Basis of Financial Statement Presentation and Summary of Significant Accounting Policies
Nature of Business
Sterling Bancorp (“Sterling” or the “Company”) is a bank holding company and financial holding company under the Bank Holding Company Act of 1956. Sterling is a Delaware corporation that owns all of the outstanding shares of Sterling National Bank (the “Bank”). Sterling is listed on the New York Stock Exchange under the symbol STL.
The Bank, an independent, full-service national bank founded in 1888, is headquartered in Montebello, New York and is the principal subsidiary of Sterling. The Bank accounts for substantially all of Sterling’s consolidated assets and results of operations. The Bank operates through commercial banking teams and financial centers which serve the greater New York metropolitan region. The Bank targets the following geographic markets: (i) the New York Metro Market, which includes Manhattan, the boroughs and Long Island; and (ii) the New York Suburban Market, which consists of Rockland, Orange, Sullivan, Ulster, Putnam and Westchester counties in New York and Bergen County in New Jersey. The Bank also operates its commercial finance businesses, which include asset-based lending, payroll financing, factoring, warehouse lending, equipment financing, and public sector financing, which target markets across the U.S.
The Bank’s principal business is accepting deposits and, together with funds generated from operations and borrowings, investing in various types of loans and securities. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”). The Office of the Comptroller of the Currency (“OCC”) and the Federal Reserve Board are the primary regulators for the Bank and the Company, respectively.
Nature of Operations and Principles of Consolidation
The consolidated financial statements include the accounts of Sterling, the Bank and the Bank’s wholly-owned subsidiaries. The Bank’s subsidiaries included at December 31, 2018: (i) Sterling National Funding Corp, a company that originates loans to municipalities and governmental entities and acquires securities issued by state and local governments; (ii) Sterling REIT, Inc., a real estate investment trust that holds a portion of the Company’s real estate loans; (iii) Provest Services Corp. II, which has engaged a third-party provider to sell mutual funds and annuities to the Bank’s customers; (iv) AF Agency, Inc., which provides various annuity and wealth management products through contractual agreements with various third parties, and makes insurance products available, primarily to customers of the Bank; (v) several limited liability companies which hold other real estate owned; and (vi) several other companies that have no significant operations or assets. Intercompany transactions and balances are eliminated in consolidation.
Merger with Astoria Financial Corporation
On October 2, 2017, Astoria Financial Corporation (“Astoria”) merged with and into Sterling (the “Astoria Merger”). In connection with the merger, Astoria Bank, the principal subsidiary of Astoria, also merged with and into the Bank.
Merger with Hudson Valley Holding Corp.
On June 30, 2015, Hudson Valley Holding Corp. (“HVHC”) merged with and into Sterling (the “HVB Merger”). In connection with the merger, Hudson Valley Bank, the principal subsidiary of HVHC, also merged with and into the Bank.
Merger with Sterling Bancorp
On October 31, 2013, Provident New York Bancorp (“Legacy Provident”) merged with Sterling Bancorp (“Legacy Sterling”). In connection with the merger, the following corporate actions occurred:
Legacy Sterling merged with and into Legacy Provident. Legacy Provident was the accounting acquirer and the surviving entity.
Legacy Provident changed its legal entity name to Sterling Bancorp and became a bank holding company and a financial holding company as defined by the Bank Holding Company Act of 1956, as amended.
Provident Bank converted to a national bank charter.
Sterling National Bank merged into Provident Bank.
Provident Bank changed its legal entity name to Sterling National Bank.
We refer to the transactions detailed above collectively as the “Provident Merger.”
Use of Estimates
To prepare financial statements in conformity with U.S. generally accepted accounting principles management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided and actual results could differ. An estimate that is particularly susceptible to significant near-term change is the allowance for loan losses, which is discussed below.
Certain amounts from prior periods have been reclassified to conform to the current period presentation. Reclassifications had no affect on prior period net income or total stockholders’ equity.
