Carver Bancorp 10-K 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2009
For the transition period from to
Commission File Number: 1-13007
CARVER BANCORP, INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: (718) 230-2900
Securities Registered Pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes þ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes þ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). o Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No
As of June 19, 2009, there were 2,475,037 shares of common stock of the registrant outstanding. The aggregate market value of the registrants common stock held by non-affiliates, as of September 30, 2008 (based on the closing sales price of $6.75 per share of the registrants common stock on September 30, 2008) was approximately $16,169,861.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of registrants proxy statement for the Annual Meeting of stockholders for the fiscal year ended March 31, 2009 are incorporated by reference into Part III of this Form 10-K.
CARVER BANCORP, INC.
2009 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 which may be identified by the use of such words as may, believe, expect, anticipate, should, plan, estimate, predict, continue, and potential or the negative of these terms or other comparable terminology. Examples of forward-looking statements include, but are not limited to, estimates with respect to the Companys financial condition, results of operations and business that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include but are not limited to the following:
Any or all of the Companys forward-looking statements in this Annual Report on Form 10-K and in any other public statements that the Company or management makes may turn out to be wrong. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. The forward-looking statements contained in this Annual Report on Form 10-K are made as of the date of this Annual Report on Form 10-K, and the Company assumes no obligation to, and expressly disclaims any obligation to, update these forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements. For a discussion of additional factors that could adversely affect the Companys future performance, see Item 1A Risk Factors and Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations.
As used in this Annual Report on Form 10-K, the word Company is used to refer to Carver Bancorp Inc. and its consolidated subsidiaries, including Carver Federal Savings Bank (Carver Federal).
ITEM 1. BUSINESS.
Carver Bancorp, Inc., a Delaware corporation (the Holding Company or Carver), is the holding company for Carver Federal Savings Bank (Carver Federal or the Bank), a federally chartered savings bank, and, on a parent-only basis, had minimal results of operations. The Holding Company is headquartered in New York, New York. The Holding Company conducts business as a unitary savings and loan holding company, and the principal business of the Holding Company consists of the operation of its wholly-owned subsidiary, Carver Federal. Carver Federal was founded in 1948 to serve African-American communities whose residents, businesses and institutions had limited access to mainstream financial services. The Bank remains headquartered in Harlem, and predominantly all its nine branches and eight stand-alone 24/7 ATM Centers are located in low- to moderate-income neighborhoods. Many of these historically underserved communities have experienced unprecedented growth and diversification of incomes, ethnicity and economic opportunity, after decades of public and private investment.
Today, Carver Federal is the largest African-American operated bank in the United States. The Bank remains dedicated to expanding wealth enhancing opportunities in the communities it serves by increasing access to capital and other financial services for consumers, businesses and non-profit organizations, including faith-based institutions. A measure of its progress in achieving this goal includes the Banks Outstanding rating, awarded by the Office of Thrift Supervision following its most recent Community Reinvestment Act (CRA) examination in 2009. The examination report noted that 76.1% of Carvers community development loan originations (loans that foster economic development and community revitalization) and 55.4% of Carvers Home-Owners Mortgage Disclosure Act (HMDA) reportable loan originations were within low- to moderate-income geographies, which far exceeded peer institutions. The Bank has approximately $791.4 million in assets as of March 31, 2009 and employs approximately 140 employees as of May 31, 2009.
Carver Federal engages in a wide range of consumer and commercial banking services. Carver Federal provides deposit products including demand, savings and time deposits for consumers, businesses, and governmental and quasi-governmental agencies in its local market area within New York City. In addition to deposit products, Carver Federal offers a number of other consumer and commercial banking products and services, including debit cards, online banking including online bill pay, and telephone banking.
Carver Federal offers loan products covering a variety of asset classes, including commercial, multi-family and residential mortgages, construction loans and business loans. The Bank finances mortgage and loan products through deposits or borrowings. Funds not used to originate mortgages and loans are invested primarily in U.S. government agency securities and mortgage-backed securities.
The Banks primary market area for deposits consists of areas currently served by its nine branches. The Banks branches are located in the Brooklyn, Manhattan and Queens boroughs of New York City. The neighborhoods in which the Banks branches are located have historically been low- to moderate-income areas. However, the shortage of housing in New York City, combined with population shifts from the suburbs into the city, has helped stimulate significant real estate and commercial development in the Banks market area.
The Banks primary lending market includes Bronx, Kings, New York and Queens counties in New York City, and lower Westchester County, New York. Although the Banks branches are primarily located in areas that were historically underserved by other financial institutions, the Bank faces significant competition for deposits and mortgage lending in its market areas. Management believes that this competition has become more intense as a result of the aforementioned market condition and increased examination emphasis by federal banking regulators on financial institutions fulfillment of their responsibilities under the CRA. Carver Federals larger competitors have greater financial resources, name recognition and market presence. The Banks competition for loans comes principally from mortgage banking companies, commercial banks, and savings institutions. The Banks most direct competition for deposits comes from commercial banks, savings institutions and credit unions. Competition for deposits also comes from money market mutual funds, corporate and government securities funds, and financial intermediaries such as brokerage firms and insurance companies. Many of the Banks competitors have substantially greater resources and offer a wider array of financial services and products. At times, these larger financial institutions may offer below market interest rates on mortgage loans and above market interest rates for deposits. These pricing concessions combined with competitors larger presence in the New York market add to the challenges the Bank faces in expanding its current market share and growing its near-term profitability.
Carver Federals 60 year history in its market area, its community involvement, relationships with key constituents, targeted products and services and personal service consistent with community banking, help the Bank compete with competitors that have entered its market.
The Bank formalized its many community focused investments on August 18, 2005, by forming Carver Community Development Corporation (CCDC). CCDC oversees the Banks participation in local economic development and other community-based initiatives, including financial literacy activities. CCDC is now coordinating the Banks development of an innovative approach to reach the unbanked customer market in Carver Federals communities. Importantly, CCDC spearheads the Banks applications for grants and other resources to help fund these important community activities. In this connection, Carver Federal has successfully competed with large regional and global financial institutions in a number of competitions for government grants and other awards. In June 2006, Carver Federal was selected by the U.S. Department of the Treasury (the Treasury) to receive an award of $59 million in New Market Tax Credits (NMTC). In May 2009, Carver Federal was selected to receive a second NMTC award in the amount of $65 million. These credits enable the Bank to invest with community and development partners in economic development projects with attractive terms including, in some cases, below market interest rates, which may have the effect of attracting capital to underserved communities and facilitating revitalization of the community. The NMTC award provides substantive credits to Carver Federal against Federal income taxes when the Bank makes qualified investments. For additional information regarding Carver Federals NMTC, refer to Item 7, New Market Tax Credit Award.
Carver Bancorp, Inc.
The Holding Company is the holding company for Carver Federal and its other active direct subsidiary, Carver Statutory Trust I (the Trust), a Delaware trust. The Trust was formed in September 2003 for the sole purpose of issuing trust preferred securities and investing the proceeds in an equivalent amount of subordinated debentures of the Holding Company.
The Companys subsidiary, Carver Statutory Trust I, is not consolidated with Carver Bancorp, Inc. for financial reporting purposes in accordance with Financial Accounting Standards Board, or FASB, revised interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, or FIN 46(R). Carver Statutory Trust I was formed in 2003 for the purpose of issuing $13.0 million aggregate liquidation amount of floating rate Capital Securities due September 17, 2033 (Capital Securities) and $0.4 million of common securities (which are the only voting securities of Carver Statutory Trust I), which are 100% owned by Carver Bancorp, Inc., and using the proceeds to acquire Junior Subordinated Debentures issued by Carver Bancorp, Inc. Carver Bancorp, Inc. has fully and unconditionally guaranteed the Capital Securities along with all obligations of Carver Statutory Trust I under the trust agreement relating to the Capital Securities.
On October 24, 1994, Carver Federal converted from mutual to stock form and issued 2,314,275 shares of its common stock at a price of $10 per share. On October 17, 1996, the Bank completed its reorganization into a holding company structure (the Reorganization) and became a wholly-owned subsidiary of the Holding Company.
On April 5, 2006, the Company entered into a definitive merger agreement to acquire Community Capital Bank (CCB), a Brooklyn-based community bank, in a cash transaction valued at $11.1 million, or $40.00 per CCB share. On September 29, 2006, the Bank acquired CCB, with approximately $165.4 million in assets and two branches. The Bank incurred an additional $0.9 million in transaction costs related to the acquisition. The acquisition of CCB and its award-winning small business lending platform has expanded the Companys ability to capitalize on substantial growth in the small business market. The Company continues to evaluate acquisition opportunities as part of its strategic objective for long-term growth.
The principal business of the Holding Company consists of the operation of its wholly owned subsidiary, the Bank. The Holding Companys executive offices are located at the home office of the Bank at 75 West 125th Street, New York, New York 10027. The Holding Companys telephone number is (718) 230-2900.
Carver Federal Savings Bank
Carver Federal was chartered in 1948 and began operations in 1949 as Carver Federal Savings and Loan Association, a federally chartered mutual savings and loan association, at which time it obtained federal deposit insurance and became a member of the Federal Home Loan Bank of New York (the FHLB-NY). Carver Federal, a certified Community Development Financial Institution (CDFI), was founded as an African- and Caribbean-American operated institution to provide residents of underserved communities the ability to invest their savings and obtain credit. Carver Federal Savings and Loan Association converted to a federal savings bank in 1986 and changed its name at that time to Carver Federal Savings Bank. None of the Banks employees is a member of a collective bargaining agreement, and the Bank considers its relations with employees to be satisfactory.
On March 8, 1995, Carver Federal formed CFSB Realty Corp. as a wholly-owned subsidiary to hold real estate acquired through foreclosure pending eventual disposition. At March 31, 2009, this subsidiary had $1.2 million in total assets and a minimal net operating loss. During the fourth quarter of the fiscal year ended March 31, 2003, Carver Federal formed Carver Asset Corporation (CAC), a wholly-owned subsidiary which qualifies as a real estate investment trust (REIT) pursuant to the Internal Revenue Code of 1986, as amended. This subsidiary may, among other things, be utilized by Carver Federal to raise capital in the future. As of March 31, 2009, CAC owned mortgage loans carried at approximately $96.7 million and total assets of $125.9 million. On August 18, 2005, Carver Federal formed CCDC, a wholly-owned community development entity, to facilitate and develop innovative approaches to financial literacy, address the needs of the unbanked and participate in local economic development and other community-based activities. As part of its operations, CCDC monitors the portfolio of investments related to NMTC awards and makes application for additional awards.
The Company makes available on or through its internet website, http://www.carverbank.com, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of The Securities Exchange Act. Such reports are free of charge and are available as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission (SEC). The public may read and copy any materials the Company files with the SEC at the SECs Public Reference Room at 100 F Street N.E. Washington D.C. 20549. Information may be obtained on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC, including the Company, at http://www.sec.gov.
In addition, certain other basic corporate documents, including the Companys Corporate Governance Principles, Code of Ethics, Code of Ethics for Senior Financial Officers and the charters of the Companys Finance and Audit Committee, Compensation Committee and Nominating/Corporate Governance Committee and the date of the Companys annual meeting are posted on the Companys website. Printed copies of these documents are also available free of charge to any stockholder who requests them. Stockholders seeking additional information should contact the Corporate Secretarys office by mail at 75 West 125th Street, New York, New York 10027 or by e-mail at email@example.com. The information on the Companys website is not part of this annual report.
General. Carver Federals loan portfolio consists primarily of mortgage loans originated by the Banks lending team and secured by commercial real estate, multi-family and one-to-four family residential property and construction loans. Substantially all of the Banks mortgage loans are secured by properties located within the Banks market area. From time-to-time, the Bank may purchase loans from other financial institutions to achieve loan growth objectives. Loans purchased comply with the Banks underwriting standards.
In recent years, Carver Federal has focused on origination of commercial real estate loans and multi-family residential loans. These loans generally have higher yields and shorter maturities than one-to-four family residential properties, and include prepayment penalties that the Bank collects if the loans pay in full prior to the contractual maturity. The Banks increased emphasis on commercial real estate and multi-family residential mortgage loans has increased the overall level of credit risk inherent in the Banks loan portfolio. The greater risk associated with commercial real estate and multi-family residential loans could require the Bank to increase its provisions for loan losses and to maintain an allowance for loan losses as a percentage of total loans in excess of the allowance currently maintained. Carver Federal continually reviews the composition of its mortgage loan portfolio and underwriting standards to manage the risk in the portfolio. To date, the Bank has not experienced significant losses in commercial real estate, multi-family residential and one-to-four family mortgage loan portfolios, although loan delinquencies as of March 31, 2009 are higher than prior comparable periods.
Carver Federals construction loan portfolio consists principally of loans originated through the Community Preservation Corporation (CPC). These loans are targeted toward affordable housing or rental dwelling units that tend to have lower risk profiles compared to other construction loans (discussed below). Nevertheless, during fiscal 2009, the Bank began to deemphasize construction loans, substantially reducing originations of new construction loans, allowing the outstanding balance of the construction loan portfolio to decline. As security for repayment, the Bank obtains a first lien position on the underlying collateral, and generally obtains personal guarantees. Construction loans also generally have a term of two years or less. Construction loans involve a greater degree of risk than other loans because, among other things, the underwriting of such loans is based on an estimated value of the developed property, which can be difficult to ascertain in light of uncertainties inherent in such estimations. In addition, construction lending entails the risk that the project may not be completed due to cost overruns or changes in market conditions. The greater risk associated with construction loans could require the Bank to increase its provision for loan losses, and to maintain an allowance for loan losses as a percentage of total loans in excess of the allowance the Bank currently maintains. To date, Carver Federal has not incurred any losses in the current construction loan portfolio.
Carver Federals business banking unit was formed in 2006 with the acquisition of Community Capital Bank (CCB), a commercial bank, to focus on loans to businesses located within the Banks market area. These loans are generally personally guaranteed by the business owners, and may be secured by the assets of the business. The interest rate on these loans is generally an adjustable rate based on a published index, usually the prime rate. These loans, while providing the Bank a higher rate of return, also present a higher level of risk. The greater risk associated with business loans could require the Bank to increase its provision for loan losses, and to maintain an allowance for loan losses as a percentage of total loans in excess of the allowance currently maintained. To date, Carver Federal has incurred some losses in the business loan portfolio from loans acquired through the CCB acquisition.
Loan Portfolio Composition. Total loans receivable increased by $9.5 million, or 1.5%, to $642.1 million at March 31, 2009 compared to $632.6 million at March 31, 2008. Carver Federals total loans receivable, net, as a percentage of total assets increased to 80.1% at March 31, 2009 compared to 79.5% at March 31, 2008. Non-residential real estate loans, which includes commercial real estate, totaled $273.6 million, or 42.6% of total loans receivable; multi-family loans totaled $80.3 million, or 12.5% of total loans receivable; construction loans (net of committed but undisbursed funds), totaled $144.3 million, or 22.5% of total loans receivable; one-to-four family mortgage loans totaled $84.7 million, or 13.2% of total loans receivable; business loans totaled $57.5 million, or 9.0% of total loans receivable; and consumer loans (credit card loans, personal loans, and home improvement loans) totaled $1.7 million, or 0.3% of total loans receivable. For additional information regarding Carver Federals loan portfolio refer to Note 5 of Notes to Consolidated Financial Statements, Loans Receivable, Net.
Non-residential Real Estate Lending. Non-residential real estate lending consists predominantly of originating loans for the purpose of purchasing or refinancing office, mixed-use (properties used for both commercial and residential purposes but predominantly commercial), retail and church buildings in the Banks market area. Mixed use loans are secured by properties which are intended for both residential and business use and are classified as commercial real estate. Non-residential real estate lending entails additional risks compared with one to four family residential and multi-family lending. For example, such loans typically involve large loan balances to single borrowers or groups of related borrowers, and the payment experience on such loans typically is dependent on the successful operation of the commercial property.
In making non-residential real estate loans, the Bank primarily considers the ability of the net operating income generated by the real estate to support the debt service, the financial resources, income level and managerial expertise of the borrower, the marketability of the property and the Banks lending experience with the borrower. Carver Federals maximum loan-to-value (LTV) ratio on non-residential real estate mortgage loans is generally 75% based on the appraised value of the mortgaged property. The Bank generally requires a Debt Service Coverage Ratio (DSCR) of at least 1.25 on non-residential real estate loans. The Bank also requires the assignment of rents of all tenants leases in the mortgaged property and personal guarantees may be obtained for additional security from these borrowers.
At March 31, 2009, non-residential real estate mortgage loans totaled $273.6 million, or 42.6% of total loans receivable. This balance reflects a year-over-year increase of $35.8 million, or 14.7%. The increase in originations in fiscal 2009 is the result of favorable pricing opportunities on non-residential real estate loan originations during the fiscal year as a result of widening spreads compared to one to four family pricing. However, under the current economic environment, the Bank has strengthened its commercial real estate loan underwriting guidelines.
The Bank offers adjustable rate mortgage (ARM) loans with interest rate adjustment periods of one to five years and generally for terms of up to 15 years and amortization schedules up to thirty years. Interest rates on ARM loans currently offered by the Bank are adjusted at the beginning of each adjustment period are generally based upon a fixed spread above the FHLB-NY corresponding Regular Advance Rate. From time to time, the Bank may originate ARM loans at an initial rate lower than the index as a result of a discount on the spread for the initial adjustment period. Commercial adjustable-rate mortgage loans generally are not subject to limitations on interest rate increases either on an adjustment period or aggregate basis over the life of the loan.
