --------- - -------
Liabilities and
Stockholders' Equity
Savings and money market
deposits $ 357,162 3,409 1.27 $ 322,590 3,568 1.48
Time deposits 248,911 5,568 2.99 212,396 7,395 4.66
- --------- -- -------- ------ - ------- -- -------- ------
Total interest-bearing
deposits 606,073 8,977 1.98 534,986 10,963 2.74
Borrowed funds 129,643 3,730 3.84 21,254 713 4.49
- --------- -- -------- ------ - ------- -- -------- ------
Total interest-bearing
liabilities 735,716 12,707 2.31 556,240 11,676 2.81
-- -------- ------ -- -------- ------
Checking deposits 317,842 328,164
Other liabilities 4,122 3,650
- --------- - -------
1,057,680 888,054
Stockholders' equity 100,131 97,220
- --------- - -------
$ 1,157,811 $ 985,274
- --------- - -------
Net interest income (1) $ 33,595 $ 29,589
-- -------- -- --------
Net interest spread (1) 3.32 % 3.13 %
------ ------
Net interest margin (1) 4.09 % 4.26 %
------ ------
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(1) Tax-equivalent basis. Interest income on a tax-equivalent basis includes the additional amount of interest income that would have been earned if the Corporation's investment in tax-exempt loans and investment securities had been made in loans and investment securities subject to Federal income taxes yielding the same after-tax income. The tax-equivalent amount of $1.00 of nontaxable income was $1.52 in each period presented based on a Federal income tax rate of 34%.
(2) For the purpose of these computations, nonaccruing loans are included in the daily average loan amounts outstanding.
Rate/Volume Analysis. The following table sets forth the effect of changes in volumes, rates, and rate/volume on tax-equivalent interest income, interest expense and net interest income.
Nine Months Ended September 30,
------------------------------------------------------
2008 Versus 2007
Increase (decrease) due to changes in:
------------------------------------------------------
Rate/ Net
Volume Rate Volume (1) Change
----------- ----------- ------------ --------
(in thousands)
Interest Income:
Federal funds sold and overnight investments $ (156 ) $ (611 ) $ 82 $ (685 )
Investment securities:
Taxable 3,271 589 204 4,064
Nontaxable (161 ) (65 ) 1 (225 )
Loans 4,127 (1,896 ) (348 ) 1,883
--- ------- -- -------- -- --------- - ------
Total interest income 7,081 (1,983 ) (61 ) 5,037
--- ------- -- -------- -- --------- - ------
Interest Expense:
Savings and money market deposits 405 (506 ) (58 ) (159 )
Time deposits 1,226 (2,621 ) (432 ) (1,827 )
Borrowed funds 3,644 (102 ) (525 ) 3,017
--- ------- -- -------- -- --------- - ------
Total interest expense 5,275 (3,229 ) (1,015 ) 1,031
--- ------- -- -------- -- --------- - ------
Increase in net interest income $ 1,806 $ 1,246 $ 954 $ 4,006
--- ------- -- -------- -- --------- - ------
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(1) Represents the change not solely attributable to change in rate or change in volume but a combination of these two factors. The rate/volume variance could be allocated between the volume and rate variances shown in the table based on the absolute value of each to the total for both.
Net interest income on a tax-equivalent basis was up $4,006,000 when comparing the first nine months of 2008 to the same period last year. The most significant reason for the increase in net interest income was growth in the Bank's loan portfolio. On an average balance basis, total loans grew by $83.1 million, or 17.7%, when comparing the first nine months of 2008 to the same period last year. Most of the loan growth was funded by an increase in interest bearing deposits. On an average balance basis, time deposits increased by $36.5 million, or 17.2%, and savings and money market deposits increased by $34.6 million, or 10.7%.