For purposes of reporting cash flows, cash equivalents include cash and deposits with other financial institutions with an original maturity of 90 days or less. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions, short-term FHLB borrowings, mortgage escrow funds and other borrowings.
Restrictions on Cash
The Bank was required to have $70,709 and $118,113 of cash on hand or on deposit with the Federal Reserve Bank to meet regulatory reserve and clearing requirements at December 31, 2018 and 2017, respectively.
Securities include U.S. government agency and government sponsored agencies securities, state and municipal and corporate bonds, and mortgage-backed securities, including collateralized mortgage obligations. The Company classifies its securities among two categories: held to maturity and available for sale. The Company determines the appropriate classification of the Company’s securities at the time of purchase. Held to maturity securities are limited to debt securities for which there is the intent and the ability to hold to maturity. These securities are reported at amortized cost. The Company does not engage in trading activities. All other debt and marketable equity securities are classified as available for sale.
Available for sale securities are reported at fair value, with unrealized gains and losses (net of the related deferred income tax effect) excluded from earnings and reported in a separate component of stockholders’ equity (accumulated other comprehensive income or loss). Available for sale securities include securities that the Company intends to hold for an indefinite period of time, such as securities to be used as part of the Company’s asset/liability management strategy or securities that may be sold to fund loan growth, in response to changes in interest rates and prepayment risks, the need to increase capital, or similar factors.
Premiums on debt securities are generally amortized in interest income on a level yield basis over the earlier of the call date or maturity. Discounts on debt securities are accreted in interest income on a level yield basis over the period to maturity. Amortization of premiums and accretion of discounts on mortgage-backed securities are based on the estimated cash flows of the mortgage-backed securities, periodically adjusted for changes in estimated lives, on a level yield basis. Gains and losses on sales of securities are recorded on the trade date and determined using the specific identification method.
Securities are evaluated for other-than-temporary-impairment (“OTTI”) at least quarterly, and more frequently when economic and market conditions warrant such an evaluation. For securities in an unrealized loss position, the Company considers the extent and duration of the unrealized loss, and the financial condition of the issuer. The Company also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either criteria regarding intent to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. If (i) the Company does not expect to recover the entire amortized cost basis of the security; (ii) the Company does not intend to sell the security; (iii) and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, the OTTI is separated into (a) the amount representing the credit loss and (b) the amount related to all other factors. The amount of OTTI related to credit loss is recognized in earnings while the amount related to other factors is recognized in other comprehensive income, net of applicable taxes. The cost basis of individual equity securities is written down to estimated fair value through a charge to earnings when declines in value below cost are considered to be other than temporary. As of December 31, 2018, the Company did not intend to sell, nor is it more likely than not that it would be required to sell, any of its debt securities with unrealized losses prior to recovery of its amortized cost basis less any current period credit loss. (See Note 3. “Securities” and see Note 25. “Subsequent Events”).
Loans Held For Sale
Residential mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Mortgage loans held for sale are generally sold with servicing rights released. Commercial loans originated and intended for sale generally represent loan syndications and are carried at amortized cost, which approximates fair value, as these loans are variable-rate loans that reprice frequently with no significant change in credit risk since origination. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.
Loans that were previously held for investment that the Company intends to sell are transferred to loans held for sale at the lower of cost or market (fair value). At December 31, 2018, the Company transferred residential mortgage loans with an unpaid principal balance of $1,601,844 to held for sale. These loans represent substantially all of the remaining 15-year and 30-year fixed rate residential mortgage loans acquired in the Astoria Merger. These loans were subject to purchase accounting discounts, and the related purchase accounting discount of $61,025 was also transferred to loans held for sale. These loans are subject to a purchase agreement with a third party and, based on the negotiated sales price, there were no amounts reflected as charge-offs recorded at the time of the transfer. Changes in the fair value of the loans are recognized in non-interest income or expense.