Historically, Carver Federal has been a New York City metropolitan area leader in the origination of loans to churches. At March 31, 2009, loans to churches totaled $43.8 million, or 6.8% of the Banks total loans receivable. These loans generally have five-, seven-, or ten-year terms with 15-, 20- or 25-year amortization periods, a balloon payment due at the end of the term and generally have no greater than a 70% LTV ratio. The Bank also provides construction financing for churches and generally provides permanent financing upon completion of construction. There are currently 52 church loans in the Banks loan portfolio.
Loans secured by real estate owned by faith-based organizations generally are larger and involve greater risks than one-to-four family residential mortgage loans. Because payments on loans secured by such properties are often dependent on voluntary contributions by members of the churchs congregation, repayment of such loans may be subject to a greater extent to adverse conditions in the economy. The Bank seeks to minimize these risks in a variety of ways, including reviewing the organizations financial condition, limiting the size of such loans and establishing the quality of the collateral securing such loans. The Bank determines the appropriate amount and type of security for such loans based in part upon the governance structure of the particular organization, the length of time the church has been established in the community and a cash flow analysis to determine the churchs ability to service the proposed loan. Carver Federal will obtain a first mortgage on the underlying real property and often requires personal guarantees of key members of the congregation and/or key person life insurance on the pastor. The Bank may also require the church to obtain key person life insurance on specific members of the churchs leadership. Historically, asset quality in the church loan category has been strong throughout Carver Federals history, however, as recent economic conditions have declined, Carver has experienced some delinquencies in this portfolio. Management believes that Carver Federal will remain a leading lender to churches in its market area, however, Carver will continue to conduct disciplined underwriting and maintain focused portfolio management.
Multi-family Real Estate Lending. Traditionally, Carver Federal originates and purchases multi-family loans, although no multi-family loans were purchased in fiscal 2009. Rates offered on this product are considered to be competitive with flexible terms that make this product attractive to borrowers. Multi-family property lending entails additional risks compared to one-to-four family residential lending. For example, such loans are dependent on the successful operation of such buildings and can be significantly impacted by supply and demand conditions in the market for multi-family residential units. Carver Federals multi-family loan portfolio increased $1.7 million in fiscal 2009, or 2.1% to $80.3 million, or 12.5%, of Carver Federals total loans receivable at March 31, 2009.
In making multi-family loans, the lending team primarily considers the propertys ability to generate net operating income sufficient to support the debt service, the financial resources, income level and managerial expertise of the borrower, the marketability of the property and the Banks lending experience with the borrower. Carver Federals multi-family product guidelines generally require that the maximum LTV not exceed 75% based on the appraised value of the mortgaged property. The Bank generally requires a DSCR of at least 1.20 on multi-family loans, which requires the properties to generate cash flow after expenses and allowances in excess of the principal and interest payment. Carver Federal originates and purchases multi-family loans, which are predominantly adjustable rate loans that generally amortize on the basis of a 15-, 20-, 25- or 30-year period and require a balloon payment after the first five years, or the borrower may have an option to extend the loan for two additional five-year periods. The Bank occasionally originates fixed rate loans with greater than five year terms. Personal guarantees may be obtained for additional security from these borrowers.
To help ensure continued collateral protection and asset quality for the term of multi-family real estate loans, Carver Federal employs a loan risk-rating system. All commercial real estate loans are risk-rated internally at the time of origination. In addition, to evaluate changes in the credit profile of the borrower and the underlying collateral, quarterly an independent consulting firm reviews and prepares a written report for a sample of multi-family real estate loan relationships of $250,000 or more, and at least annually prepares a written report for all relationships exceeding $2.0 million. Summary reports are then reviewed by management for changes in the credit profile of individual borrowers and the portfolio as a whole.
Construction Lending. The Bank originates or participates in construction loans for new construction and renovation of multi-family buildings, residential developments, community service facilities, churches, and affordable housing programs. The Banks construction loans generally have adjustable interest rates and are underwritten in accordance with the same standards as the Banks mortgage loans on existing properties. The loans provide for disbursement in stages as construction is completed. Participation in construction loans may be at various stages of funding. Construction terms are usually from 12 to 24 months. The construction loan interest is capitalized as part of the overall project cost and is funded monthly from the loan proceeds. Borrowers must satisfy all credit requirements that apply to the Banks permanent mortgage loan financing for the mortgaged property. Carver Federal has additional criteria for construction loans to include an engineers plan and cost review on all construction budgets with interest reserves for loans in excess of $250,000.
Construction financing generally is considered to involve a higher degree of risk of loss than long term financing on improved and occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the mortgaged propertys value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in project delays and cost overruns. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, the Bank may be confronted, at or prior to the maturity of the loan, with a project having a value that is insufficient to assure full repayment of such loan. The ability of a developer to sell completed dwelling units will depend on, among other things, demand, pricing, availability of comparable properties and economic conditions. The Bank has sought to minimize this risk by limiting construction lending to qualified borrowers in the Banks market areas, limiting the aggregate amount of outstanding construction loans and imposing a stricter LTV ratio requirement than that required for one-to-four family mortgage loans.
At March 31, 2009, the Bank had $144.3 million (net of $33.5 million of committed but undisbursed funds) in construction loans outstanding, comprising 22.5% of the Banks gross loan portfolio. The balance at March 31, 2009 reflects a $14.6 million, or 9.2%, decrease over fiscal 2008, consistent with the Banks objective of deemphasizing construction loans and letting the remaining principal balances amortize down. Purchased construction loans represent 68.9% of total construction loans in portfolio. The Banks primary source of construction loan purchases is with the Community Preservation Corporation (CPC), a non-profit corporation sponsored by more than 90 commercial banks, savings institutions and insurance companies that provides mortgage, construction and other lending for affordable housing, with a complementary goal to revitalize low- and moderate-income communities.
Due to the recent downturn in real estate conditions and the economy in general, it has become increasingly difficult for developers of these construction projects to provide end loan financing for purchasers of their units. This is due to more stringent pre-sale and other financing guidelines established by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation and the traditional buyers of these end loans. The Bank is actively working with the developers to commence a program to provide end loan financing to qualified prospective buyers of these units. If the developers are unable to obtain end loan financing for the sellout of the projects, such developments may be converted to rental units. The Bank has also underwritten such construction projects as residential rental building in the event the units cannot be sold, which would allow a takeout of the loans by various governmental agencies. In this connection, at March 31, 2009, Carver Federal had 24 CPC originated loans aggregating $76.4 million that have been originated for the development of for sale dwelling units with the option of the developer to convert the properties to rental units and close on committed financing from the New York City Pension Fund (NYC Pension Fund), which financing will be used to satisfy Carver Federals loan. Carver Federal has personal guarantees to cover any short-fall between NYC Pension Fund loan commitment amounts and the amount due Carver Federal. At March 31, 2009, Carver Federal also had seventeen CPC loans aggregating $23.0 million that were originated as rental properties with the expectation that these loans would be satisfied by existing loan commitments issued by the NYC Pension Fund.
One-to-four Family Residential Lending. Historically, Carver Federal emphasized the origination and purchase of first mortgage loans secured by one-to-four family properties that serve as the primary residence of the owner. To a much lesser degree, the Bank has made loans to investors that are secured by non-owner occupied one-to-four family properties, although this practice has been discontinued. In the past the Bank has also purchased one-to-four family loans, however, no such loans were purchased in fiscal 2009. Recently, the Bank has entered into an arrangement with a third party to originate and underwrite one-to-four family loans for the Bank using the Banks underwriting standards.
Carver Federal offers both fixed-rate and adjustable-rate residential mortgage loans with maturities of up to 30 years and a general maximum loan amount of $1.0 million. Approximately 92% of the one-to-four family residential mortgage loans maturing in greater than one year at March 31, 2009 were adjustable rate and approximately 8% were fixed-rate. One-to-four family residential real estate loans decreased $18.8 million to $84.7 million, or 18.1%, of the gross loan portfolio at March 31, 2009 compared to March 31, 2008. Of this amount, $1.2 million are subprime loans, or 0.2% of total loans receivable. $0.8 million are non-performing loans. The Bank decreased it emphasis on one-to-four family lending due to more favorable pricing on multi-family residential and commercial real estate lending.
The Banks lending policies generally limit the maximum loan-to-value (LTV) ratio on one-to-four family residential mortgage loans secured by owner-occupied properties to 90% of the lesser of the appraised value or purchase price, with private mortgage insurance required on loans with LTV ratios in excess of 80%. Under certain special loan programs, Carver Federal may originate and sell loans secured by single-family homes purchased by first time home buyers where the LTV ratio may be up to 97%.
Carver Federals fixed-rate, one-to-four family residential mortgage loans are underwritten in accordance with applicable secondary market underwriting guidelines and requirements for sale. From time to time the Bank has sold such loans to the Federal National Mortgage Association (FNMA), the State of New York Mortgage Agency (SONYMA) and other third parties. Loans are generally sold with limited recourse on a servicing retained basis except to SONYMA where the sale is made with servicing released. Carver Federal uses several servicing firms to sub-service mortgage loans, whether held in portfolio or sold with the servicing retained. At March 31, 2009, the Bank, through its sub-servicers, serviced $50.2 million in loans for FNMA and $6.6 million for other third parties.
Carver Federal offers one-year, three-year, five/one-year and five/three-year adjustable-rate one-to-four family residential mortgage loans. These loans are generally retained in Carver Federals portfolio although they may be sold in the secondary market. They are indexed to the weekly average rate on one-year, three-year and five-year U.S. Treasury or Federal Home Loan Bank (FHLB) securities, respectively, adjusted to a constant maturity (usually one year), plus a margin. The rates at which interest accrues on these loans are adjustable every one, three or five years, generally with limitations on adjustments of two percentage points per adjustment period and six percentage points over the life of a one-year adjustable-rate mortgage and four percentage points over the life of three-year and five-year adjustable-rate mortgages.
The retention of adjustable-rate loans in Carver Federals portfolio helps reduce Carver Federals exposure to increases in prevailing market interest rates. However, there are unquantifiable credit risks resulting from potential increases in costs to borrowers in the event of upward re-pricing of adjustable-rate loans. It is possible that during periods of rising interest rates, the risk of default on adjustable-rate loans may increase due to increases in interest costs to borrowers. Although adjustable-rate loans allow the Bank to increase the sensitivity of its interest-earning assets to changes in interest rates, the extent of this interest rate sensitivity is limited by periodic and lifetime interest rate adjustment limitations. Accordingly, there can be no assurance that yields on the Banks adjustable-rate loans will fully adjust to compensate for increases in the Banks cost of funds. Adjustable-rate loans increase the Banks exposure to decreases in prevailing market interest rates, although decreases in the Banks cost of funds would tend to offset this effect.
Business Loans. Carver Federals small business lending portfolio increased by $6.1 million to $57.5 million, or 11.9%, of the Banks gross loan portfolio. Carver Federal provides revolving credit and term loan facilities to small businesses with annual sales of approximately $1 million to $25 million in manufacturing, services and wholesale segments. Business loans are personally guaranteed by the owners, and may also be secured by additional collateral, including real estate, equipment and inventory. Included in commercial business loans are loans made to owners of New York City taxi medallions. These loans, which totaled $9.1 million at March 31, 2009, are secured through first liens on the taxi medallions. Carver Federal originates taxi medallion loans up to 80% of the value of the taxi medallion.
Consumer and other Loans. At March 31, 2009, the Bank had $1.7 million in consumer and other loans, or 0.3%, of the Banks gross loan portfolio. At March 31, 2009, $1.5 million, or 88.2%, of the Banks consumer loans were unsecured loans, consisting of consumer loans other than loans secured by savings deposits, and $0.2 million, or 11.8%, were secured by savings deposits.
Consumer loans generally involve more risk than first mortgage loans. Collection of a delinquent loan is dependent on the borrowers continuing financial stability, and thus is more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Further, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered. These loans may also give rise to claims and defenses by a borrower against Carver Federal, and a borrower may be able to assert claims and defenses against Carver Federal which it has against the seller of the underlying collateral. In underwriting unsecured consumer loans other than secured credit cards, Carver Federal considers the borrowers credit history, an analysis of the borrowers income, expenses and ability to repay the loan and the value of the collateral. The underwriting for secured credit cards only takes into consideration the value of the underlying collateral. See Asset QualityNon-performing Assets.
Loan Processing. Carver Federals loan originations are derived from a number of sources, including referrals by realtors, builders, depositors, borrowers and mortgage brokers, as well as walk-in customers. Loans are originated by the Banks personnel who receive a base salary, commissions and other incentive compensation. Real estate, business and unsecured loan applications are forwarded to the Banks Lending Department for underwriting pursuant to standards established in Carver Federals loan policy. The underwriting and loan processing for residential one-to-four family loans are performed by an outsourced third party loan originator using lending standards established by the Bank.
A commercial real estate loan application is completed for all multi-family and non-residential properties which the Bank finances. Prior to loan approval, the property is inspected by a loan officer. As part of the loan approval process, consideration is given to an independent appraisal, location, accessibility, stability of the neighborhood, environmental assessment, personal credit history of the applicant(s) and the financial capacity of the applicant(s). Business loan applications are completed for all business loans. Most business loans are secured by real estate, personal guarantees, and/or guarantees by the United States Small Business Association (SBA) or Uniform Commercial Code (UCC) filings. The loan approval process considers the credit history of the applicant, collateral, cash flow and purpose and stability of the business.
Upon receipt of a completed loan application from a prospective borrower, a credit report and other verifications are ordered to confirm specific information relating to the loan applicants income and credit standing. It is the Banks policy to obtain an appraisal of the real estate intended to secure a proposed mortgage loan from an independent appraiser approved by the Bank.
It is Carver Federals policy to record a lien on the real estate securing the loan and to obtain a title insurance policy that insures that the property is free of prior encumbrances. Borrowers must also obtain hazard insurance policies prior to closing and, when the property is in a flood plain as designated by the Department of Housing and Urban Development, paid flood insurance policies must be obtained. Most borrowers are also required to advance funds on a monthly basis, together with each payment of principal and interest, to a mortgage escrow account from which the Bank makes disbursements for items such as real estate taxes and hazard insurance. Written conformation of the guarantee for SBA loans and evidence of the UCC filing is also required.
Loan Approval. Except for real estate and business loans in excess of $6.0 million and $3.0 million, respectively, mortgage and business loan approval authority has been delegated by the Banks Board to the Boards Asset Liability and Interest Rate Risk Committee. The Asset Liability and Interest Rate Risk Committee has delegated to the Banks Management Loan Committee, which consists of certain members of executive management, loan approval authority for loans up to and including $3.0 million for real estate loans, $2.0 million for business loans secured by real estate and $1.0 million for all other business loans. Any loan that represents an exception to the Banks lending policies must be ratified by the next higher approval authority. Real estate and business loans above $6.0 million and $3.0 million, respectively, must be approved by the full Board. Purchased loans are subject to the same approval process as originated loans. One-to-four family mortgage loans that conform to FNMA standards and limits may be approved by the outsourced third party loan originator.
Loans-to-One-Borrower. Under the loans-to-one-borrower limits of the United States Office of Thrift Supervision (OTS), with certain limited exceptions, loans and extensions of credit to a single or related group of borrowers outstanding at one time generally may not exceed 15% of the unimpaired capital and surplus of a savings bank. See Regulation and SupervisionFederal Banking RegulationLoans-to-One-Borrower Limitations. At March 31, 2009, the maximum loans-to-one-borrower under this test would be $12.6 million and the Bank had no relationships that exceeded this limit.
Loan Sales. Originations of one-to-four family real estate loans are generally made on properties located within the New York City metropolitan area, although Carver Federal occasionally funds loans secured by property in other areas. All such loans, however, satisfy the Banks underwriting criteria regardless of location. The Bank continues to offer one-to-four family fixed-rate mortgage loans in response to consumer demand but requires that such loans satisfy applicable secondary market guidelines of FNMA, SONYMA or other third-party purchaser to provide the opportunity for subsequent sale in the secondary market as desired to manage interest rate risk exposure.
Loan Originations and Purchases. Loan originations, including loans originated for sale, were $151.4 million in fiscal 2009 compared to $182.7 million in fiscal 2008. In prior years, the Bank increased its loan production of non-residential commercial real estate and multi-family lending, including those in construction, to take advantage of higher yields and better interest rate risk characteristics. However, due to the recent downturn in the real estate market and the economy in general, the Bank has strengthened its underwriting guidelines related to originations of non-residential commercial real estate loans and has curtailed construction lending given the additional risks associated with this product. In addition, the Bank has become more selective in purchasing loans. As a result, there were no purchases of loans during fiscal 2009 compared to $29.7 million for fiscal 2008.
The following table sets forth certain information with respect to Carver Federals loan originations, purchases and sales for the fiscal years ended March 31 (in thousands):
Loans purchased by the Bank entail certain risks not necessarily associated with loans the Bank originates. The Banks purchased loans are generally acquired without recourse, with certain exceptions related to the sellers compliance with representations and warranties, and in accordance with the Banks underwriting criteria for originations. In addition, purchased loans have a variety of terms, including maturities, interest rate caps and indices for adjustment of interest rates, that may differ from those offered at that time by the Bank. The Bank initially seeks to purchase loans in its market area, however, the Bank may purchase loans secured by property secured outside its market area to meet its financial objectives. The market areas in which the properties that secure the purchased loans are located may differ from Carver Federals market area and may be subject to economic and real estate market conditions that may significantly differ from those experienced in Carver Federals market area. There can be no assurance that economic conditions in these out-of-state markets will not deteriorate in the future, resulting in increased loan delinquencies and loan losses among the loans secured by property in these areas.
In an effort to reduce risks, the Bank has sought to ensure that purchased loans satisfy the Banks underwriting standards and do not otherwise have a higher risk of collection or loss than loans originated by the Bank. A review of each purchased loan is conducted, and the Bank also requires appropriate documentation and further seeks to reduce its risk by requiring, in each buy/sell agreement, a series of warranties and representations as to the underwriting standards and the enforceability of the related legal documents. These warranties and representations remain in effect for the life of the loan. Any misrepresentation must be cured within 90 days of discovery or trigger certain repurchase provisions in the buy/sell agreement.