Also contributing to the increase in net interest income was a borrowing and investing strategy undertaken in the latter part of 2007 and continued in 2008. This strategy, which accounts for $127 million of the borrowings under repurchase agreements at September 30, 2008, is primarily responsible for the increase in average borrowings of $108.4 million and the increase in average taxable investment securities of $94.1 million when comparing the first nine months of 2008 to the same period last year. Of the total borrowings under this strategy, $75 million have embedded interest rate caps with a notional amount of $120 million. The borrowings without caps were undertaken to increase current earnings by taking advantage of the spread between borrowing and investing rates for similar duration instruments. The borrowings with caps also added to earnings, but to a lesser extent because they include the cost of the caps, and were
primarily undertaken to protect the Bank's future earnings in the event of an increase in interest rates.
A decline in interest rates during the first nine months of 2008 is yet another important factor that contributed to the increase in net interest income. Net interest income increased because the Bank's interest-bearing deposit liabilities are generally shorter in duration than its interest-earning assets and therefore reprice faster in a changing rate environment. In addition, short-term interest rates, which are the primary driver of the rates paid by the Bank on its deposit products, declined more than intermediate and longer-term interest rates, which are the primary drivers of the yields available to the Bank on the repricing and origination of loans and purchase of securities. When comparing the first nine months of 2008 to the same period last year, the overall yield on interest-earning assets declined by 31 basis points while the overall cost of deposits decreased by 76 basis points.
Short-term interest rates declined further after the close of the third quarter as evidenced by a 50 basis point reduction in the federal funds target rate on October 8, 2008. Despite this decline, interest rates on deposit products being offered by some significant competitors in the Bank's market area have begun to trend upward partially as a result of the liquidity problems being experienced by these competitors. So rather than decreasing deposits rates in response to the decline in the federal funds rate, the Bank has actually increased certain deposit rates to remain competitive. On the other hand, the decline in the federal funds rate has decreased the rate being paid by the Bank on its other borrowings.
The investment securities purchased with borrowed funds had a higher overall yield than the Bank's existing securities portfolio. This is the primary reason that the yield on the Bank's taxable securities portfolio increased by 28 basis points when comparing the first nine months of 2008 to the same period last year.
Net interest margin declined by 17 basis points and net interest spread increased by 19 basis points when comparing the first nine months of 2008 to the same period last year. The decline in net interest margin occurred largely because the margin on the borrowing and investing strategy is less than the margin on the balance of the Bank's interest-earning assets and interest-bearing liabilities. In addition, the return on noninterest-bearing checking balances and capital decreased due to the lower yield on interest-earning assets. Excluding the borrowing and investing strategy, net interest margin for the first nine months of 2008 would have increased versus the same period last year and the increase in net interest spread would have been greater.
Application of Critical Accounting Policies
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported asset and liability balances and revenue and expense amounts. Our determination of the allowance for loan losses is a critical accounting estimate because it is based on our subjective evaluation of a variety of factors at a specific point in time and involves difficult and complex judgments about matters that are inherently uncertain. In the event that management's estimate needs to be adjusted based on, among other things, additional information that comes to light after the estimate is made or changes in circumstances, such adjustment could result in the need for a significantly higher allowance for loan losses and thereby have a material negative impact on the Bank's results of operations.
The Bank's Reserve Committee, which is chaired by the Senior Lending Officer, meets on a quarterly basis and is responsible for determining the allowance for loan losses after considering, among other things, the results of credit reviews performed by the Bank's loan review officer. In addition, and in consultation with the Bank's Chief Financial Officer, the Reserve Committee is responsible for implementing and maintaining policies and procedures surrounding the calculation of the required allowance. The Bank's allowance for loan losses is subject to periodic examination by the Office of the Comptroller of the Currency, the Bank's primary federal banking regulator, whose safety and soundness examination includes a determination as to its adequacy to absorb probable incurred losses.