Loans where Sterling has the intent and ability to hold for the foreseeable future or until maturity or payoff (other than loans held for sale) are reported at the principal balance outstanding, net of acquisition related purchase accounting adjustments, deferred loan fees and costs from loan originations and the allowance for loan losses. Interest income on loans is accrued on the unpaid principal balance. The Company defers nonrefundable loan origination and commitment fees, and certain direct loan origination costs, and amortizes the net amount as an adjustment of the yield over the estimated life of the loan using the level-yield method without anticipating prepayments. If a loan is prepaid or sold, the net deferred amount is recognized in the income statement at that time. Interest and fees on loans include prepayment fees and late charges collected.
A loan is placed on non-accrual status upon the earlier of: (i) when Sterling determines that the borrower may likely be unable to meet contractual principal or interest obligations; or (ii) when payments are 90 days or more past due based on the contractual terms of the loan, unless the loan is well secured and in the process of collection. Accrual of interest ceases and, in general, uncollected past due interest is reversed and charged against current interest income. Interest payments received on non-accrual loans, including impaired loans, are generally applied to reduce the principal balance outstanding and not recognized as income unless warranted based on the borrower’s financial condition and payment record. (See Note 4. “Portfolio Loans”).
Acquired Loans, Including Purchased Credit Impaired Loans
Loans the Company acquired in acquisitions are initially recorded at fair value with no carryover of the related allowance for loan losses. Determining the fair value of the loans involves estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest. Acquired loans are part of our portfolio loans in the consolidated balance sheets and are presented separately in Note 4. “Portfolio Loans”.
Loans for which there is both evidence of deterioration of credit quality since origination and probability, at acquisition, that all contractually required payments would not be collected represent purchase credit impaired loans (“PCI loans”). For PCI loans, the Company initially determines which loans will be treated under the cost recovery method (similar to a non-accrual loan) from loans that will be subject to accretion, which represent loans for which the Company was unable to reasonably estimate the timing and amount of expected cash flows. Other acquired loans, including PCI loans, and loans that met the criteria for non-accrual designation at the time of acquisition, are subject to accretion if the Company can reasonably estimate the timing and amount of the expected cash flows on such loans and if the Company expects to fully collect the new carrying value of the loans.
The Company recognizes the accretable yield, which is defined as the excess of all cash flows expected at acquisition over the initial fair value of the loan, as interest income on a level-yield basis over the expected remaining life of the loan. The excess of the loan’s contractually required payments over the cash flows expected to be collected is the nonaccretable difference. The nonaccretable difference is not recognized as an adjustment of yield, a loss accrual, or a valuation allowance. Going forward, on a quarterly basis, the Company continues to evaluate whether the timing and the amount of cash to be collected are reasonably expected. Subsequent significant increases in cash flows the Company expects to collect will first reduce any previously recognized valuation allowance and then be reflected prospectively as an increase to the level yield. Subsequent decreases in expected cash flows may result in the loan being considered impaired. Interest income is not recognized to the extent that the net investment in the loan would increase to an amount greater than the estimated payoff amount.
For PCI loans, the expected cash flows reflect anticipated prepayments, determined on a loan by loan basis according to the anticipated collection plan of these loans. The expected prepayments used to determine the accretable yield are consistent between the cash flows expected to be collected and projections of contractual cash flows so as to not affect the nonaccretable difference. Changes in prepayment assumptions may change the amount of interest income and principal expected to be collected.
For loans for which there was no clear evidence of deterioration of credit quality since origination nor evidence that all contractually required payments would not be collected, the Company accretes interest income based on the contractually required cash flows.
Acquired loans at December 31, 2018 and 2017 include loans that were acquired in the following transactions: the Advantage Funding Acquisition (as defined below; See Note 2. “Acquisitions”); the Astoria Merger; the restaurant franchise financing portfolio acquisition from GE Capital; the NBSC Acquisition, the HVB Merger, and the Provident Merger. Under our current credit and accounting guidelines, once a loan relationship reaches maturity and is re-underwritten, the loan is no longer considered an acquired loan and is included in originated loans. In addition, acquired performing loans that were subsequently subject to a credit evaluation, such as after designation as criticized or classified or placed on non-accrual since the acquisition date, are also included in originated loans. Through this process acquired loans that were subject to a purchase accounting adjustment with a life of loan loss estimate become subject to our loan loss methodology and allowance for loan losses evaluation methodology.