Loan Maturity Schedule. The following table sets forth information at March 31, 2009 regarding the amount of loans maturing in Carver Federals portfolio, including scheduled repayments of principal, based on contractual terms to maturity. Demand loans, loans having no schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. The table below does not include any estimate of prepayments, which significantly shorten the average life of all mortgage loans and may cause Carver Federals actual repayment experience to differ significantly from that shown below (in thousands):
The following table sets forth as of March 31, 2009 amounts in each loan category that are contractually due after March 31, 2010 and whether such loans have fixed or adjustable interest rates. Scheduled contractual principal repayments of loans do not necessarily reflect the actual lives of such assets. The average life of long term loans is substantially less than their contractual terms due to prepayments. In addition, due-on-sale clauses in mortgage loans generally give Carver Federal the right to declare a conventional loan due and payable in the event, among other things, that a borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan market rates are higher than rates on existing mortgage loans and tends to decrease when current mortgage loan market rates are lower than rates on existing mortgage loans (in thousands):
General. One of the Banks key operating objectives continues to be to maintain a high level of asset quality. Through a variety of strategies, including, but not limited to, monitoring loan delinquencies and borrower workout arrangements, the Bank has been proactive in addressing problem loans and non-performing assets. The maintenance of sound credit standards for loan originations has resulted in the Bank historically having lower net charge-offs of loans.
The underlying credit quality of the Banks loan portfolio is dependent primarily on each borrowers ability to continue to make required loan payments and, in the event a borrower is unable to continue to do so, the adequacy of the value of the collateral securing the loan. For non-residential real estate and multi-family loans, the borrowers ability to pay typically is dependent on rental income which can be impacted by vacancies and general market conditions. For one-to-four family loans, a borrowers ability to pay typically is dependent primarily on employment and other sources of income. A borrowers ability to pay is also impacted by general economic and other factors, such as unanticipated expenditures or changes in the financial markets. Collateral values, particularly real estate values, are also impacted by a variety of factors, including general economic conditions, demographics, maintenance and collection or foreclosure delays.
Non-performing Assets. Non-performing assets consist of non-accrual loans, accruing loans 90 days or more past due and property acquired in settlement of loans. When a borrower fails to make a payment on a loan, immediate steps are taken by Carver Federal and its loan servicers to have the delinquency cured and the loan restored to current status. This includes a series of actions including phone calls, letters and, if necessary, legal action or other appropriate action. In the case of business loans the collection process is similar. The Bank may pursue foreclosure or other appropriate action for business loans secured by real estate. For business loans not secured by real estate, the Bank may seek the Small Business Administration (SBA) guarantee or other appropriate action, where applicable. Loans that remain delinquent are reviewed for charge-off. The Banks collection efforts continue after the loan is charged off, except when a determination is made that collection efforts have been exhausted or are not productive.
The Bank may from time to time agree to modify the contractual terms of a borrowers loan. In cases where such modifications represent a concession to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring. Loans modified in a troubled debt restructuring are placed on non-accrual status until the Bank determines that future collection of principal and interest is reasonably assured, which generally requires that the borrower demonstrate a period of performance according to the restructured terms of six months. At March 31, 2009, loans modified in a troubled debt restructuring, which are included in non-accrual loans, totaled $8.7 million.
The following table sets forth information with respect to Carver Federals non-performing assets which includes non-accrual loans, accruing loans 90 days or more past due and property acquired in settlement of loans. as of March 31 (dollars in thousands):
At March 31, 2009, total non-performing assets increased by $23.1 million to $27.1 million, compared to $4.0 million at March 31, 2008. Non-accrual loans consist of 10 one- to four- family loans, 2 multi-family loans, 12 non-residential real estate loans, 1 construction loan and 29 small business and SBA loans. The increase in delinquent loans from the prior year appears to be primarily the result of deterioration in economic conditions which have already impacted some borrowers. Management believes that the risk of losses on certain delinquent loans is mitigated by the values of the properties securing these delinquent loans and existing loan loss reserves. Other real estate owned of $0.5 million reflects three properties foreclosed upon.
Asset Classification and Allowances for Losses. Federal regulations and the Banks policies require the classification of assets on the basis of credit quality on a quarterly basis. An asset is classified as substandard if it is non-performing and/or determined to be inadequately protected by the current net worth and paying capacity of the obligor or the current value of the collateral pledged, if any. An asset is classified as doubtful if full collection is highly questionable or improbable. An asset is classified as loss if it is considered un-collectible, even if a partial recovery could be expected in the future. The regulations also provide for a special mention designation, described as assets that do not currently expose a savings institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving managements close attention. Assets classified as substandard or doubtful result in a higher level of allowances for loan losses recorded under SFAS No. 5 Accounting for Contingencies. If an asset or portion thereof is classified as a loss, a savings institution must either establish specific allowances for loan losses pursuant to SFAS No. 114 Accounting by Creditors for Impairment of a Loan in the amount of the portion of the asset classified loss or charge off such amount. Federal examiners may disagree with a savings institutions classifications. If a savings institution does not agree with an examiners classification of an asset, it may appeal this determination to the OTS Regional Director.
The OTS, in conjunction with the other federal banking agencies, has adopted an interagency policy statement on the allowance for loan losses and lease losses. The policy statement provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate allowances and guidance for banking agency examiners to use in determining the adequacy of general valuation guidelines. Generally, the policy statement recommends that institutions have effective systems and controls to identify, monitor and address asset quality problems, that management analyze all significant factors that affect the ability to collect the portfolio in a reasonable manner and that management establish acceptable allowance evaluation processes that meet the objectives set forth in the policy statement. Management is responsible for determining the adequacy of the allowance for loan losses and the periodic provisioning for estimated losses included in the consolidated financial statements. The evaluation process is undertaken on a quarterly basis, but may increase in frequency should conditions arise that would require managements prompt attention, such as business combinations and opportunities to dispose of non-performing and marginally performing loans by bulk sale or any development which may indicate an adverse trend. Although management believes that adequate specific and general loan loss allowances have been established, actual losses are dependent upon future events and, as such, further additions to the level of specific and general loan loss allowances may become necessary. Federal examiners may disagree with a savings institution as to the appropriate level of the institutions allowance for loan losses. While management believes Carver Federal has established its existing loss allowances in accordance with the ALLL, there can be no assurance that regulators, in reviewing Carver Federals assets, will not require Carver Federal to increase its loss allowance, thereby negatively affecting Carver Federals reported financial condition and results of operations. For additional information regarding Carver Federals ALLL policy, refer to Note 2 of Notes to Consolidated Financial Statements, Summary of Significant Accounting Policies.
The Board has designated the Internal Asset Review Committee on a quarterly basis to perform a review of the Banks asset quality, establish general and specific allowances, determine loan classifications and submit their report to the Board for review. Carver Federals methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses that have not been identified but can be expected to occur. Further, management reviews the ratio of allowances to total loans (including projected growth) and recommends adjustments to the level of allowances accordingly. Although management believes it uses the best information available to make determinations with respect to the allowances for losses, future adjustments may be necessary if economic conditions differ from the economic conditions in the assumptions used in making the initial determinations, or if circumstances pertaining to individual loans change, or new information pertaining to individual loans or the loan portfolio is identified. The Bank has a centralized loan servicing structure that relies upon outside servicers, each of which generates a monthly report of delinquent loans. The Asset Liability and Interest Rate Risk Committee of the Board establishes policy relating to internal classification of loans and also provides input to the Internal Asset Review Committee in its review of classified assets. In originating loans, Carver Federal recognizes that credit losses will occur and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan.
It is managements policy to maintain a general allowance for loan losses based on, among other things, regular reviews of delinquencies and loan portfolio quality, character and size, the Banks and the industrys historical and projected loss experience and current and forecasted economic conditions. In addition, considerable uncertainty exists as to the future improvement or deterioration of the real estate markets in various states, or of their ultimate impact on Carver Federal as a result of its purchased loans in such states. See Lending ActivitiesLoan Purchases and Originations. Carver Federal increases its allowance for loan losses by charging provisions for possible losses against the Banks income. General allowances are established by management on at least a quarterly basis based on an assessment of risk in the Banks loans, taking into consideration the composition and quality of the portfolio, delinquency trends, current charge-off and loss experience, the state of the real estate market and economic conditions generally. Specific allowances are provided for individual loans, or portions of loans, when ultimate collection is considered improbable by management based on the current payment status of the loan and the fair value or net realizable value of the security for the loan. A loan is generally deemed impaired when it is probable the Bank will be unable to collect both principal and interest due according to the contractual terms of the loan agreement. Loans the Bank individually classifies as impaired include multi-family mortgage loans, commercial real estate loans, construction loans, business loans and one-to-four family mortgage loans, which have been classified by the Banks credit review officer as substandard, doubtful or loss, and certain loans modified in a troubled debt restructuring A valuation allowance is established when the current estimated fair value of the property that collateralizes the impaired loan, if any, is less than the recorded investment in the loan.
At the date of foreclosure or other repossession or at the date the Bank determines a property is an impaired property, the Bank transfers the property to real estate acquired in settlement of loans at the lower of cost or fair value, less estimated selling costs. Fair value is defined as the amount in cash or cash-equivalent value of other consideration that a real estate parcel would yield in a current sale between a willing buyer and a willing seller. Any amount of cost in excess of fair value is charged-off against the allowance for loan losses. Carver Federal records an allowance for estimated selling costs of the property immediately after foreclosure. Subsequent to acquisition, management periodically evaluates the property and an allowance is established if the estimated fair value of the property, less estimated costs to sell, declines. If, upon ultimate disposition of the property, net sales proceeds exceed the net carrying value of the property, a gain on sale of real estate is recorded, providing the Bank did not provide the loan.
The following table sets forth an analysis of Carver Federals allowance for loan losses for the years ended March 31 (dollars in thousands):
The following table allocates the allowance for loan losses by asset category at March 31 (dollars in thousands):
The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
General. The Bank utilizes mortgage-backed and other investment securities in its asset/liability management strategy. In making investment decisions, the Bank considers, among other things, its yield and interest rate objectives, its interest rate and credit risk position and its liquidity and cash flow.
Generally, the investment policy of the Bank is to invest funds among categories of investments and maturities based upon the Banks asset/liability management policies, investment quality, loan and deposit volume and collateral requirements, liquidity needs and performance objectives. Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, requires that securities be classified into three categories: trading, held-to-maturity, and available-for-sale. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and are reported at fair value with unrealized gains and losses included in earnings. Debt securities for which the Bank has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. All other securities not classified as trading or held-to-maturity are classified as available-for-sale and reported at fair value with unrealized gains and losses included, on an after-tax basis, in a separate component of stockholders equity. At March 31, 2009, the Bank had no securities classified as trading. At March 31, 2009, $60.0 million, or 80.2% of the Banks mortgage-backed and other investment securities, was classified as available-for-sale. The remaining $14.8 million, or 19.8%, was classified as held-to-maturity.
Mortgage-Backed Securities. The Bank has invested in mortgage-backed securities to help achieve its asset/liability management goals and collateral needs. Although mortgage-backed securities generally yield less than whole loans, they present substantially lower credit risk, are more liquid than individual mortgage loans and may be used to collateralize obligations of the Bank. Because Carver Federal receives regular payments of principal and interest from its mortgage-backed securities, these investments provide more consistent cash flows than investments in other debt securities, which generally only pay principal at maturity. Mortgage-backed securities also help the Bank meet certain definitional tests for favorable treatment under federal banking and tax laws. See Regulation and SupervisionFederal Banking RegulationQualified Thrift Lender Test and Federal and State Taxation.
At March 31, 2009, mortgage-backed securities constituted 9.4% of total assets, as compared to 4.6% of total assets at March 31, 2008. Carver Federal maintains a portfolio of mortgage-backed securities in the form of Government National Mortgage Association (GNMA) pass-through certificates, Federal National Mortgage Association ( FNMA) and Federal Home Loan Mortgage Corp (FHLMC) participation certificates. GNMA pass-through certificates are guaranteed as to the payment of principal and interest by the full faith and credit of the United States Government while FNMA and FHLMC certificates are each guaranteed by their respective agencies as to principal and interest. Mortgage-backed securities generally entitle Carver Federal to receive a pro rata portion of the cash flows from an identified pool of mortgages. The cash flows from such pools are segmented and paid in accordance with a predetermined priority to various classes of securities issued by the entity. Carver Federal has also invested in pools of loans guaranteed as to principal and interest by the Small Business Administration (SBA).
The Bank seeks to manage interest rate risk by investing in adjustable-rate mortgage-backed securities, which at March 31, 2009, constituted $20.2 million, or 40.2%, of the mortgage-backed securities portfolio. Mortgage-backed securities, however, expose Carver Federal to certain unique risks. In a declining rate environment, accelerated prepayments of loans underlying these securities expose Carver Federal to the risk that it will be unable to obtain comparable yields upon reinvestment of the proceeds. In the event the mortgage-backed security has been funded with an interest-bearing liability with maturity comparable to the original estimated life of the mortgage-backed security, the Banks interest rate spread could be adversely affected. Conversely, in a rising interest rate environment, the Bank may experience a lower than estimated rate of repayment on the underlying mortgages, effectively extending the estimated life of the mortgage-backed security and exposing the Bank to the risk that it may be required to fund the asset with a liability bearing a higher rate of interest. For additional information regarding Carver Federals mortgage-backed securities portfolio and its maturities refer to Note 4 of Notes to Consolidated Financial Statements, Securities.
Other Investment Securities. In addition to mortgage-backed securities, the Bank also invests in high-quality assets (primarily government and agency obligations) with short and intermediate terms (typically seven years or less) to maturity. Carver Federal is permitted under federal law to make certain investments, including investments in securities issued by various federal agencies and state and municipal governments, deposits at the FHLB-NY, certificates of deposit in federally insured institutions, certain bankers acceptances and federal funds. The Bank may also invest, subject to certain limitations, in commercial paper having one of the two highest investment ratings of a nationally recognized credit rating agency, and certain other types of corporate debt securities and mutual funds (See Note 4 of Notes to Consolidated Financial Statements).
Other Earning Assets. Federal regulations require the Bank to maintain an investment in FHLB-NY stock and a sufficient amount of liquid assets which may be invested in cash and specified securities. For additional information, see Regulation and SupervisionFederal Banking RegulationLiquidity.
Securities Impairment. The Banks available-for-sale securities portfolio is carried at estimated fair value, with any unrealized gains and losses, net of taxes, reported as accumulated other comprehensive income/loss in stockholders equity. Securities that the Bank has the positive intent and ability to hold to maturity are classified as held-to-maturity and are carried at amortized cost. The fair values of securities in portfolio are based on published or securities dealers market values and are affected by changes in interest rates. The Bank quarterly reviews and evaluates the securities portfolio to determine if the decline in the fair value of any security below its cost basis is other-than-temporary. The Bank generally views changes in fair value caused by changes in interest rates as temporary, which is consistent with its experience. However, if such a decline is deemed to be other-than-temporary, the security is written down to a new cost basis and the resulting loss is charged to earnings. At March 31, 2009, the Bank held a private label mortgage-backed security which was determined to be other than temporarily impaired in the amount of $52 thousand.
Sources of Funds
General. Deposits are the primary source of Carver Federals funds for lending and other investment purposes. In addition to deposits, Carver Federal derives funds from loan principal repayments, loan and investment interest payments, maturing investments and fee income. Loan and mortgage-backed securities repayments and interest payments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by prevailing market interest rates, pricing of deposits, competition and general economic conditions. Borrowed money may be used to supplement the Banks available funds, and from time to time the Bank borrows funds from the FHLB-NY and has borrowed funds through repurchase agreements and trust preferred debt securities.
Deposits. Carver Federal attracts deposits from consumers, businesses, non-profit organizations and public entities through its nine branches principally from within its market area by offering a variety of deposit instruments, including passbook and statement accounts and certificates of deposit, which range in term from 91 days to five years. Deposit terms vary, principally on the basis of the minimum balance required, the length of time the funds must remain on deposit and the interest rate. Carver Federal also offers Individual Retirement Accounts. Carver Federal also holds deposits from various governmental agencies or authorities and corporations.
The Banks Malcom X, Bradhurst, Jamaica and Sunset Park branches operate in New York State designated Banking Development Districts (BDD), which allows Carver Federal to obtain New York City and New York State deposits. As of March 31, 2009, Carver Federal held $118.7 million in BDD deposits. BDD deposits are designed to encourage the development of branches and provision of banking products and services in underserved communities.
At March 31, 2009 the Bank held $25.0 million in brokered certificates of deposits which the Bank intends to replace with non-brokered deposits as they mature.
The Bank also has $62.3 million of reciprocal deposits acquired through its participation in the Certificate of Deposit Account Registry Service (CDARS). As a participant, the CDARS network arranges for placement of Carver Federals customer funds into certificate of deposit accounts issued by other CDARS member banks in increments of less than the individual FDIC insurance limit amount to ensure that both principal and interest are eligible for full FDIC deposit insurance. This allows the Bank to maintain its customer relationship while still providing its customers with FDIC insurance for the full amount of their deposits, up to $50 million per customer. In exchange, Carver Federal receives from other member banks their customers deposits in like amounts. Depositors are allowed to withdraw funds, with a penalty, from these accounts. Carver Federal may, but has not at this time elected to, make or receive non-reciprocal deposits. Prior to the Emergency Economic Stabilization Act of 2008 (ESSA) the FDIC deposit insurance limit was $100,000. As result of ESSA, this limit has been increased to $250,000 through December 31, 2009.