The first step in determining the allowance for loan losses is to identify loans in the Bank's portfolio that are individually deemed to be impaired. In doing so, subjective judgments need to be made regarding whether or not it is probable that a borrower will be unable to pay all principal and interest due according to contractual terms. Once a loan is identified as being impaired, management uses the fair value of the underlying collateral and/or the discounted value of expected future cash flows to determine the amount of the impairment loss, if any, that needs to be included in the overall allowance for loan losses. In estimating the fair value of real estate collateral management utilizes appraisals and also makes qualitative judgments based on, among other things, its knowledge of the local real estate market and analyses of current economic conditions and trends. Estimating the fair value of collateral other than real estate is also subjective in nature and sometimes requires difficult and complex judgments. Determining expected future cash flows can be more subjective than determining fair values. Expected future cash flows could differ significantly, both in timing and amount, from the cash flows actually received over the loan's remaining life.
In addition to estimating losses for loans individually deemed to be impaired, management also estimates collective impairment losses for pools of loans that are not specifically reviewed. Statistical information regarding the Bank's historical loss experience over a period of time is the starting point in making such estimates. However, future losses could vary significantly from those experienced in the past and accordingly management periodically adjusts its historical loss experience to reflect current conditions. In doing so, management considers a variety of general qualitative factors and then subjectively determines the weight to assign to each in estimating losses. The factors include, among others, national and local economic conditions and trends, environmental risks, trends in volume and terms of loans, concentrations of credit, changes in lending policies and procedures, and experience, ability, and depth of the Bank's lending staff. Because of the nature of the factors and the difficulty in assessing their impact, management's resulting estimate of losses may not accurately reflect actual losses in the portfolio.
Although the allowance for loan losses has two separate components, one for impairment losses on individual loans and one for collective impairment losses on pools of loans, the entire allowance for loan losses is available to absorb realized losses as they occur whether they relate to individual loans or pools of loans.
Asset Quality
The Corporation has identified certain assets as risk elements. These assets include nonaccruing loans, foreclosed real estate, loans that are contractually past due 90 days or more as to principal or interest payments and still accruing and troubled debt restructurings. These assets present more than the normal risk that the Corporation will be unable to eventually collect or realize their full carrying value. The Corporation's risk elements at September 30, 2008 and December 31, 2007 are as follows:
September 30, December 31,
2008 2007
--------------- -------------
(dollars in thousands)
Nonaccruing loans $ 112 $ 257
Loans past due 90 days or more as to principal or
interest payments and still accruing 3 95
Foreclosed real estate - -
---- ---------- --- ---------
Total nonperforming assets 115 352
Troubled debt restructurings - -
---- ---------- --- ---------
Total risk elements $ 115 $ 352
---- ---------- --- ---------
Nonaccruing loans as a percentage of total loans .02 % .05 %
---- ---------- --- ---------
Nonperforming assets as a percentage of total loans
and foreclosed real estate .02 % .07 %
---- ---------- --- ---------
Risk elements as a percentage of total loans and
foreclosed real estate .02 % .07 %
---- ---------- --- ---------
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Allowance and Provision for Loan Losses
The allowance for loan losses grew by $865,000 during the first nine months of 2008, amounting to $5,318,000 at September 30, 2008, or .88% of total loans, as compared to $4,453,000 at December 31, 2007, or .85% of total loans. During the first nine months of 2008 the Bank had loan chargeoffs and recoveries of $25,000 and $3,000, respectively, and recorded an $887,000 provision for loan losses. The provision for loan losses increased by $511,000 when comparing the first nine months of 2008 to the same period last year primarily because there was more loan growth in the first nine months of 2008 than 2007 and economic conditions deteriorated.
The allowance for loan losses is an amount that management currently believes will be adequate to absorb probable incurred losses in the Bank's loan portfolio. In determining the allowance for loan losses, there is not an exact amount but rather a range for what constitutes an appropriate allowance. As more fully discussed in the "Application of Critical Accounting Policies" section of this discussion and analysis of financial condition and results of operations, the process for estimating credit losses and determining the allowance for loan losses as of any balance sheet date is subjective in nature and requires material estimates. Actual results could differ significantly from those estimates.
Loans secured by real estate represent approximately 91% of the Bank's total loans outstanding at September 30, 2008. Most of these loans were made to borrowers domiciled on Long Island and in New York City. Local economic . . .
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