Allowance for Loan Losses
The allowance for loan losses is a valuation allowance, established through a provision for loan losses charged to expense, which represents management’s best estimate of probable incurred credit losses inherent in the loan portfolio. The level of the allowance for loan losses reflects management’s continuing evaluation of loan loss experience, specific credit risks, current loan portfolio quality, industry and loan type concentrations, economic and regulatory conditions and unidentified losses inherent in the loan portfolios. The allowance for loan losses is a critical accounting estimate and requires substantial judgment of management. The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans in which the borrower is experiencing financial difficulties and for which the terms have been modified resulting in a concession are considered troubled debt restructurings (“TDRs”) and classified as impaired.
Factors considered by the Company in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. The Company determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into account all circumstances surrounding the loan and the borrower, including the length of the delay, reasons for the delay, prior payment history and the amount of the shortfall in relation to the total amount owed.
The Company’s policy is to evaluate loans over $750 individually for impairment. If a loan is impaired, and there is a shortfall of the present value of the estimated future cash flows using the existing interest rate of the loan or as determined by the fair value of collateral if repayment is expected solely from the collateral, the Company’s practice is to charge-off the identified impairment. As a result, at December 31, 2018 and 2017, there was no portion of the allowance for loan losses allocated to impaired loans.
The general component of the allowance for loan losses covers loans that are collectively evaluated for impairment. Large groups of smaller balance homogeneous loans, such as consumer loans, which include home equity lines of credit, and residential mortgage loans are generally collectively evaluated for impairment and they are not included in the separately identified impairment disclosures. The general allowance for loan losses component also includes loans that are not individually identified for impairment evaluation, such as commercial loans below the individual evaluation threshold as well as those loans that are individually evaluated but not considered impaired, including loans rated special mention. The general component of the allowance is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent three years, consumer loans which is based on the most recent two years. The actual loss experience is supplemented with qualitative loss factors that are determined by management and are adjusted to reflect management’s evaluation of:
levels of, and trends in, delinquencies and non-performing loans, and criticized and classified loans;
trends in volume of loans;
effects of exceptions to lending policies and procedures;
experience, ability, and depth of lending management and staff;
national and local economic trends and conditions;
concentrations of credit by such factors as property type, industry, and relationship; and
for commercial loans, trends in risk ratings.
The Company applies the methodology described above to each portfolio segment. These segments include: traditional commercial and industrial (“C&I”), asset-based lending, payroll finance, warehouse lending, factored receivables, equipment financing, and public sector finance (collectively the C&I portfolio,) loans collateralized by real estate including commercial real estate (“CRE”), multi-family, and acquisition, development and construction (“ADC”) loans, residential mortgage, and certain consumer loans including home equity lines of credit.
C&I lending presents a risk because repayment depends on the successful operation of the business, which is subject to a wide range of risks and uncertainties. In addition, the ability to successfully liquidate collateral, if any, is subject to a variety of risks because the Company must gain control of assets used in the borrower’s business before foreclosing, which it cannot be assured of doing, and the value in a foreclosure sale or other means of liquidation is uncertain.
In addition, CRE and multi-family loans subject the Company to the risks that the property securing the loan may not generate sufficient cash flow to service the debt or the borrower may use the cash flow for other purposes. In addition, if necessary, the foreclosure process may be slow and properties may deteriorate in the process. The market values are also subject to a wide variety of factors, including general economic conditions, industry specific factors, environmental factors, interest rates and the availability and terms of credit.
ADC lending is considered higher risk and exposes the Company to greater credit risk than permanent mortgage financing. The repayment of ADC loans depends upon the sale of the property to third parties or the availability of permanent financing upon completion of all improvements. The Company has deemphasized originations of land acquisition and land development loans; however, it does originate construction loans to select clients principally within its immediate footprint.