Deposit interest rates, maturities, service fees and withdrawal penalties on deposits are established based on the Banks funds acquisition and liquidity requirements, the rates paid by the Banks competitors, current market rates, the Banks growth goals and applicable regulatory restrictions and requirements. For additional information regarding Banks deposit accounts and the related weighted average interest rates paid; and amount and maturities of certificates of deposit in specified weighted average interest rate categories refer to Note 8 of Notes to Consolidated Financial Statements, Deposits.
Borrowed Money. While deposits are the primary source of funds for Carver Federals lending, investment and general operating activities, Carver Federal is authorized to obtain advances from the FHLB-NY and securities sold under agreements to repurchase (Repos) from approved primary dealers to supplement its supply of funds and to meet deposit withdrawal requirements. The FHLB-NY functions as a central bank providing credit for savings institutions and certain other member financial institutions. As a member of the FHLB, Carver Federal is required to own stock in the FHLB-NY and is authorized to apply for advances. Advances are made pursuant to several different programs, each of which has its own interest rate and range of maturities. Advances from the FHLB-NY are secured by Carver Federals stock in the FHLB-NY and a pledge a portion of Carver Federals mortgage loan and mortgage-backed securities portfolios. The Bank takes into consideration the term of borrowed money with the re-pricing cycle of the mortgage loans on its balance sheet. At March 31, 2009, Carver had $101.6 million in FHLB-NY advances and Repos.
On September 17, 2003, Carver Statutory Trust I issued 13,000 shares, liquidation amount $1,000 per share, of floating rate capital securities. Gross proceeds from the sale of these trust preferred debt securities were $13.0 million and, together with the proceeds from the sale of the trusts common securities, were used to purchase approximately $13.4 million aggregate principal amount of the Holding Companys floating rate junior subordinated debt securities due 2033. The trust preferred debt securities are redeemable quarterly at the option of the Company beginning on or after September 17, 2008 and have a mandatory redemption date of September 17, 2033. Cash distributions on the trust preferred debt securities are cumulative and payable at a floating rate per annum (reset quarterly) equal to 3.05% over 3-month LIBOR, with a rate at March 31, 2009 of 4.37%. The subordinated debt securities amounted to $13.4 million at March 31, 2009 and are included in other borrowed money on the consolidated statement of financial condition. For additional information regarding Banks advances from the FHLB-NY and other borrowed money, refer to Note 9 of Notes to Consolidated Financial Statements, Borrowed Money.
REGULATION AND SUPERVISION
The Bank is subject to extensive regulation, examination and supervision by its primary regulator, the OTS. The Banks deposit accounts are insured up to applicable limits by the Federal Deposit Insurance Corporation (FDIC) under the Deposit Insurance Fund (DIF), and is a member of the FHLB. The Bank must file reports with the OTS concerning its activities and financial condition, and it must obtain regulatory approvals prior to entering into certain transactions, such as mergers with, or acquisitions of, other depository institutions. The Holding Company, as a unitary savings and loan holding company, is subject to regulation, examination and supervision by the OTS and is required to file certain reports with, and otherwise comply with, the rules and regulations of the OTS and of the SEC under the federal securities laws. The OTS and the FDIC periodically perform safety and soundness examinations of the Bank and the Holding Company and test compliance with various regulatory requirements. The OTS has primary enforcement responsibility over federally chartered savings banks and has substantial discretion to impose enforcement action on an institution that fails to comply with applicable regulatory requirements, particularly with respect to its capital requirements. In addition, the FDIC has the authority to recommend to the Director of the OTS that enforcement action be taken with respect to a particular federally chartered savings bank and, if action is not taken by the Director, the FDIC has authority to take such action under certain circumstances.
This regulation and supervision establishes a comprehensive framework to regulate and control the activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. This 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 whether by the OTS, the FDIC or through legislation could have a material adverse impact on the Bank and the Holding Company and their operations and stockholders.
The description of statutory provisions and regulations applicable to federally chartered savings banks and their holding companies and of tax matters set forth in this document does not purport to be a complete description of all such statutes and regulations and their effects on the Bank and the Holding Company.
Recent Government Actions
The Emergency Economic Stabilization Act of 2008 (EESA), was signed into law on October 3, 2008 and authorizes the Treasury to establish the Troubled Asset Relief Program (TARP) to purchase certain troubled assets from financial institutions, including banks and thrifts. Under the TARP, the Treasury may purchase residential and commercial mortgages, and securities, obligations or other instruments based on such mortgages, originated or issued on or before March 14, 2008 that the Secretary of the Treasury determines promotes market stability, as well as any other financial instrument that the Treasury, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, or FRB, determines the purchase of which is necessary to promote market stability. In the case of a publicly-traded financial institution that sells troubled assets into the TARP, the Treasury must receive a warrant giving the Treasury the right to receive nonvoting common stock or preferred stock in such financial institution, or voting stock with respect to which the Treasury agrees not to exercise voting power, subject to certain de minimis exceptions. In addition, all financial institutions that sell troubled assets to the TARP and meet certain conditions will also be subject to certain executive compensation restrictions, which differ depending on how the troubled assets are acquired under the TARP.
On October 14, 2008, the Treasury announced that it will purchase equity stakes in a wide variety of banks and thrifts. Under this program, known as the Troubled Asset Relief Program Capital Purchase Program (the TARP CPP), the Treasury made $250 billion of capital available (from the $700 billion authorized by the EESA) to U.S. financial institutions in the form of preferred stock. In conjunction with the purchase of preferred stock, the Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions will be required to adopt the Treasurys standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP CPP. On January 20, 2009, the Company announced that it completed the sale of $18.98 million in preferred stock to the Treasury in connection with Carvers participation in the TARP CPP. Importantly, Carver is exempt from the requirement to issue a warrant to the Treasury to purchase shares of common stock, as the Bank is a certified CDFI, conducting most of its depository and lending activities in disadvantaged communities. Therefore, the investment did not dilute common stock stockholders. As a participant in TARP CPP, the Company is subject to certain obligations currently in effect, such as compensation restrictions, a luxury expenditure policy, the requirement the Company include a say on pay proposal in the proxy statement and certain certifications. The Company is also subject to additional restrictions or obligations as may be imposed under TARP CPP for as long as the Company participates in TARP CPP.
In addition to establishing the TARP, the EESA also requires that the Secretary of the Treasury establish a program that will guarantee the principal of, and interest on, troubled assets originated or issued prior to March 14, 2008 to help restore liquidity and stability to the financial system known as the Temporary Liquidity Guaranty Program (TLGP). The Secretary of the Treasury will establish premiums for financial institutions that participate in this program and may provide for variations in such rates in accordance with the credit risk associated with the particular troubled asset being guaranteed.
Federal Banking Regulation
Activity Powers. The Bank derives its lending and investment powers from the Home Owners Loan Act (HOLA), as amended, and the regulations of the OTS. Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and commercial real estate, commercial and consumer loans, certain types of debt securities and certain other assets. The Bank may also establish service corporations that may engage in activities not otherwise permissible for the Bank, including certain real estate equity investments and securities and insurance brokerage. The Banks authority to invest in certain types of loans or other investments is limited by federal law. These investment powers are subject to various limitations, including (1) a prohibition against the acquisition of any corporate debt security that is not rated in one of the four highest rating categories, (2) a limit of 400% of an associations capital on the aggregate amount of loans secured by non-residential real estate property, (3) a limit of 20% of an associations assets on commercial loans, with the amount of commercial loans in excess of 10% of assets being limited to small business loans, (4) a limit of 35% of an associations assets on the aggregate amount of consumer loans and acquisitions of certain debt securities, (5) a limit of 5% of assets on non-conforming loans (loans in excess of the specific limitations of HOLA), and (6) a limit of the greater of 5% of assets or an associations capital on certain construction loans made for the purpose of financing what is or is expected to become residential property.
On October 4, 2006, the OTS and other federal bank regulatory authorities published the Interagency Guidance on Nontraditional Mortgage Product Risks, or the Guidance. The Guidance describes sound practices for managing risk, as well as marketing, originating and servicing nontraditional mortgage products, which include, among other things, interest-only loans. The Guidance sets forth supervisory expectations with respect to loan terms and underwriting standards, portfolio and risk management practices and consumer protection. For example, the Guidance indicates that originating interest-only loans with reduced documentation is considered a layering of risk and that institutions are expected to demonstrate mitigating factors to support their underwriting decision and the borrowers repayment capacity. Specifically, the Guidance indicates that a lender should be able to readily document income and a lender may accept a borrowers statement as to the borrowers income without obtaining verification only if there are mitigating factors that clearly minimize the need for direct verification of repayment capacity.
On December 14, 2006, the OTS published guidance entitled Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices, or the CRE Guidance, to address concentrations of commercial real estate loans in savings associations. The CRE Guidance reinforces and enhances the OTS existing regulations and guidelines for real estate lending and loan portfolio management, but does not establish specific commercial real estate lending limits. The Bank has evaluated the CRE Guidance to determine its compliance and, as necessary, modified its risk management practices, underwriting guidelines and consumer protection standards. See Lending Activities and Asset Quality in Item 1, Business for discussions of Carver Federals loan product offerings and related underwriting standards.
On June 29, 2007, the OTS and other federal bank regulatory agencies issued a final Statement on Subprime Mortgage Lending, or the Statement, to address the growing concerns facing the subprime mortgage market, particularly with respect to rapidly rising subprime default rates that may indicate borrowers do not have the ability to repay adjustable rate subprime loans originated by financial institutions. In particular, the agencies expressed concern in the Statement that current underwriting practices do not take into account that many subprime borrowers are not prepared for payment shock and that the current subprime lending practices compound risk for financial institutions. The Statement describes the prudent safety and soundness and consumer protection standards that financial institutions should follow to ensure borrowers obtain loans that they can afford to repay. These standards include a fully indexed, fully amortized qualification for borrowers and cautions on risk-layering features, including an expectation that stated income and reduced documentation should be accepted only if there are documented mitigating factors that clearly minimize the need for verification of a borrowers repayment capacity. Consumer protection standards include clear and balanced product disclosures to customers and limits on prepayment penalties that allow for a reasonable period of time, typically at least 60 days, for borrowers to refinance prior to the expiration of the initial fixed interest rate period without penalty. The Statement also reinforces the April 17, 2007 Interagency Statement on Working with Mortgage Borrowers, in which the federal bank regulatory agencies encouraged institutions to work constructively with residential borrowers who are financially unable or reasonably expected to be unable to meet their contractual payment obligations on their home loans. In addition, the Statement referenced expanded guidance issued by the agencies by press release dated January 31, 2001. According to the expanded guidance, subprime loans are loans to borrowers which display one or more characteristics of reduced payment capacity. Five specific criteria, which are not intended to be exhaustive and are not meant to define specific parameters for all subprime borrowers and may not match all markets or institutions specific subprime definitions, are set forth, including having a FICO credit score of 660 or below at the time of origination. Within the Banks loan portfolio, there are loans to borrowers who had FICO scores of 660 or below at the time of origination. However, as a portfolio lender, the Bank reviews all data contained in borrower credit reports and does not base underwriting decisions solely on FICO scores. The Bank believes the aforementioned loans, when made, were amply collateralized and otherwise conformed to the Banks prime lending standards. These loans are not a material component of the one-to-four family mortgage loan portfolio.
Carver Federal has evaluated the Guidance, the CRE Guidance and the Statement to determine compliance and, as necessary, modified risk management practices, underwriting guidelines and consumer protection standards. See Lending Activities One-to-Four Family Mortgage Lending and Multi-family and Commercial Real Estate Lending for a discussion of the Banks loan product offerings and related underwriting standards and Asset Quality in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations for information regarding the Banks interest-only and reduced documentation loan portfolio composition.
Loans-to-One Borrower Limitations. The Bank is generally subject to the same limits on loans to one borrower as a national bank. With specified exceptions, the Banks total loans or extension of credit to a single borrower or group of related borrowers may not exceed 15% of the Banks unimpaired capital and unimpaired surplus, which does not include accumulated other comprehensive income. The Bank may lend additional amounts up to 10% of its unimpaired capital and unimpaired surplus if the loans or extensions of credit are fully secured by readily marketable collateral. The Bank currently complies with applicable loans to one borrower limitations. At March 31, 2009, the Banks limit on loans to one borrower based on its unimpaired capital and surplus was $12.6 million.
Qualified Thrift Lender Test. Under HOLA, the Bank must comply with a Qualified Thrift Lender (QTL) test. Under this test, the Bank is required to maintain at least 65% of its portfolio assets in certain qualified thrift investments on a monthly basis in at least nine months of the most recent twelve-month period. Portfolio assets means, in general, an associations total assets less the sum of (a) specified liquid assets up to 20% of total assets, (b) goodwill and other intangible assets and (c) the value of property used to conduct the Banks business. Qualified thrift investments include various types of loans made for residential and housing purposes, investments related to such purposes, including certain mortgage-backed and related securities and consumer loans. If the Bank fails the QTL test, it must either operate under certain restrictions on its activities or convert from a thrift charter to a bank charter. In addition, if the Bank does not re-qualify under the QTL test within three years after failing the test, the Bank would be prohibited from engaging in any activity not permissible for a national bank and would have to repay any outstanding advances from the FHLB-NY as promptly as possible. At March 31, 2009, the Bank maintained approximately 74.9% of its portfolio assets in qualified thrift investments. The Bank had also met the QTL test in each of the prior 12 months and was, therefore, a qualified thrift lender.
Capital Requirements. The OTS capital regulations require federally chartered savings associations to meet three minimum capital ratios: a 1.5% tangible capital ratio, a 4% leverage (core) capital ratio and an 8% total risk-based capital ratio. In assessing an institutions capital adequacy, the OTS takes into consideration not only these numeric factors but also qualitative factors as well, and has the authority to establish higher capital requirements for individual institutions where necessary. Carver Federal, as a matter of prudent management, targets as its goal the maintenance of capital ratios which exceed these minimum requirements and that are consistent with Carver Federals risk profile. At March 31, 2009, Carver Federal exceeded each of its capital requirements with a tangible capital ratio of 9.51%, leverage capital ratio of 9.52% and total risk-based capital ratio of 12.78%.
The Federal Deposit Insurance Corporation Improvement Act, or FDICIA, requires that the OTS and other federal banking agencies revise their risk-based capital standards, with appropriate transition rules, to ensure that they take into account IRR concentration of risk and the risks of non-traditional activities. The OTS regulations do not include a specific IRR component of the risk-based capital requirement. However, the OTS monitors the IRR of individual institutions through a variety of means, including an analysis of the change in net portfolio value, or NPV. NPV is defined as the net present value of the expected future cash flows of an entitys assets and liabilities and, therefore, hypothetically represents the value of an institutions net worth. The OTS has also used this NPV analysis as part of its evaluation of certain applications or notices submitted by thrift institutions. In addition, OTS Thrift Bulletin 13a provides guidance on the management of IRR and the responsibility of boards of directors in that area. The OTS, through its general oversight of the safety and soundness of savings associations, retains the right to impose minimum capital requirements on individual institutions to the extent the institution is not in compliance with certain written guidelines established by the OTS regarding NPV analysis. The OTS has not imposed any such requirements on Carver Federal.
Prompt Corrective Action Regulations. Under the prompt corrective action regulations, the OTS is authorized and, in some cases, required to take supervisory actions against undercapitalized savings banks. For this purpose, a savings bank would be placed in one of the following five categories based on the banks regulatory capital: well-capitalized; adequately capitalized; undercapitalized; significantly undercapitalized; or critically undercapitalized.
The severity of the action authorized or required to be taken under the prompt corrective action regulations increases as a banks 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. Generally, a capital restoration plan must be filed with the OTS within 45 days of the date a bank receives notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. In addition, various mandatory supervisory actions become immediately applicable to the institution, including restrictions on growth of assets and other forms of expansion. Under the OTS regulations, generally, a federally chartered savings 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 6% or greater, and its leverage ratio is 5% or greater, and it is not subject to any order or directive by the OTS to meet a specific capital level. When appropriate, the OTS can require corrective action by a savings association holding company under the prompt corrective action provisions of federal law. At March 31, 2009, the Bank was considered well-capitalized by the OTS.
Limitation on Capital Distributions. The OTS imposes various restrictions on the Banks ability to make capital distributions, including cash dividends, payments to repurchase or otherwise acquire its shares and other distributions charged against capital. A savings institution that is the subsidiary of a savings and loan holding company, such as the Bank, must file a notice with the OTS at least 30 days before making a capital distribution. However, the Bank must file an application for prior approval if the total amount of its capital distributions (including each proposed distribution), for the applicable calendar year would exceed the Banks net income for that year plus the Banks retained net income for the previous two years.
The Bank may not pay dividends to the Holding Company if, after paying those dividends, the Bank would fail to meet the required minimum levels under risk-based capital guidelines and the minimum leverage and tangible capital ratio requirements or the OTS notified the Bank that it was in need of more than normal supervision.
The Bank is prohibited from making capital distributions if:
Liquidity. The Bank maintains liquidity levels to meet operational needs. In the normal course of business, the levels of liquid assets during any given period are dependent on operating, investing and financing activities. Cash and due from banks, federal funds sold and repurchase agreements with maturities of three months or less are the Banks most liquid assets. The Bank maintains a liquidity policy to maintain sufficient liquidity to ensure its safe and sound operations.
Branching. Subject to certain limitations, federal law permits the Bank to establish branches in any state of the United States. The authority for the Bank to establish an interstate branch network would facilitate a geographic diversification of the Banks activities. This authority under federal law and OTS regulations preempts any state law purporting to regulate branching by federal savings associations.