When the Company evaluates residential mortgage loans and home equity loans (which are included as consumer loans), it weighs both the credit capacity of the borrower and the collateral value of the home. If unemployment or underemployment increase, the credit capacity of underlying borrowers will decrease, which increases the risk of such loan. Similarly, as the Company obtains a mortgage on the property, if home prices decline, it is exposed to risk in both its first mortgage and equity lending programs due to declines in the value of its collateral. The Company is also exposed to risk because the time to foreclose is significant and has become longer under current market conditions.
For C&I loans, CRE, multi-family and ADC loans the Company evaluates available financial information from the borrower as well as collateral pledged, evaluates whether the borrower can continue to service the debt and their near term prospects. When the Company concludes the collateral and or debt service capacity of the borrower are insufficient to repay its debt, it charges-off the amount that is deemed uncollectible. For unsecured consumer loans, charge-offs are recognized once the loan is 90 days to 120 days or more past due or the borrower files for bankruptcy protection. For secured consumer loans and residential mortgage loans the company monitors the value of the collateral and the borrower’s ability to service debt and records a charge-off when it becomes aware of the loss from and within the time frames specified by regulatory guidance.
Subsequent recoveries, if any, are credited to the allowance for loan losses.
Troubled Debt Restructuring
TDR is a formally renegotiated loan in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that would not have been granted to the borrower otherwise. At the time of restructuring, the Company evaluates whether a TDR loan should remain on accrual based on the accrual status immediately prior to modification and whether, as a result of the TDR, the Company recorded a partial charge-off. A TDR on accrual prior to modification may remain on accrual status provided the Company believes, based on its credit analysis, that collection of principal and interest in accordance with the modified terms is reasonably certain. If the restructuring results in a partial charge-off, the loan is generally classified as non-accrual. Restructured loans can convert from non-accrual to accrual status when said loans have demonstrated performance, generally evidenced by six months of consistent payment performance in accordance with the restructured terms, or by the presence of other significant items. (See Note 4. “Portfolio Loans”).
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the asset has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the rights (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before maturity.
Federal Reserve Bank of New York and Federal Home Loan Bank Stock
As a member of the Federal Reserve Bank of New York (“FRB”) and the Federal Home Loan Bank of New York (“FHLB”), the Bank is required to hold a certain amount of FRB and FHLB common stock. This stock is a non-marketable equity security and is reported at cost. Both cash and stock dividends are reported as interest and dividend income on other earning assets in the consolidated income statements.
Premises and Equipment
Land is reported at cost, while premises and equipment are reported at cost, less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, which range from three years for equipment and 40 years for premises. Leasehold improvements are amortized on a straight-line basis over the terms of the respective leases, including renewal options, or the estimated useful lives of the improvements, whichever is shorter. Routine holding costs are charged to expense as incurred, while significant improvements are capitalized. The Company recognizes an impairment charge to its premises and equipment, generally in connection with a decision to consolidate or close a financial center. Impairment is based on the excess of the carrying amount of assets over the fair value of the assets. Fair value is determined by third-party valuations or appraisals and evaluations prepared by management. (See Note 6. “Premises and Equipment, Net”).
Goodwill, Trade Names and Other Intangible Assets
Goodwill resulting from business combinations represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill and trade names (which are included with core deposits and other intangible assets in the consolidated balance sheets) acquired in a purchase business combination that have an indefinite useful life are not amortized, but are tested for impairment at least annually. Goodwill and trade names are the only intangible assets with an indefinite life on the Company’s balance sheet. The Company operates as one reporting unit. Goodwill is tested for impairment in the fourth quarter of each year, or on an interim basis if an conditions warrant that could more likely than not reduce the fair value of the reporting unit below its carrying value.
Core deposit intangibles recorded in acquisitions are amortized to expense using an accelerated method over their estimated lives of eight to ten years. Non-compete agreements are amortized on a straight line basis over their estimated life. Impairment losses on intangible assets and other long-term assets are charged to expense, if and when they occur, with the assets recorded at fair value. (See Note 7. “Goodwill and Other Intangible Assets”).
Bank Owned Life Insurance (“BOLI”)
The Company owns life insurance policies (purchased and acquired) on certain officers and key executives. BOLI is recorded at its cash surrender value (or the amount that can be realized). Changes in the net cash surrender value of the policies, as well as insurance proceeds received, are included in non-interest income on the consolidated income statements and are not subject to income taxes.
In the Astoria Merger the Company acquired BOLI with a carrying value of $441,840 and $441,751, at December 31, 2018 and 2017, respectively, which included a claims stabilization reserve of $35,391 and $32,624. Repayment of the claims stabilization reserve (funds transferred from the cash surrender value to provide for future death benefit payments) is guaranteed by the insurance carrier provided that certain conditions are met at the date of contract surrender. The Company satisfied these conditions at December 31, 2018 and 2017.
Other Real Estate Owned (“OREO”)
Real estate properties acquired through loan foreclosures are recorded initially at estimated fair value, less expected sales costs, with any resulting write-down charged to the allowance for loan losses. The carrying amount of an OREO asset is reduced by a charge to OREO, net expense to reflect any subsequent declines in estimated fair value. Fair value estimates are based on recent appraisals and other available information. Routine holding costs are charged to expense as incurred, while significant improvements are capitalized. Gains and losses on sales of OREO properties are recognized upon disposition.
Mortgage Servicing Rights
Mortgage servicing rights are included in other assets in the consolidated balance sheets. Servicing assets are initially recognized as separate assets at fair value when rights are acquired through acquisition or through the sale of residential mortgage loans with servicing retained. Servicing rights are accounted for under the amortization method. Under that method, capitalized servicing rights are amortized periodically to expense in proportion to and over the expected net servicing income.
Servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as a reduction of servicing expense (which is part of other non-interest expense). (See Note 20. “Fair Value Measurements” for a discussion of how fair value is calculated.)
Other Borrowings - Securities Repurchase Agreements
In securities repurchase agreements, the Company transfers securities to a counterparty under an agreement to repurchase the identical securities at a fixed price on a future date. These agreements are accounted for as secured financing transactions since the Company maintains effective control over the transferred securities and the transfer meets other specified criteria. Accordingly, the transaction proceeds are recorded as borrowings and the underlying securities continue to be carried in the Company’s investment securities portfolio. Disclosure of the pledged securities is made in the consolidated balance sheets if the counterparty has the right by contract to sell or re-pledge such collateral. (See Note 9. “Borrowings, Senior Notes and Subordinated Notes”).
Income tax expense includes U.S. federal corporate income taxes and income taxes due to states and other jurisdictions in which the Company operates. In addition, for the year ended December 31, 2017, income tax expense included the impact of the enactment of the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) which reduced the U.S. federal corporate income tax rate from 35% to 21% and resulted in a charge to reduce the carrying value of the Company’s net deferred income tax assets, which are included in the consolidated balance sheets as part of other assets.
Net deferred tax assets are recognized for the estimated future tax effects attributable to “temporary differences” between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to be recovered or settled. 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.
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, 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, we determine 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. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to income tax expense. The Company recognizes interest and/or penalties related to income tax matters in other non-interest expense.
The Company evaluates uncertain tax positions in a two step process. The first step is recognition, which requires a determination of whether it is more likely than not that a tax position will be sustained upon examination with an examination presumed to occur. The second step is measurement. Under the measurement step, a tax position that meets the more likely than not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more likely than not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. A previously recognized tax position that no longer meets the more likely than not recognition threshold should be derecognized in the first subsequent financial reporting period in which the threshold is no longer met. The Company did not have any such position as of December 31, 2018 and 2017. (See Note 11. “Income Taxes”).