Community Reinvestment. Under CRA, as amended, as implemented by OTS regulations, the Bank has a continuing and affirmative obligation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. CRA does not establish specific lending requirements or programs for the Bank nor does it limit the Banks discretion to develop the types of products and services that it believes are best suited to its particular community. CRA does, however, require the OTS, in connection with its examination of the Bank, to assess the Banks record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by the Bank.
In particular, the system focuses on three tests:
CRA also requires all institutions to make public disclosure of their CRA ratings. The Bank received an Outstanding CRA rating in its most recent examination conducted in 2009.
Regulations require that Carver Federal publicly disclose certain agreements that are in fulfillment of CRA. The Holding Company has no such agreements in place at this time.
Transactions with Related Parties. The Banks authority to engage in transactions with its affiliates and insiders is limited by OTS regulations and by Sections 23A, 23B, 22(g) and 22(h) of the Federal Reserve Act (FRA). In general, these transactions must be on terms which are as favorable to the Bank as comparable transactions with non-affiliates. Additionally, certain types of these transactions are restricted to an aggregate percentage of the Banks capital. Collateral in specified amounts must usually be provided by affiliates to receive loans from the Bank. In addition, OTS regulations prohibit a savings bank from lending to any of its affiliates that is engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate other than a subsidiary.
The Banks authority to extend credit to its directors, executive officers, and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the FRB. Among other things, these provisions require that extensions of credit to insiders (a) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features and (b) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Banks capital. In addition, extensions of credit in excess of certain limits must be approved by the Banks Board. At March 31, 2009, there were no loans to officers or directors.
The FRB has confirmed its previous interpretations of Sections 23A and 23B of the FRA with Regulation W. The OTS has also conformed its regulations to agree with Regulation W. Regulation W made various changes to existing law regarding Sections 23A and 23B, including expanding the definition of what constitutes an affiliate subject to Sections 23A and 23B and exempting certain subsidiaries of state-chartered banks from the restrictions of Sections 23A and 23B.
The OTS regulations provide for additional restrictions imposed on savings associations under Section 11 of HOLA, including provisions prohibiting a savings association from making a loan to an affiliate that is engaged in non-bank holding company activities and provisions prohibiting a savings association from purchasing or investing in securities issued by an affiliate that is not a subsidiary. The OTS regulations also include certain specific exemptions from these prohibitions. The FRB and the OTS expect each depository institution that is subject to Sections 23A and 23B to implement policies and procedures to ensure compliance with Regulation W and the OTS regulation. These regulations have had no material adverse effect on the Banks business.
Section 402 of the Sarbanes-Oxley Act 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 mortgages advanced by an insured depository institution, such as the Bank, that is subject to the insider lending restrictions of Section 22(h) of the FRA.
Assessment. The OTS charges assessments to recover the cost of examining savings associations and their affiliates. These assessments are based on three components: the size of the association, on which the basic assessment is based; the associations 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 the complexity of the associations operations, which results in an additional assessment based on a percentage of the basic assessment for any savings association 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. Effective July 1, 2004, the OTS adopted a final rule replacing examination fees for savings and loan holding companies with semi-annual assessments. For fiscal 2009, Carver paid $0.2 million in OTS assessments.
Enforcement. The OTS has primary enforcement responsibility over the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices.
Standards for Safety and Soundness. The OTS has adopted guidelines prescribing safety and soundness standards. The guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings, 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, OTS regulations authorize, but do not require, the OTS to order an institution that has been given notice that it is not satisfying these safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the OTS must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized association is subject under the prompt corrective action provisions of federal law. If an institution fails to comply with such an order, the OTS may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Insurance of Deposit Accounts
The FDIC merged the Savings Association Insurance Fund and the Bank Insurance Fund to create the Depositors Insurance Fund (DIF) on March 31, 2006. The Bank is a member of the DIF and pays its deposit insurance assessments to the DIF.
Effective January 1, 2007, the FDIC established a new risk-based assessment system for determining the deposit insurance assessments to be paid by insured depository institutions. Under this new assessment system, the FDIC assigns an institution to one of four risk categories, with the first category having two sub-categories, based on the institutions most recent supervisory ratings and capital ratios. Base assessment rates range from two to four basis points for Risk Category I institutions and are seven basis points for Risk Category II institutions, twenty-five basis points for Risk Category III institutions and forty basis points for Risk Category IV institutions. For institutions within Risk Category I, assessment rates generally depend upon a combination of CAMELS (capital adequacy, asset quality, management, earnings, liquidity, sensitivity to market risk) component ratings and financial ratios, or for large institutions with long-term debt issuer ratings, assessment rates depend on a combination of long-term debt issuer ratings and CAMELS component ratings. The FDIC has the flexibility to adjust rates, without further notice-and-comment rulemaking, provided that no such adjustment can be greater than three basis points from one quarter to the next, that adjustments cannot result in rates more than three basis points above or below the base rates and that rates cannot be negative. Effective January 1, 2007, the FDIC set the assessment rates at three basis points above the base rates. Therefore, assessment rates ranged from two to forty-five basis points of deposits. As of March 31, 2009, the Bank had an assessment rate of seven basis points.
The deposit insurance assessment rates are in addition to the assessments for payments on the bonds issued in the late 1980s by the Financing Corporation to recapitalize the now defunct Federal Savings and Loan Insurance Corporation. The Financing Corporation payments will continue until the bonds mature in 2017 through 2019. The Banks expense for these payments totaled $0.5 million in 2009 and $0.1 million in 2008. The FDIC also established 1.25% of estimated insured deposits as the designated reserve ratio of the DIF. The FDIC is authorized to change the assessment rates as necessary, subject to the previously discussed limitations, to maintain the designated reserve ratio of 1.25%.
The FDIC also provided for a one-time credit for eligible institutions based on their assessment base as of December 31, 1996. Subject to certain limitations with respect to institutions that are exhibiting weaknesses, credits can be used to offset assessments until exhausted.
The FDIC has authority to adjust the DIF ratio to insured deposits within a range of 1.15% to 1.50%, in contrast to the prior statutorily fixed ratio of 1.25%. The ratio, which is viewed by the FDIC as the level that the fund should achieve, was established by the agency at 1.25% for 2008. As a result of the recent failures of a number of banks and thrifts, there has been a significant increase in the loss provisions of the DIF of the FDIC. This has resulted in a decline in the DIF reserve ratio. Because the DIF reserve ratio declined below 1.15% and is expected to remain below 1.15%, the FDIC was required to establish a restoration plan to restore the reserve ratio to 1.15% within five years. To restore the reserve ratio to 1.15%, the FDIC has adopted a final rule increasing assessment rates uniformly by 7 basis points (annualized) for the first quarter of 2009 and proposed other changes effective for the second quarter of 2009. Under the proposed plan, beginning with the second quarter of 2009, the initial base assessment rates will range from 10 to 45 basis points depending on an institutions risk category, with adjustments resulting in increased assessment rates for institutions with a significant reliance on secured liabilities and brokered deposits. As currently written, the proposal will result in a significant increase in the Banks federal deposit insurance premiums which will have a material impact on the Banks results of operations beginning in 2009. For further discussion of the FDIC restoration plan and proposal, see Item 1A, Risk Factors.
On October 3, 2008, in response to the financial crises affecting the banking system and financial markets, the FDIC announced a temporary increase in deposit insurance from $100,000 to $250,000 per depositor through December 31, 2009, On November 21, 2008, the FDIC adopted the Temporary Liquidity Guarantee Program, or TLGP, pursuant to its authority to prevent systemic risk in the U.S banking system. The TLGP was announced by the FDIC on October 14, 2008 as an initiative to counter the system-wide crisis in the nations financial sector. Under the TLGP the FDIC will (1) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008, and before June 30, 2009 under the Debt Guarantee Program and (2) fully insure non-interest bearing transaction deposit accounts held at participating FDIC-insured institutions, through December 31, 2009 under the Transaction Account Guarantee Program.
Eligible institutions were covered under the TLGP at no cost for the first 30 days. Institutions that did not want to continue to participate in one or both parts of the TLGP were required to notify the FDIC of their election to opt out on or before December 5, 2008. Institutions that did not opt out are subject to a fee of up to 100 basis points per annum based on the amount of senior unsecured debt issued under the Debt Guarantee Program. Under the Transaction Account Guarantee Program, a 10 basis point surcharge will be added to the institutions current insurance assessment, quarterly, for balances in non-interest bearing transaction accounts that exceed the existing deposit insurance limit of $250,000. The TLGP was due to expire in June of 2009, however, on February 10, 2009 the FDIC announced its intention to extend the TLGP through October 2009 for an additional premium. Carver Federal has elected to participate in both components of the TLGP.
On January 16, 2009, in an effort to further strengthen the financial system and U.S economy, the FDIC announced that it will soon propose rule changes to the TLGP to extend the maturity of the guarantee from three to up to 10 years where the debt is supported by collateral and the issuance supports new consumer lending. Until the details of this extended program are finalized and published, the Bank cannot determine to what extent, if any, it would participate in this program.
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC 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. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Anti-Money Laundering and Customer Identification
The Bank is subject to OTS regulations implementing the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act). The USA PATRIOT Act gives the federal government new 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 bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the United States Commodity Exchange Act of 1936, as amended.
Title III of the USA PATRIOT Act and the related OTS regulations impose the following requirements with respect to financial institutions:
In addition, bank regulators are directed to consider a holding companys effectiveness in combating money laundering when ruling on FRA and Bank Merger Act applications.
Federal Home Loan Bank System
The Bank is a member of the FHLB-NY, which is one of the twelve regional banks composing the FHLB System. Each regional bank provides a central credit facility primarily for its member institutions. The Bank, as a FHLB-NY member, is required to acquire and hold shares of capital stock in the FHLB-NY in an amount equal to the greater of (i) 1% of the aggregate principal amount of its unpaid residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year, and (ii) 5% (or such greater fraction as established by the FHLB-NY) of its outstanding advances from the FHLB-NY. The Bank was in compliance with this requirement with an investment in the capital stock of the FHLB-NY at March 31, 2009 of $4.2 million. Any advances from the FHLB-NY must be secured by specified types of collateral, and all long term advances may be obtained only for the purpose of providing funds for residential housing finance.
FHLB-NY is required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of earnings that the FHLB-NY can pay as dividends to its members and could also result in the FHLB-NY imposing a higher rate of interest on advances to its members. If dividends were reduced, or interest on future FHLB-NY advances increased, the Banks net interest income would be adversely affected. Dividends from FHLB-NY to the Bank amounted to $0.1 million, $0.2 million and $0.3 million for fiscal years 2009, 2008 and 2007, respectively. The dividend rate paid on FHLB-NY stock at March 31, 2009 was 5.60%.
Under the Gramm-Leach-Bliley Act, as amended (GLB), which, among other things, repeals historical restrictions and eliminates many federal and state law barriers to affiliations among banks and securities firms, insurance companies and other financial service providers, membership in the FHLB system is now voluntary for all federally-chartered savings banks such as the Bank. GLB also replaces the existing redeemable stock structure of the FHLB system with a capital structure that requires each FHLB to meet a leverage limit and a risk-based permanent capital requirement. Two classes of stock are authorized: Class A (redeemable on six months notice) and Class B (redeemable on five years notice). Pursuant to regulations promulgated by the Federal Housing Finance Board, as required by GLB, the FHLB has adopted a capital plan that will change the foregoing minimum stock ownership requirements for FHLB stock. Under the new capital plan, each member of the FHLB will have to maintain a minimum investment in FHLB capital stock in an amount equal to the sum of (1) the greater of $1,000 or 0.20% of the members mortgage-related assets and (2) 4.50% of the dollar amount of any outstanding advances under such members Advances, Collateral Pledge and Security Agreement with the FHLB-NY.
Federal Reserve System
FRB regulations require federally chartered savings associations to maintain non-interest-earning cash reserves against their transaction accounts (primarily NOW and demand deposit accounts). A reserve of 3% is to be maintained against aggregate transaction accounts between $10.3 million and $44.4 million (subject to adjustment by the FRB) plus a reserve of 10% (subject to adjustment by the FRB between 8% and 14%) against that portion of total transaction accounts in excess of $44.4 million. The first $10.3 million of otherwise reservable balances (subject to adjustment by the FRB) is exempt from the reserve requirements. The Bank is in compliance with the foregoing requirements. Since required reserves must be maintained in the form of either vault cash, a non-interest-bearing account at a Federal Reserve Bank or a pass-through account as defined by the FRB, the effect of this reserve requirement is to reduce Carver Federals interest-earning assets. FHLB System members are also authorized to borrow from the Federal Reserve discount window, but FRB regulations require institutions to exhaust all FHLB sources before borrowing from a Federal Reserve Bank.
Pursuant to the EESA, the FRB announced on October 6, 2008, that the Federal Reserve Banks will begin to pay interest on depository institutions required and excess reserve balances. Paying interest on required reserve balances should essentially eliminate the opportunity cost of holding required reserves, promoting efficiency in the banking sector. The interest rate paid on required reserve balances is currently the average target federal funds rate over the reserve maintenance period. The rate on excess balances will be set equal to the lowest target federal funds rate in effect during the reserve maintenance period. The payment of interest on excess reserves will permit the Federal Reserve to expand its balance sheet as necessary to provide the liquidity necessary to support financial stability.
The Bank is subject to regulatory guidelines establishing standards for safeguarding customer information. These regulations implement certain provisions of GLB. 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 insure 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. The Bank has a policy to comply with the foregoing guidelines.
Holding Company Regulation.
The Holding Company is a savings and loan holding company regulated by the OTS. As such, the Holding Company is registered with and is subject to OTS examination and supervision, as well as certain reporting requirements. In addition, the OTS has enforcement authority over the Holding Company and its subsidiaries. Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the financial safety, soundness or stability of a subsidiary savings institution. Unlike bank holding companies, federal savings and loan holding companies are not subject to any regulatory capital requirements or to supervision by the FRB.
GLB restricts the powers of new unitary savings and loan holding companies. Unitary savings and loan holding companies that are grandfathered, i.e., unitary savings and loan holding companies in existence or with applications filed with the OTS on or before May 4, 1999, such as the Holding Company, retain their authority under the prior law. All other unitary savings and loan holding companies are limited to financially related activities permissible for bank holding companies, as defined under GLB. GLB also prohibits non-financial companies from acquiring grandfathered unitary savings and loan holding companies.
Restrictions Applicable to All Savings and Loan Holding Companies. Federal law prohibits a savings and loan holding company, including the Holding Company, directly or indirectly, from acquiring:
A savings and loan holding company may not acquire as a separate subsidiary an insured institution that has a principal office outside of the state where the principal office of its subsidiary institution is located, except:
The HOLA prohibits a savings and loan holding company (directly or indirectly, or through one or more subsidiaries) from acquiring another savings association or holding company thereof without prior written approval of the OTS; acquiring or retaining, with certain exceptions, more than 5% of a non-subsidiary savings association, a non-subsidiary holding company, or a non-subsidiary company engaged in activities other than those permitted by the HOLA; or acquiring or retaining control of a depository institution that is not federally insured. In evaluating applications by holding companies to acquire savings associations, the OTS 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 insurance funds, the convenience and needs of the community and competitive factors.
Federal Securities Laws
The Holding Company is subject to the periodic reporting, proxy solicitation, tender offer, insider trading restrictions and other requirements under the Securities Exchange Act of 1934, as amended (Exchange Act).
Delaware Corporation Law
The Holding Company is incorporated under the laws of the State of Delaware. Thus, it is subject to regulation by the State of Delaware and the rights of its shareholders are governed by the General Corporation Law of the State of Delaware.
FEDERAL AND STATE TAXATION
General. The Holding Company and the Bank currently file consolidated federal income tax returns, report their income for tax return purposes on the basis of a taxable-year ending March 31st, using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including in particular the Banks tax reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Holding Company.
Bad Debt Reserves. Prior to fiscal 2004, the Bank met the requirement as a small bank (one with assets having an adjusted tax basis of $500 million or less) and was permitted to maintain a reserve for bad debts, and to make, within specified formula limits, annual additions to the reserve which are deductible for purposes of computing the Banks taxable income. Since fiscal year 2004, the Bank has not been considered to be a small bank because its total assets have exceeded $500 million. (See Income Taxes Note 10 of Notes to the Consolidated Financial Statements.)
Distributions. To the extent that the Bank makes non-dividend distributions to shareholders, such distributions will be considered to result in distributions from the Banks base year reserve, i.e., its reserve as of March 31, 1988, to the extent thereof and then from its supplemental reserve for losses on loans, and an amount based on the amount distributed will be included in the Banks taxable income. Non-dividend distributions include distributions in excess of the Banks current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of the Banks current or accumulated earnings and profits, as calculated for federal income tax purposes, will not constitute non-dividend distributions and, therefore, will not be included in the Banks taxable income.
The amount of additional taxable income created from a non-dividend distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, approximately one and one-half times the non-dividend distribution would be includable in gross income for federal income tax purposes, assuming a 34% federal corporate income tax rate.
Dividends Received Deduction and Other Matters. The Holding Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Holding Company and the Bank will not file a consolidated tax return, except that if the Holding Company or the Bank owns more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted.
State and Local Taxation
State of New York. The Bank and the Holding Company are subject to New York State franchise tax on their entire net income or one of several alternative bases, whichever results in the highest tax. Entire net income means federal taxable income with adjustments. If, however, the application of an alternative minimum tax (based on taxable assets allocated to New York, alternative net income, or a flat minimum fee) results in a greater tax, an alternative minimum tax will be imposed. The Company was subject to the alternative minimum tax based upon assets for New York State for fiscal 2009. In addition, New York State imposes a tax surcharge of 17.0% of the New York State Franchise Tax, calculated using an annual franchise tax rate of 9.0% (which represents the 2000 annual franchise tax rate), allocable to business activities carried on in the Metropolitan Commuter Transportation District. These taxes apply to the Holding Company, Carver Federal and certain of Carvers subsidiaries. The Bank and the Holding Company file combined returns and are subject to taxation in the same manner as other corporations with some exceptions, including the Banks deductions for additions to its reserve for bad debts.