Derivatives are recognized as assets and liabilities in the consolidated balance sheets and measured at fair value. For exchange-traded contracts, fair value is based on quoted market prices. For non-exchange traded contracts, fair value is based on dealer quotes, pricing models, discounted cash flow methodologies, or similar techniques for which the determination of fair value may require management judgment or estimation relating to future rates and credit activities.
For asset/liability management purposes, the Bank uses interest rate swap agreements to modify interest rate risk characteristics of certain portfolio loans as an accommodation to our borrowers. Interest rate swaps are contracts in which a series of interest rate flows are exchanged over a prescribed period. The notional amount on which the interest payments are based is not exchanged. These swap agreements are derivative instruments and these instruments effectively convert a portion of the Bank’s fixed-rate loans to variable rate loans. (See Note 10. “Derivatives”).
Fair Values of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 20. “Fair Value Measurements.” Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
In the Astoria Merger the Company assumed Astoria Bank’s pension plan, which covers Astoria employees and former Astoria employees meeting specified eligibility criteria. In addition to this pension plan, it assumed other non-qualified and unfunded supplemental retirement plans. These plans were suspended for the accrual of additional benefits prior to the Company’s assumption. The Company also assumed the liability for a health care plan that provides for post-retirement medical and dental coverage to select individuals, which is an active plan in which select individuals continued to vest through December 31, 2018. At December 31, 2018, the pension plan is over funded and the net asset balance is included in other assets in the consolidated balance sheets. For the remainder of the retirement plans, the net liabilities are included in other liabilities in the consolidated balance sheets. (See Note 14. “Pension and Other Post Retirement Plans Benefits”).
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. The Company does not believe there are such matters that will have a material effect on the consolidated financial statements. (See Note 19. “Commitments and Contingencies”).
Loan Commitments and Related Financial Instruments
Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. (See Note 18. “Off-Balance Sheet Financial Instruments”).
Stock-Based Compensation Plans
Compensation expense for stock options and non-vested stock awards/stock units is based on the fair value of the award on the measurement date, which is the date of grant. The expense is recognized ratably over the service period of the award. The fair value of non-vested stock awards/stock units is generally the market price of the Company’s common stock on the date of grant. (See Note 13. “Stock-Based Compensation”).
Earnings Per Common Share
Basic earnings per common share (“EPS”) is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS is computed in a similar manner to basic EPS, except that the weighted average number of common shares is increased to include incremental shares (computed using the treasury stock method) that would have been outstanding if all potentially dilutive stock options were exercised and unvested restricted stock became vested during the periods. (See Note 16. “Earnings Per Common Share”).
The Company recognizes revenue when all of the criteria below have been met: (i) persuasive evidence of an arrangement exists; (ii) delivery of our obligations to our client has occurred; (iii) the price is fixed or determinable; and (iv) collectability of the balance advanced is reasonably assured.
Interest income and fees. Interest income and fees on loans and investment securities are recognized based on the contractual provisions of the underlying agreements and instruments. Loan origination fees and costs are generally deferred and amortized into interest income as yield adjustments over the contractual life and / or commitment period using the effective interest method.
Payroll finance. The Company provides financing and business process outsourcing, including full back-office, technology and tax accounting services to independently-owned temporary staffing companies nationwide. Services include preparation of payroll, payroll tax payments, billings and collections. Non-interest income is recognized when billing to the Company’s customer occurs. The Company remits collections from the client’s customers to the Company’s clients for the amounts collected, net of payroll taxes withheld, the Company’s fees, subject to a hold back reserve to offset potential uncollectible balances from the client’s other customers.
Factored Receivables. The Company provide accounts receivable management services. The purchase of a client’s accounts receivable is traditionally known as “factoring” and results in payment by the client of a factoring fee. The factoring fee included in non-interest income represents compensation to the Company for the bookkeeping and collection services provided. The factoring fee, which is non-refundable, is recognized at the time the receivable is assigned to the Company. Other revenue associated with factored receivables includes wire fees, technology fees, field examination fees and UCC fees. All such fees are recognized as income upon receipt, which is when the Company’s obligations are provided to the Company’s customers. (See Note 15. “Non-Interest Income and Other Non-Interest Expense” for additional disclosure regarding revenue recognition.)
Public companies are required to report certain financial information about significant revenue-producing segments of the business for which such information is available and utilized by the chief operating decision maker. Substantially all of the Company’s operations occur through the Bank and involve the delivery of loan and deposit products to customers. Management makes operating decisions and assesses performance based on an ongoing review of its banking operation, which constitutes the Company’s only operating segment for financial reporting purposes.
Recently Adopted Accounting Standards
The Company adopted the following new accounting standards effective January 1, 2018:
Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (the “New Revenue Standard”), (i) creates a single framework for recognizing revenue from contracts with customers that fall within its scope and (ii) revises when it is appropriate to recognize a gain (loss) from the transfer of non-financial assets, such as OREO. The Company adopted the New Revenue Standard using the modified retrospective method applied to all contracts not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under the New Revenue Standard, while prior period amounts continue to be reported in accordance with legacy GAAP. The adoption of the New Revenue Standard did not result in a significant change to the accounting for any in-scope revenue streams. As such, no cumulative effect adjustment was recorded. The majority of the Company’s revenues come from interest income and other sources, including loans and securities, that are outside the scope of the New Revenue Standard. The Company’s services that fall within the scope of the New Revenue Standard are primarily included within non-interest income in the consolidated income statements and are recognized as revenue as the Company satisfies its obligation to the customer. Services within the scope of the New Revenue Standard include deposit fees and services charges, accounts receivable management / factoring commissions and other fees, investment management fees and the sale of OREO, which is included within OREO, net expense. See Note 15. “Non-Interest Income and Other Non-Interest Expense” for further discussion on the Company’s accounting policies for revenue sources within the scope of the New Revenue Standard.
Accounting Standards Update (“ASU”) No. 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition of Financial Assets and Financial Liabilities (the “New Fair Value Standard”), makes targeted amendments to the guidance for recognition, measurement, presentation and disclosure of financial instruments. The New Fair Value Standard requires equity investments to be measured at fair value with changes in fair value recognized in net income; however, the Company owned no assets subject to this
portion of the New Fair Value Standard. The New Fair Value Standard also emphasizes the existing requirement to use exit prices to measure fair value for disclosure purposes and clarifies that entities should not make use of a practicability exception in determining the fair value of loans. As a result of the adoption of the New Fair Value Standard, the Company modified its calculation used to estimate the fair value of portfolio loans. See Note 20. “Fair Value Measurements” for further discussion of the Company’s methodology. The New Fair Value Standard had no impact to the consolidated balance sheets or income statements.
ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (the “New Retirement Standard”), requires employers to present the service cost component of the net periodic benefit cost in the same income statement line item as other employee compensation costs arising from services rendered during the period. The other components of net benefit cost, including interest cost, expected return on plan assets, amortization of prior service cost/credit and actuarial gain/loss, and settlement and curtailment effects, are presented as a component of other non-interest expense. The adoption of this standard resulted in the reclassification of a net benefit of $306 and net expense of $415 from compensation and benefits to other non-interest expense for the years ended December 31, 2017 and 2016, respectively.
ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” (the “AOCI Standard”), allows a reclassification from accumulated other comprehensive income (“AOCI”) to retained earnings for the stranded tax effects caused by the revaluation of estimated deferred taxes resulting from the enactment of the Tax Act. As a result of the adoption of the AOCI Standard the Company reduced AOCI and increased retained earnings by $5,129 in the year ended December 31, 2018 related to unrealized losses on securities available for sale, securities transferred to held to maturity and a net actuarial loss on defined benefit retirement plans. As a result of the adoption of the AOCI standard, the Company will release such income tax effects only when the entire portfolio to which the underlying items are liquidated, sold or extinguished. The adoption of the AOCI Standard did not impact total stockholders’ equity or the consolidated income statements for any period.