For fiscal 2008, the New York State franchise tax rate based upon entire net income was 8.63% (including the Metropolitan Commuter Transportation District Surcharge) of net income. In general, the Holding Company is not required to pay New York State tax on dividends and interest received from the Bank or on gains realized on the sale of Bank stock. Sixty percent of dividend income, and gains and losses from subsidiary capital are excluded from New York State entire net income. Distributions to Carver Federal received from CAC are eligible for the New York State dividends received deduction. However, the Holding Company was subject to a franchise tax rate of 3.51% (including the Metropolitan Commuter Transportation District Surcharge) for fiscal 2009 based upon alternative entire net income. For this purpose, alternative entire net income is determined by adding back 60% of dividend income, and gains and losses from subsidiary capital to New York State entire net income.
New York State has enacted legislation that enabled the Bank to avoid the recapture of the New York State tax bad debt reserves that otherwise would have occurred as a result of the changes in federal law and to continue to utilize either the federal method or a method based on a percentage of its taxable income for computing additions to its bad debt reserve.
New York City. The Bank and the Holding Company are also subject to a similarly calculated New York City banking corporation tax of 9% on income allocated to New York City. In this connection, legislation was enacted regarding the use and treatment of tax bad debt reserves that is substantially similar to the New York State legislation described above. The Bank and the Holding Company also are subject to New York City banking corporation tax of 3% on alternative entire net income allocated to New York City. In addition, the Bank and the Holding Company were subject to the alternative minimum tax for New York City (which is similar to the New York State alternative minimum tax) for fiscal 2009.
Delaware Taxation. As a Delaware holding company not earning income in Delaware, the Holding Company is exempted from Delaware corporate income tax but is required to file an annual report with and pay an annual franchise tax to the State of Delaware.
EXECUTIVE OFFICERS OF THE HOLDING COMPANY
The name, position, term of office as officer and period during which he or she has served as an officer is provided below for each executive officer of the Holding Company as of June 15, 2009. Each of the persons listed below is an executive officer of the Holding Company and the Bank, holding the same office in each.
Deborah C. Wright, age 51, is Chairman, President and Chief Executive Officer of Carver and Carver Federal. The Board of Directors elected her to the post of Chairman in February 2005. Ms. Wright has held the titles President & CEO since June 1, 1999. Prior to joining Carver in June 1999, Ms. Wright was President and Chief Executive Officer of the Upper Manhattan Empowerment Zone Development Corporation, a position she had held from May 1996 through May 1999. She previously served as Commissioner of the Department of Housing Preservation and Development under Mayor Rudolph W. Giuliani from January 1994 through March 1996. Prior to that appointment, Mayor David N. Dinkins appointed Ms. Wright to the New York City Housing Authority Board, which manages New York Citys 189,000 public housing units. Ms. Wright serves on the boards of Kraft Foods Inc., Time Warner Inc., The Partnership for New York City, the Childrens Defense Fund and Sesame Workshop. She is a member of the Board of Managers of the Memorial Sloan-Kettering Cancer Center. Ms. Wright earned A.B., J.D. and M.B.A. degrees from Harvard University.
Mark A. Ricca, age 52, is Executive Vice President, Chief Risk Officer and General Counsel. Mr. Ricca joined Carver in November 2008. Prior to joining Carver, Mr. Ricca held several positions at New York Community Bancorp, Inc. and its principle subsidiary, New York Community Bank, beginning in 2000 and finishing in 2007 as its Executive Vice President, General Counsel and Assistant to the Chief Operating Officer, after which Mr. Ricca served as a legal consultant and lectured for Learning Dynamics, Inc. Prior to New York Community Bank, Mr. Ricca held various positions at Haven Bancorp, Inc., and its principal subsidiary, CFS Bank, as Senior Vice President, Residential and Consumer Lending, Corporate Secretary, General Counsel and Chief Compliance Officer and was a partner in the law firm of Ricca & Donnelly. Mr. Ricca holds a B.A. degree in economics from the University of Notre Dame, a J.D. cum laude, Law Review and Jurisprudence Award from St. Johns University, School of law, and an LL.M. from New York University, School of Law.
James H. Bason, age 54, is Senior Vice President and Chief Lending Officer. He joined Carver in March 2003. Previously Mr. Bason was Vice President and Real Estate Loan Officer at The Bank of New York where he had been employed since 1991 when The Bank of New York acquired Barclays Bank (where he had been employed since 1986). At The Bank of New York, Mr. Bason was responsible for developing and maintaining relationships with developers, builders, real estate investors and brokers to provide construction and permanent real estate financing. At Barclays, Mr. Bason began his career in residential lending and eventually became the banks CRA officer. Mr. Bason earned a B.S. in Business Administration from the State University of New York at Oswego.
James Carter, age 58, is Senior Vice President of Operations. Mr. Carter joined Carver in August 2008 from TD Bank in New York where he served as Senior Vice President of Banking Services for nine years. Prior to that, Mr. Carter served four years as Vice President of Retail Operations for Home Federal Savings Bank in New York and 20 years as Vice President and Senior Savings Officer at Columbia Federal Savings Bank in New York. Mr. Carter earned a B.S. in Business Administration and an MBA in Financial Management from Iona College in New Rochelle, NY.
Blondel A. Pinnock, age 41, is Senior Vice President, Carver Federal and President of CCDC. Ms. Pinnock joined Carver in April 2008. Prior to joining Carver, Ms. Pinnock was Senior Vice President at Bank of America where she was a community development lender and business development officer. Ms. Pinnock has over a ten years of experience in financing the development of residential and commercial real estate projects located within low and moderate income neighborhoods throughout New York City and outlying areas. Prior to Bank of America, Ms. Pinnock worked as counsel and deputy director for the New York Citys Housing, Preservation and Development Departments Tax Incentives Unit, where she assisted in the implementation of the citys real estate tax programs for low, moderate and market rate projects. She earned a B. A. from Columbia College and a J. D. from Hofstra University School of Law.
Margaret D. Roberts, age 58, is Senior Vice President and Chief Human Resources Officer. Ms. Roberts joined Carver in November 1999 as Senior Vice President and Chief Administrative Officer from Deutsche Bank where she had served as a Compensation Planning Consultant in Corporate Human Resources. Prior to that, Ms. Roberts was a Vice President and Senior Human Resources Generalist for Citibank Global Asset Management. Ms. Roberts also has 10 years of systems and technology experience in various positions held at JP Morgan and Chase Manhattan Bank. Ms. Roberts earned a B.P.S. degree from Pace University, an M.B.A. from Columbia University as a Citicorp Fellow, and has been designated a Certified Compensation Professional (CCP) by the WorldatWork Society of Certified Professionals and a Senior Professional in Human Resources (SPHR) by the Human Resources Certification Institute.
John Spencer, age 43, is Senior Vice President and Chief Retail Officer. Mr. Spencer joined the Carver in February 2009 after 22 years at JPMorgan Chase where he held management positions in Retail Sales/Customer Service, Audit, and Operations Management. Additionally, he served as a Branch Administration Executive for the banks Retail Division, supporting a network with 700 branches, and over $50 billion in deposits. Mr. Spencer is a graduate of the JPMorgan Chase management-training program and earned a B.A. in Banking and Finance from Pace University.
Thomas Sperzel, CPA, age 37, is Senior Vice President and Controller. Mr. Sperzel joined Carver in February 2009 from Robert Martin Company, LLC in New York. Prior to that, Mr. Sperzel was the Controller of City and Suburban Federal Savings Bank where he was responsible for overseeing all aspects of financial and regulatory reporting, FDICIA implementation, evaluation of acquisition targets, and management of external auditors. Mr. Sperzel earned a B.S. in Accounting from Penn State University, an M.B.A. from University of Maryland, and has also been designated the Companys acting Principal Accounting Officer. Mr. Sperzel has resigned his position with the Holding Company and the Bank.
ITEM 1A. RISK FACTORS.
Risk is an inherent part of Carvers business and activities. The following is a summary of risk factors relevant to the Companys operations which should be carefully reviewed. These risk factors do not necessarily appear in the order of importance.
Changes in interest rate environment may negatively affect Carvers net income, mortgage loan originations and valuation of available-for-sale securities.
The Companys earnings depend largely on the relationship between the yield on interest-earning assets, primarily mortgage, construction and business loans and mortgage-backed securities, and the cost of deposits and borrowings. This relationship, known as the interest rate spread, is subject to fluctuation and is affected by economic and competitive factors which influence market interest rates, the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. Fluctuations in market interest rates affect customer demand for products and services. Carver is subject to interest rate risk to the degree that its interest-bearing liabilities reprice or mature more slowly or more rapidly or on a different basis than its interest-earning assets.
In addition, the actual amount of time before mortgage, construction and business loans and mortgage-backed securities are repaid can be significantly impacted by changes in mortgage prepayment rates and prevailing market interest rates. Mortgage prepayment rates will vary due to a number of factors, including the regional economy in the area where the underlying mortgages were originated, seasonal factors, demographic variables and the ability to assume the underlying mortgages. However, the major factors affecting prepayment rates are prevailing interest rates, related loan refinancing opportunities and competition.
The Companys objective is to fund its liquidity needs primarily through lower costing deposit growth. However, from time to time Carver Federal borrows from the FHLB-NY. More recently, the cost of deposits and borrowings have become significantly higher with the rising interest rate environment, which has negatively impacted net interest income.
Interest rates do and will continue to fluctuate. The Federal Open Market Committee, or FOMC, reduced the federal funds rate by 100 basis points during the second half of 2007 and then an additional 400+ basis points during 2008 bringing the target rate to 0.00% to 0.25%. The Bank cannot predict future FOMC or FRB actions or other factors that will cause rates to change. No assurance can be given that further changes in interest rates or further increases in mortgage loan prepayments will not have a negative impact on net interest income, net interest rate spread or net interest margin.
The estimated fair value of the Companys available-for-sale securities portfolio may increase or decrease depending on changes in interest rates. Carver Federals securities portfolio is comprised primarily of adjustable rate securities. There has been an improvement in valuation of the Banks available for sale securities because interest rates have declined in fiscal 2009.
Carvers results of operations are affected by economic conditions in the New York metropolitan area.
At March 31, 2009, a majority of the Banks lending portfolio was concentrated in the New York metropolitan area. As a result of this geographic concentration, Carvers results of operations are largely dependent on economic conditions in this area. Decreases in real estate values could adversely affect the value of property used as collateral for loans to its borrowers. Adverse changes in the economy caused by inflation, recession, unemployment or other factors beyond the Banks control may also have a negative effect on the ability of borrowers to make timely mortgage or business loan payments, which would have an adverse impact on earnings. Consequently, deterioration in economic conditions in the New York metropolitan area could have a material adverse impact on the quality of the Banks loan portfolio, which could result in increased delinquencies, decreased interest income results as well as an adverse impact on loan loss experience with probable increased allowance for loan losses. Such deterioration also could adversely impact the demand for products and services, and, accordingly, further negatively affect results of operations.
The Bank is operating in a challenging and uncertain economic environment, both nationally and locally. Financial institutions continue to be affected by sharp declines in the real estate market and constrained financial markets. Continued declines in real estate values, home sales volumes and financial stress on borrowers as a result of the ongoing economic recession, including job losses, could have an adverse effect on the Banks borrowers or their customers, which could adversely affect the Banks financial condition and results of operations. In addition, decreases in real estate values could adversely affect the value of property used as collateral for loans. At March 31, 2009, the average loan-to-value ratio of the Banks mortgage loan portfolio was less than 53% based on current principal balances and original appraised values. However, no assurance can be given that the original appraised values are reflective of current market conditions as the Bank has experienced declines in real estate values in all markets in which it lends.
The Bank has experienced increases in loan delinquencies and charge-offs in fiscal 2009. The Banks non-performing loans, which are comprised primarily of mortgage loans, increased $23.1 million to $26.6 million, or 4.15% of total loans, at March 31, 2009, from $2.9 million, or 0.43% of total loans, at March 31, 2008. The Banks net loan charge-offs totaled $0.5 million for fiscal 2009 compared to $0.8 million for fiscal 2008. The Banks provision for loan losses totaled $2.7 million for fiscal 2009 compared to $0.2 million for fiscal 2008. As a residential lender, Carver Federal is particularly vulnerable to the impact of a severe job loss recession. Significant increases in job losses and unemployment will have a negative impact on the financial condition of residential borrowers and their ability to remain current on their mortgage loans. A continuation or further deterioration in national and local economic conditions, including an accelerating pace of job losses, particularly in the New York metropolitan area, could have a material adverse impact on the quality of The Banks loan portfolio, which could result in further increases in loan delinquencies, causing a decrease in The Banks interest income as well as an adverse impact on The Banks loan loss experience, causing an increase in The Banks allowance for loan losses and related provision and a decrease in net income. Such deterioration could also adversely impact the demand for The Banks products and services, and, accordingly, The Banks results of operations.
No assurance can be given that these conditions will improve or will not worsen or that such conditions will not result in a decrease in the Banks interest income or an adverse impact on loan losses.
Strong competition within the Banks market areas could hurt expected profits and slow growth.
The New York metropolitan area has a high density of financial institutions, of which many are significantly larger than Carver Federal and with greater financial resources. Additionally, various large out-of-state financial institutions may continue to enter the New York metropolitan area market. All are considered competitors to varying degrees.
Carver Federal faces intense competition both in making loans and attracting deposits. Competition for loans, both locally and in the aggregate, comes principally from mortgage banking companies, commercial banks, savings banks and savings and loan associations. Most direct competition for deposits comes from commercial banks, savings banks, savings and loan associations and credit unions. The Bank also faces competition for deposits from money market mutual funds and other corporate and government securities funds as well as from other financial intermediaries such as brokerage firms and insurance companies. Market area competition is a factor in pricing the Banks loans and deposits, which could reduce net interest income. Competition also makes it more challenging to effectively grow loan and deposit balances. The Companys profitability depends upon its continued ability to successfully compete in its market areas.
The Banks increased emphasis on non-residential, construction real estate lending and small business lending may increase exposure to lending risks.
At March 31, 2009, $417.9 million, or 65.1%, of the Banks total loans receivable portfolio consisted of non-residential and construction real estate loans compared to $397.4 million, or 62.7%, at March 31, 2008. Non-residential and construction real estate loans generally involve a greater degree of credit risk than one-to-four family loans because they typically have larger balances and are more sensitive to changes in the economy. Payments on these loans often depend upon the successful operation and management of the underlying properties and the businesses which operate from within them; repayment of such loans may be affected by factors outside the borrowers control, such as adverse conditions in the real estate market or the economy or changes in government regulation (see Note 5 of Notes to Consolidated Financial Statements).
While the Bank continues to originate multi-family and commercial real estate loans, under current economic conditions, the Bank has strengthened its underwriting guidelines. As of March 31, 2009, Carver Federal is primarily offering to originate multi-family and commercial real estate loans to select customers in New York and New Jersey. The market for multi-family and commercial real estate loans does and will continue to change based upon market conditions and other factors, thereby, affecting the Banks election to pursue the originations of such loans in the future.
At March 31, 2009, $57.5 million, or 9.0%, of the Banks total loans receivable consisted of business loans compared to $51.4 million, or 8.1%, at March 31, 2008. Business loans generally involve a greater degree of credit risk than one- to four- family loans because they typically have larger balances and are more sensitive to changes in the economy. Payments on these loans often depend upon the successful operation and management of the underlying business; repayment of such loans may be affected by factors outside the borrowers control, such as adverse economic conditions, increased competition or changes in government regulation (see Note 5 of Notes Consolidated Financial Statements).
The Bank operates in a highly regulated industry, which limits the manner and scope of business activities.
Carver Federal is subject to extensive supervision, regulation and examination by the OTS, the FDIC, and, to a lesser extent, by the New York State Banking Department. As a result, the Bank is limited in the manner in which the Bank conducts its business, undertakes new investments and activities and obtains financing. This regulatory structure is designed primarily for the protection of the deposit insurance funds and depositors, and not to benefit the Holding Companys stockholders. This 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 capital levels, the timing and amount of dividend payments, the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. In addition, the Bank must comply with significant anti-money laundering and anti-terrorism laws. Government agencies have substantial discretion to impose significant monetary penalties on institutions which fail to comply with these laws.
On October 4, 2006, the OTS and other federal bank regulatory authorities published the Interagency Guidance on Nontraditional Mortgage Product Risk, or the Guidance. In general, the Guidance applies to all residential mortgage loan products that allow borrowers to defer repayment of principal or interest. The Guidance describes sound practices for managing risk, as well as marketing, originating and servicing nontraditional mortgage products, which include, among other things, interest-only loans. The Guidance sets forth supervisory expectations with respect to loan terms and underwriting standards, portfolio and risk management practices and consumer protection. For example, the Guidance indicates that originating interest-only loans with reduced documentation is considered a layering of risk and that institutions are expected to demonstrate mitigating factors to support their underwriting decision and the borrowers repayment capacity. Specifically, the Guidance indicates that a lender may accept a borrowers statement as to the borrowers income without obtaining verification only if there are mitigating factors that clearly minimize the need for direct verification of repayment capacity and that, for many borrowers, institutions should be able to readily document income.
The Bank has evaluated the Guidance for compliance, risk management practices and underwriting guidelines as they relate to originations and purchases of the subject loans, or practices relating to communications with consumers. The Guidance has no impact on the Companys loan origination and purchase volumes or the Companys underwriting procedures currently or in future periods.
Efforts to comply with the Sarbanes-Oxley Act involve significant expenditures, and non-compliance with the Sarbanes-Oxley Act may adversely affect the Bank.
The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the SEC increase the scope, complexity and cost of corporate governance, reporting, and disclosure practice. The Company has experienced, and expects to continue to experience, greater compliance costs, including design, testing and audit costs related to internal controls, as a result of the Sarbanes-Oxley Act. For example, under Section 404 of Sarbanes-Oxley, the Companys management is required to issue a report on the Companys internal controls over financial reporting. Beginning with Carvers fiscal 2010, Carvers management will also be required to file an auditors attestation report on the Companys internal controls over financial reporting. The Company expects the implementation of these new rules and regulations to continue to increase its accounting, legal, and other costs, and to make some activities more difficult, time consuming, and costly. In the event that the Company is unable to maintain or achieve compliance with the Sarbanes-Oxley Act and related rules, Carvers profitability and the market price of Carvers stock may be adversely affected.
In addition, the rules adopted as a result of the Sarbanes-Oxley Act could make it more difficult or more costly for the Company to obtain certain types of insurance, including directors and officers liability insurance, which could make it more difficult for the Company to attract and retain qualified persons to serve on the Companys boards of directors or as executive officers.
Changes in laws, government regulation and monetary policy may have a material effect on results of operations.
Financial institution regulation has been the subject of significant legislation and may be the subject of further significant legislation in the future, none of which is in the Companys control. Significant new laws or changes in, or repeals of, existing laws, including with respect to federal and state taxation, may cause results of operations to differ materially. In addition, cost of compliance could adversely affect Carvers ability to operate profitably. Further, federal monetary policy significantly affects credit conditions for Carver Federal, particularly as implemented through the Federal Reserve System. A material change in any of these conditions could have a material impact on Carver Federal, and therefore on the Companys results of operations.
On October 3, 2008, President Bush signed the EESA into law in response to the financial crises affecting the banking system and financial markets. Pursuant to the EESA, the Treasury has the authority to, among other things, purchase up to $700 billion of troubled assets (including mortgages, mortgage-backed securities and certain other financial instruments) from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On October 14, 2008, the Treasury, the FRB and the FDIC issued a joint statement announcing additional steps aimed at stabilizing the financial markets. First, the Treasury announced the TARP CPP, a $250 billion voluntary capital purchase program available to qualifying financial institutions that sell preferred shares to the Treasury (to be funded from the $700 billion authorized for troubled asset purchases.) Second, the FDIC announced that its Board of Directors, under the authority to prevent systemic risk in the U.S. banking system, approved the TLGP, which is intended to strengthen confidence and encourage liquidity in the banking system by permitting the FDIC to (1) guarantee certain newly issued senior unsecured debt issued by participating institutions under the Debt Guarantee Program and (2) fully insure non-interest bearing transaction deposit accounts held at participating FDIC-insured institutions, regardless of dollar amount, under the Transaction Account Guarantee Program. Third, to further increase access to funding for businesses in all sectors of the economy, the FRB announced further details of its Commercial Paper Funding Facility, or CPFF, which provides a broad backstop for the commercial paper market.
There can be no assurance, however, as to the actual impact that the foregoing or any other governmental program will have on the financial markets. The failure of any such program or the U.S. government to stabilize the financial markets and a continuation or worsening of current financial market conditions and the national and regional economy is expected to materially and adversely affect the Companys business, financial condition, results of operations, access to credit and the trading price of the Holding Companys common stock.
Pursuant to Carvers participation in the TARP CPP, the Company entered into certain agreements with the Treasury that limit the Companys activities in a number of ways and gives the Treasury the ability to impose additional restrictions as it determines. For example, the Companys ability to declare or pay dividends on any of Carvers shares is restricted. Specifically, the Company is not able to declare dividends payments on common, junior preferred or pari passu preferred shares if it is in arrears on the dividends on the senior preferred shares issued to the Treasury. Further, the Company is not permitted to increase dividends on common stock without the Treasurys approval until the third anniversary of the investment unless the senior preferred stock issued to the Treasury has been redeemed or transferred. In addition, the Companys ability to repurchase shares of common stock is prohibited without the Treasurys prior consent until the third anniversary of the investment or until the senior preferred stock issued to the Treasury has been redeemed or transferred. Further, common, junior preferred or pari passu preferred shares may not be repurchased if the Company is in arrears on the dividends on the senior preferred shares issued to the Treasury.
In addition, the Company must also adopt the Treasurys standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under this program. These standards would generally apply to the Companys CEO, CFO and the three next most highly compensated officers (Senior Executives). The standards include (1) ensuring that incentive compensation for Senior Executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required claw back of any bonus or incentive compensation paid to a Senior Executive based on statements of earnings, gains or other criteria that are later proven to be materially inaccurate; (3) prohibition on making golden parachute payments to Senior Executives; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each Senior Executive. In particular, the change to the deductibility limit on executive compensation would likely increase slightly the overall cost of the Companys compensation programs.
The FDIC recently adopted a restoration plan and issued a notice of proposed rulemaking and request for comment that would initially raise the assessment rate schedule, uniformly across all four risk categories into which the FDIC assigns insured institutions, by seven basis points (annualized) of insured deposits beginning on January 1, 2009. Under the proposed plan, beginning with the second quarter of 2009, the initial base assessment rates will range from 10 to 45 basis points depending on an institutions risk category, with adjustments resulting in increased assessment rates for institutions with a significant reliance on secured liabilities and brokered deposits. Under the proposal the FDIC may continue to adopt actual rates that are higher without further notice-and-comment rulemaking subject to certain limitations. If the FDIC determines that assessment rates should be increased, institutions in all risk categories could be affected. The FDIC has exercised this authority several times in the past and could continue to raise insurance assessment rates in the future. The increased deposit insurance premiums proposed by the FDIC are expected to result in a significant increase in the Banks non-interest expense, which will have a material impact on the Banks results of operations beginning in 2009. On May 29, 2009, FDIC voted to levy a special assessment on insured institutions as part of the agencys efforts to rebuild the DIF and help maintain public confidence in the banking system. The final rule establishes a special assessment of five basis points on each FDIC-insured depository institutions assets, minus its Tier 1 capital, as of June 30, 2009. The special assessment will be collected September 30, 2009.
Management expects to face increased regulation and supervision of the banking industry as a result of the existing financial crisis, and there will be additional requirements and conditions imposed on the Company to the extent that it participates in any of the programs established or to be established by the Treasury or by the federal bank regulatory agencies. Such additional regulation and supervision may increase the Companys costs and limit the Companys ability to pursue business opportunities.
The Company is subject to certain risks with respect to liquidity.
Liquidity refers to the Companys ability to generate sufficient cash flows to support operations and to fulfill obligations, including commitments to originate loans, to repay wholesale borrowings, and to satisfy the withdrawal of deposits by customers.
The Companys primary sources of liquidity are the cash flows generated through the repayment of loans and securities, cash flows from the sale of loans and securities, deposits gathered organically through the Banks branch network, from socially motivated depositors, city and state agencies; and borrowed funds, primarily in the form of wholesale borrowings from the FHLB-NY. In addition, and depending on current market conditions, the Company has the ability to access the capital markets from time to time.
Deposit flows, calls of investment securities and wholesale borrowings, and prepayments of loans and mortgage-related securities are strongly influenced by such external factors as the direction of interest rates, whether actual or perceived; local and national economic conditions; and competition for deposits and loans in the markets the Bank serves. Furthermore, changes to the FHLB-NYs underwriting guidelines for wholesale borrowings may limit or restrict the Banks ability to borrow, and could therefore have a significant adverse impact on liquidity.
A decline in available funding could adversely impact the Banks ability to originate loans, invest in securities, and meet expenses, or to fulfill such obligations as repaying borrowings or meeting deposit withdrawal demands.
The Banks ability to pay dividends or lend funds to the Holding Company is subject to regulatory limitations which may prevent the Holding Company from making future dividend payments or principal and interest payments on its debt obligation.
Carver is a unitary savings and loan association holding company regulated by the OTS and almost all of its operating assets are owned by Carver Federal. Carver relies primarily on dividends from the Bank to pay cash dividends to its stockholders, to engage in share repurchase programs and to pay principal and interest on its trust preferred debt obligation. The OTS regulates all capital distributions by the Bank to the Company, including dividend payments. As the subsidiary of a savings and loan association holding company, Carver Federal must file a notice or an application (depending on the proposed dividend amount) with the OTS prior to each capital distribution. The OTS will disallow any proposed dividend that would result in failure to meet the OTS minimum capital requirements. Based on Carver Federals current financial condition, it is not expected that this provision will have any impact on the Companys receipt of dividends from the Bank although it is possible. Payment of dividends by Carver Federal may also be restricted at any time, at the discretion of the OTS, if it deems the payment to constitute an unsafe or unsound banking practice.
Pursuant to Carvers participation in the TARP CPP, the Company entered into certain agreements with the Treasury that limit the Companys activities in a number of ways and provide the Treasury the ability to impose additional restrictions as it determines. For example, the Holding Companys ability to declare or pay dividends on any of its shares is restricted. Specifically, the Company is not able to declare dividends payments on common, junior preferred or pari passu preferred shares if it is in arrears on the dividends on the senior preferred shares issued to the Treasury. Further, the Company is not permitted to increase dividends on common stock without the Treasurys approval until the third anniversary of the investment unless the senior preferred stock issued to the Treasury has been redeemed or transferred. In addition, the Companys ability to repurchase shares of common stock is prohibited without the Treasurys prior consent until the third anniversary of the investment or until the senior preferred stock issued to the Treasury has been redeemed or transferred. Further, common, junior preferred or pari passu preferred shares may not be repurchased if the Company is in arrears on the dividends on the senior preferred shares issued to the Treasury.
Carver may not be able to utilize its income tax benefits.
The Companys ability to utilize the deferred tax asset generated by New Markets Tax Credit income tax benefits over the next five years, as well as other deferred tax assets, depends on its ability to meet the NMTC compliance requirements and its ability to generate sufficient taxable income from operations or from potential tax strategies to generate taxable income in the future. Since the Bank has not generated sufficient taxable income to utilize tax credits previously recognized, a deferred tax asset has been recorded in the Companys financial statements. For additional information regarding Carvers NMTC, refer to Item 7, New Markets Tax Credit Award.
Carver faces system failure risks and security risks.
The computer systems and network infrastructure the Company and its third party service providers use could be vulnerable to unforeseen problems. Fire, power loss or other failures may effect Carvers computer equipment and other technology, or that of the Companys third party service providers. Also, the Companys computer systems and network infrastructure could be damaged by hacking and identity theft which could adversely affect the results of Carvers operations, or that of the Companys third party service providers.
The Bank may be required to record a charge to earnings if goodwill or other intangible assets become impaired.
Under U.S. Generally Accepted Accounting Principles, if impairment of goodwill or other identifiable intangible assets is determined, the Bank may be required to record a charge to earnings in the period of such determination. The Bank commenced an interim goodwill impairment analysis during the second quarter of fiscal year 2009, based on indications that the fair value of the Banks reporting unit may have declined below its carrying value as a result of factors such as the further decline in the Banks market capitalization relative to the book value of shareholders equity and the adverse market conditions impacting the financial services sector generally. The Company completed its interim impairment analysis during the third quarter ended December 31, 2008. A valuation specialist was engaged to assist management in its fair value assessment of goodwill. As a result of the finalization of the goodwill impairment analysis the Bank determined that goodwill was fully impaired and recorded an impairment charge of $7.1 million. However, the Banks tangible capital ratio and regulatory capital ratios were not affected by this non-cash expense since goodwill is not included in these calculations. The Bank is not aware of any other impairment of its intangible assets.
The Companys business could suffer if it fails to retain skilled people.
The Companys success depends on its ability to attract and retain key employees reflecting current market opportunities and challenges. Competition for the best people is intense, and the Companys size and limited resources may present additional challenges in being able to retain the best possible employees, which could adversely affect the results of operations.
A natural disaster could harm Carvers business.
Natural disasters could harm the Companys operations directly through interference with communications, as well as through the destruction of facilities and financial information systems. Such disasters may also have an impact on collateral underlying the Banks loans. The Company may face higher insurance costs in the event of such disasters.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
ITEM 2. PROPERTIES.
The Bank currently conducts its business through two administrative offices and nine branches (including the 125th Street branch) and twelve separate ATM locations. During fiscal 2009, the Bank closed the Livingston Branch and consolidated its deposits to another Carver Federal branch. The Bank is still obligated under the lease agreement to make payments; however, the Bank is actively trying to sublease the location. The following table sets forth certain information regarding Carver Federals offices and other material properties at March 31, 2009. The Bank believes that such facilities are suitable and adequate for its operational needs.
ITEM 3. LEGAL PROCEEDINGS.
From time to time, Carver Federal is a party to various legal proceedings incident to its business. Certain claims, suits, complaints and investigations involving Carver Federal, arising in the ordinary course of business, have been filed or are pending. The Company is of the opinion, after discussion with legal counsel representing Carver Federal in these proceedings, that the aggregate liability or loss, if any, arising from the ultimate disposition of these matters would not have a material adverse effect on the Companys consolidated financial position or results of operations. At March 31, 2009, there were no material legal proceedings to which the Company was a party or to which any of their property was subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
During the quarter ended March 31, 2009, no matters were submitted to a vote of the Companys security holders through the solicitation of proxies or otherwise.
The Holding Companys common stock has been listed on the NASDAQ Global Market under the symbol CARV since July 10, 2008. Before that, the Companys stock was listed on the American Stock Exchange under the symbol CNY. As of June 20, 2009, there were 2,475,037 shares of common stock outstanding, held by 951 stockholders of record. The following table shows the high and low per share sales prices of the common stock and the dividends declared for the quarters indicated.
Each quarter the Board meets to determine the dividend amount per share to be declared. On May 27, 2009, the Companys Board of Directors declared a $0.10 cash dividend to shareholders for the fourth quarter of fiscal 2009. This dividend amount is consistent with dividends paid during the previous three quarters of fiscal 2009. Any future decision to change the quarterly cash dividend will based on, among other things, the dividend payout ratio coupled with the Banks strategy to retain capital in the current economic environment. As in the past, the Companys Board of Directors reviews the payment of dividends quarterly and plans to continue to maintain a regular quarterly dividend in the future, dependent upon earnings, financial condition and other factors.
Under OTS regulations, the Bank will not be permitted to pay dividends to the Holding Company on its capital stock if its regulatory capital would be reduced below applicable regulatory capital requirements or if its stockholders equity would be reduced below the amount required to be maintained for the liquidation account, which was established in connection with the Banks conversion to stock form. The OTS capital distribution regulations applicable to savings institutions (such as the Bank) that meet their regulatory capital requirements permit, after not less than 30 days prior notice to the OTS, capital distributions during a calendar year that do not exceed the Banks net income for that year plus its retained net income for the prior two years. Since the Bank incurred a net loss in fiscal 2009, prior approval of the OTS is required for any capital distribution to the Holding Company. For information concerning the Banks liquidation account, see Note 12 of the Notes to the Consolidated Financial Statements.
Unlike the Bank, the Holding Company is not subject to OTS regulatory restrictions on the payment of dividends to its stockholders, although the source of such dividends is dependent, primarily, upon capital distributions from the Bank. The Holding Company is subject to the requirements of Delaware law, which generally limit dividends to an amount equal to the excess of the net assets of the Company (the amount by which total assets exceed total liabilities) over its statutory capital, or if there is no such excess, to its net profits for the current and/or immediately preceding fiscal year.
On August 6, 2002 the Holding Company announced a stock repurchase program to repurchase up to 231,635 shares of its outstanding common stock. As of March 31, 2009, 176,174 shares of its common stock have been repurchased in open market transactions at an average price of $15.72 per share. The Holding Company intends to use repurchased shares to fund its stock-based benefit and compensation plans and for any other purpose the Board deems advisable in compliance with applicable law. As a result of the Companys participation in the TARP CPP, the U.S. Treasurys prior approval is required to make further repurchases.
Carver has four equity compensation plans as follows:
(1) The Management Recognition Plan (MRP) which provides for automatic grants of restricted stock to certain employees and non-employee directors as of the date the plan became effective in June of 1995. Additionally, the MRP makes provision for added discretionary grants of restricted stock to those employees so selected by the Compensation Committee of the Board, which administers the plan. There are no shares available for grant under the MRP.
(2) The Incentive Compensation Plan (ICP) provides for grants of cash bonuses, restricted stock and stock options to the employees selected by the Compensation Committee. Carver terminated this plan in 2006 and there are no grants outstanding under it.
(3) The 1995 Stock Option Plan provides for automatic option grants to certain employees and directors as of the date the plan became effective in September of 1995, and like the MRP, also makes provision for added discretionary option grants to those employees so selected by the Compensation Committee. The 1995 Stock Option Plan expired in 2005, however, options are still outstanding under this plan.
(4) The 2006 Stock Incentive Plan became effective in September of 2006 and provides for discretionary option grants, stock appreciation rights and restricted stock to those employees and directors so selected by the Compensation Committee.
Additional information regarding Carvers equity compensation plans is incorporated by reference from the section entitled Securities Authorized for Issuance Under Equity Compensation Plans in the Proxy Statement (as defined below in Item 10).
Stock Performance Graph
The graph below compares Carver Bancorp, Inc.s cumulative 5-year total shareholder return on common stock with the cumulative total returns of the S & P Small Cap Thrift & Mortgage finance and AMEX companies listed in SIC Code 6030-6039. The graph tracks the performance of a $100 investment in the Holding Companys common stock, in each index and in each of the peer groups (with the reinvestment of all dividends) from 3/31/2004 to 3/31/2009.
The stock price performance included in this graph is not necessarily indicative of future stock performance.
The companies listed in the S&P Small Cap Thrift & Mortgage Finance index are Anchor Bancorp Wisconsin, Bank Mutual Corp., Brookline Bancorp Inc., Corus Bank Shares Inc., Dime Community Bancshares, Flagstar Bancorp Inc. and Traid Guaranty Inc. The AMEX listed companies in SIC Codes 6030-6039 are: Federal Trust Corp., Gouverneur Bancorp Inc. and Teche Holdings Company.
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial and other data is as of and for the years ended March 31 and is derived in part from, and should be read in conjunction with the Companys consolidated financial statements and related notes (dollars in thousands):
The following discussion and analysis should be read in conjunction with the Companys Consolidated Financial Statements and Notes to Consolidated Financial Statements presented elsewhere in this report. The Companys results of operations are significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies, changes in accounting standards and actions of regulatory agencies.
The following overview should be read in conjunction with the Companys Managements Discussion and Analysis of Financial Condition and Results of Operation in its entirety.
The financial services industry is facing unprecedented challenges in the face of the current national and global economic crisis. The global and U.S. economies are experiencing significantly reduced business activity as a result of among other factors, disruptions in the financial system during the past year. Dramatic declines in the housing market during the past year, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, have caused many financial institutions to seek additional capital; to merge with larger and stronger institutions; and, in some cases, to fail. The Company is fortunate that the markets it serves have been impacted to a lesser extent than many areas around the country.
In response to the financial crises affecting the banking system and financial markets, there have been several recent announcements of Federal programs designed to purchase assets from, provide equity capital to, and guarantee the liquidity of the industry.
On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the EESA) was signed into law. The EESA authorizes the U.S. Treasury to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities, and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. The Company did not materially originate or invest in sub-prime assets and, therefore, does not expect to participate in the sale of any of its assets into these programs. EESA also immediately increased the FDIC deposit insurance limit from $100,000 to $250,000 through December 31, 2009.
On October 14, 2008, the Treasury announced that it will purchase equity stakes in a wide variety of banks and thrifts. Under this program, known as the Troubled Asset Relief Program Capital Purchase Program (the TARP CPP), the Treasury made $250 billion of capital available (from the $700 billion authorized by the EESA) to U.S. financial institutions in the form of preferred stock. In conjunction with the purchase of preferred stock, the Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions will be required to adopt the Treasurys standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP CPP.
On January 20, 2009, the Company announced that it completed the sale of $19 million in preferred stock to the Treasury in connection with Carvers participation in the TARP CPP. Importantly, Carver is exempt from the requirement to issue a warrant to the Treasury to purchase shares of common stock, as the Bank is a certified Community Development Financial Institution (CDFI), conducting most of its depository and lending activities in disadvantaged communities. Therefore the investment will not dilute current common stock stockholders. Carver issued 18,980 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A, with a liquidation preference of $1,000 per share. The preferred stock investment represents approximately 3 percent of Carvers risk weighted assets as of March 31, 2009 resulting in the Banks capital ratios exceeding minimum regulatory capital requirements. The Treasury investment substantially increased the Banks capital ratios producing a tangible capital ratio of 9.51%; core capital ratio of 9.52%; and risk-based capital ratio of 12.78%. The Bank has used funds from TARP CPP to increase its securities and loan portfolios.
Fiscal 2009 was a particularly challenging year for Carver as it reported a net loss of $7.0 million as compared to a profit of $3.9 million in fiscal 2008. The net loss was primarily the result of a $2.7 million provision for loan losses and a $7.1 million goodwill impairment charge.
The provision for loan losses recorded during fiscal 2009 reflects the increase in and composition of loan delinquencies, non-performing loans, net loan charge-offs and overall loan portfolio, as well as evaluation of the continued deterioration of the housing and real estate markets and increasing weakness in the overall economy, particularly the accelerating pace of job losses. At March 31, 2009 non-performing loans represent 3.89% of total loans as compared to 0.43% at March 31, 2008.
Carver reported $7.1 million in goodwill from its acquisition of Community Capital Bank in 2006. Based on indications that the fair value of the Companys reporting unit declined below its carrying value as a result of factors such as the further decline in the Companys market capitalization relative to the book value of shareholders equity and the adverse market conditions impacting the financial services sector generally the Company determined that goodwill was impaired and recorded an impairment charge of $7.1 million for fiscal 2009.
Net interest income was essentially flat from the prior year with a net interest margin decrease of 7 basis points to 3.55%. During fiscal 2009 overall interest rates declined, however the Bank was able to take advantage of its favorable asset/liability position by matching the reduction in the yield on its interest-earning assets with a reduction in its costs of interest-bearing deposits. As interest rates declined, the bank has benefited from the repricing of CD maturities and borrowings at significantly lower rates of interest offsetting the effect of the decline in the yields on loans and securities.
The business climate continues to present significant challenges, without a near term inflection point signaling recovery. Carver Federal expects that loan growth will continue in fiscal 2010 as the opportunity for portfolio lending remains strong. However, the Bank expects to reduce the risk in its loan portfolio, given the very challenging credit environment, by curtailing the origination of construction loans for the time being, and refocusing on multifamily and non-profit lending, which have historically produced low loss ratios, even during difficult economic times. The Bank expect deposit growth in fiscal 2010, particularly as the intense competition for core community deposits which the Bank experienced in prior years has recently abated. Carver Federal intends to continue to focus on costs. In fiscal 2009, the Bank took very difficult steps including eliminating 20% of its workforce, closing a branch and outsourcing the residential loan division. In fiscal year 2010 the Bank is focused on additional efficiencies, targeting vendor consolidation. However, industry-wide increases in FDIC insurance premiums coupled with potentially reduced dividends on FHLB-NY stock will have a negative impact on fiscal 2010 earnings. With respect to asset quality, continued weakness in the real estate market exacerbated by a severe downturn in the economy presents challenges for all financial institutions in the year ahead. Continued job losses coupled with declining real estate values may put increased pressure on the loan portfolio which may result in higher delinquencies and non-performing loans in fiscal 2010.
Acquisition of Community Capital Bank
On September 29, 2006, the Bank completed its acquisition of Community Capital Bank, a Brooklyn-based New York State chartered commercial bank, with approximately $165.4 million in assets and two branches, in a cash transaction totaling approximately $11.1 million. Under the terms of the merger agreement, CCBs shareholders were paid $40.00 per outstanding share (including options which immediately vested with the consummation of the merger) and the Bank incurred an additional $0.9 million in transaction related costs. The transaction, which was accounted for under the purchase accounting method, included the recognition of approximately $0.8 million of core deposit intangibles and $7.1 million representing the excess of the purchase price over the fair value of identifiable net assets (goodwill). As noted above, during fiscal 2009 the Bank recorded and impairment charge for the entire amount of goodwill.
New Markets Tax Credit Award
In June 2006, Carver Federal was selected by the U.S. Department of Treasury, in a highly competitive process, to receive an award of $59 million in New Markets Tax Credits. The NMTC award is used to stimulate economic development in low- to moderate-income communities. The NMTC award enables the Bank to invest with community and development partners in economic development projects with attractive terms including, in some cases, below market interest rates, which may have the effect of attracting capital to underserved communities and facilitating the revitalization of the community, pursuant to the goals of the NMTC program. The NMTC award provides a credit to Carver Federal against Federal income taxes when the Bank makes qualified investments. The credits are allocated over seven years from the time of the qualified investment. Most recently, in May 2009, Carver Federal received another award in the amount of $65 million NMTC. The Bank is currently considering various options as to how to utilize this award.
Recognition of the Banks $59.0 million NMTC award began in December 2006 when the Bank invested $29.5 million, one-half of its $59 million award. In December 2008, the Bank invested an additional $10.5 million and transferred rights to $19.2 million to an investor in a NMTC project. The Banks NMTC allocation was fully invested as of December 31, 2008. During the seven year period, assuming the Bank meets compliance requirements, the Bank will receive 39% of the $40.0 million invested award amount in tax benefits (5% over each of the first three years, and 6% over each of the next four years). The Company expects to receive the remaining NMTC tax benefits of approximately $10.1 million from its $40.0 million investment over the next five years.
With the Banks most recent NMTC award in May 2009, the utilization of this award allows the Bank to receive additional NMTC tax benefits of 39% on the $65.0 million directly invested, or approximately $25.4 million, over the next seven years.
Critical Accounting Policies
Various elements of accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Carvers policy with respect to the methodologies used to determine the allowance for loan losses is the most critical accounting policy. This policy is important to the presentation of Carvers financial condition and results of operations, and it involves a higher degree of complexity and requires management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. The use of different judgments, assumptions and estimates could result in material differences in the Companys results of operations or financial condition.
See Note 2 of Notes to Consolidated Financial Statements for a description of the Companys summary of significant accounting policies, including those related to allowance for loan losses, and an explanation of the methods and assumptions underlying their application.
The Banks available-for-sale securities portfolio is carried at estimated fair value, with any unrealized gains and losses, net of taxes, reported as accumulated other comprehensive income/loss in stockholders equity. Securities that the Bank has the positive intent and ability to hold to maturity are classified as held-to-maturity and are carried at amortized cost. The fair values of securities in the portfolio are based on published or securities dealers market values and are affected by changes in interest rates. The Bank quarterly reviews and evaluates the securities portfolio to determine if the decline in the fair value of any security below its cost basis is other-than-temporary. The Bank generally views changes in fair value caused by changes in interest rates as temporary, which is consistent with its experience. However, if such a decline is deemed to be other-than-temporary, the security is written down to a new cost basis and the resulting loss is charged to earnings. At March 31, 2009, the Bank held a private label mortgage-backed security which was determined to be other than temporarily impaired in the amount of $52 thousand.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level considered adequate to provide for probable loan losses inherent in the portfolio as of March 31, 2009. During the third quarter of fiscal 2008, Carver changed its loan loss methodology to be consistent with the Interagency Policy Statement on the Allowance for Loan and Lease Losses released by the Federal Financial Regulatory Agencies on December 13, 2006. The change had an immaterial affect on the allowance for loan losses at March 31, 2009. Management is responsible for determining the adequacy of the allowance for loan losses and the periodic provisioning for estimated losses included in the consolidated financial statements. The evaluation process is undertaken on a quarterly basis, but may increase in frequency should conditions arise that would require managements prompt attention, such as business combinations and opportunities to dispose of non-performing and marginally performing loans by bulk sale or any development which may indicate an adverse trend.
Carver Federal maintains a loan review system, which includes periodic review of its loan portfolio and the early identification of potential problem loans. Such system takes into consideration, among other things, delinquency status, size of loans, type of collateral and financial condition of the borrowers. Loan loss allowances are established for problem loans based on a review of such information and/or appraisals of the underlying collateral. On the remainder of its loan portfolio, loan loss allowances are based upon a combination of factors including, but not limited to, actual loan loss experience, composition of loan portfolio, current economic conditions and managements judgment. Although management believes that adequate loan loss allowances have been established, actual losses are dependent upon future events and, as such, further additions to the level of the loan loss allowance may be necessary in the future.
The methodology employed for assessing the appropriateness of the allowance consists of the following criteria:
All new loan originations are assigned a credit risk grade which commences with loan officers and underwriters grading the quality of their loans one to five under a nine-category risk classification scale, the first five categories of which represent performing loans. Reserves are held based on actual loss factors based on several years of loss experience and other qualitative factors applied to the outstanding balances in each loan category. All loans are subject to continuous review and monitoring for changes in their credit grading. Grading that falls into criticized or classified categories (credit grading six through nine) are further evaluated and reserved amounts are established for each loan based on each loans potential for loss and include consideration of the sufficiency of collateral. Any adverse trend in real estate markets could seriously affect underlying values available to protect against loss.
Other evidence used to support the amount of the allowance and its components includes:
A loan is considered to be impaired, as defined by SFAS No. 114, Accounting by Creditors for Impairment of a Loan (SFAS 114), when it is probable that Carver Federal will be unable to collect all principal and interest amounts due according to the contractual terms of the loan agreement. Carver Federal tests loans covered under SFAS 114 for impairment if they are on non-accrual status or have been restructured. Consumer credit non-accrual loans are not tested for impairment because they are included in large groups of smaller-balance homogeneous loans that, by definition, are excluded from the scope of SFAS 114. Impaired loans are required to be measured based upon (i) the present value of expected future cash flows, discounted at the loans initial effective interest rate, (ii) the loans market price, or (iii) fair value of the collateral if the loan is collateral dependent. If the loan valuation is less than the recorded value of the loan, an allowance must be established for the difference. The allowance is established by either an allocation of the existing allowance for loan losses or by a provision for loan losses, depending on various circumstances. Allowances are not needed when credit losses have been recorded so that the recorded investment in an impaired loan is less than the loan valuation.
The Companys primary earnings source is net interest income, which is affected by changes in the level of interest rates, the relationship between the rates on interest-earning assets and interest-bearing liabilities, the impact of interest rate fluctuations on asset prepayments, the level and composition of deposits and the credit quality of earning assets. Managements asset/liability objectives are to maintain a strong, stable net interest margin, to utilize its capital effectively without taking undue risks, to maintain adequate liquidity and to manage its exposure to changes in interest rates.
The economic environment is uncertain regarding future interest rate trends. Management monitors the Companys cumulative gap position, which is the difference between the sensitivity to rate changes on the Companys interest-earning assets and interest-bearing liabilities. In addition, the Company uses various tools to monitor and manage interest rate risk, such as a model that projects net interest income based on increasing or decreasing interest rates.
Stock Repurchase Program
Refer to ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Discussion of Market RiskInterest Rate Sensitivity Analysis
As a financial institution, the Banks primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on a large portion of the Banks assets and liabilities, and the market value of all interest-earning assets, other than those which are short term in maturity. Since virtually all of the Companys interest-bearing assets and liabilities are held by the Bank, most of the Companys interest rate risk exposure is retained by the Bank. As a result, all significant interest rate risk management procedures are performed at the Bank. Based upon the Banks nature of operations, the Bank is not subject to foreign currency exchange or commodity price risk. The Bank does not own any trading assets.
Carver Federal seeks to manage its interest rate risk by monitoring and controlling the variation in repricing intervals between its assets and liabilities. To a lesser extent, Carver Federal also monitors its interest rate sensitivity by analyzing the estimated changes in market value of its assets and liabilities assuming various interest rate scenarios. As discussed more fully below, there are a variety of factors that influence the repricing characteristics of any given asset or liability.
The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are interest rate sensitive and by monitoring an institutions interest rate sensitivity gap. An asset or liability is said to be interest rate sensitive within a specific period if it will mature or reprice within that period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific period of time and the amount of interest-bearing liabilities maturing or repricing within that same time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities and is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. Generally, during a period of falling interest rates, a negative gap could result in an increase in net interest income, while a positive gap could adversely affect net interest income. Conversely, during a period of rising interest rates a negative gap could adversely affect net interest income, while a positive gap could result in an increase in net interest income. As illustrated below, Carver Federal had a negative one-year gap equal to 15.71% of total rate sensitive assets at March 31, 2009. As a result, Carver Federals net interest income may be negatively affected by rising interest rates and may be positively affected by falling interest rates.
The following table sets forth information regarding the projected maturities, prepayments and repricing of the major rate-sensitive asset and liability categories of Carver Federal as of March 31, 2009. Maturity repricing dates have been projected by applying estimated prepayment rates based on the current rate environment. The information presented in the following table is derived in part from data incorporated in Schedule CMR: Consolidated Maturity and Rate, which is part of the Banks quarterly reports filed with the OTS. The repricing and other assumptions are not necessarily representative of the Banks actual results. Classifications of items in the table below are different from those presented in other tables and the financial statements and accompanying notes included herein and do not reflect non-performing loans (dollars in thousands):
The table above assumes that fixed maturity deposits are not withdrawn prior to maturity and that transaction accounts will decay as disclosed in the table above.
Certain shortcomings are inherent in the method of analysis presented in the table above. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in the market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate mortgages, generally have features that restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayments and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Additionally, credit risk may increase as many borrowers may experience an inability to service their debt in the event of a rise in interest rate. Virtually all of the adjustable-rate loans in Carver Federals portfolio contain conditions that restrict the periodic change in interest rate.
Net Portfolio Value (NPV) Analysis. As part of its efforts to maximize net interest income while managing risks associated with changing interest rates, management also uses the NPV methodology. NPV is the present value of expected net cash flows from existing assets less the present value of expected cash flows from existing liabilities plus the present value of net expected cash inflows from existing financial derivatives and off-balance-sheet contracts.
Under this methodology, interest rate risk exposure is assessed by reviewing the estimated changes in NPV that would hypothetically occur if interest rates rapidly rise or fall along the yield curve. Projected values of NPV at both higher and lower regulatory defined rate scenarios are compared to base case values (no change in rates) to determine the sensitivity to changing interest rates.
Presented below, as of March 31, 2009, is an analysis of the Banks interest rate risk as measured by changes in NPV for instantaneous and sustained parallel shifts of 100 basis points and 50 basis points plus or minus changes in market interest rates. Such limits have been established with consideration of the impact of various rate changes and the Banks current capital position. The Bank considers its level of interest rate risk for fiscal 2009, as measured by changes in NPV, to be minimal. The information set forth below relates solely to the Bank; however, because virtually all of the Companys interest rate risk exposure lies at the Bank level, management believes the table below also similarly reflects an analysis of the Companys interest rate risk (dollars in thousands):
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV require the making of certain assumptions, which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV table presented assumes that the composition of Carver Federals interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the NPV table provides an indication of Carver Federals interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on Carver Federals net interest income and may differ from actual results.
Average Balance, Interest and Average Yields and Rates
The following table sets forth certain information relating to Carver Federals average interest-earning assets and average interest-bearing liabilities and related yields for the years ended March 31. The table also presents information for the fiscal years indicated with respect to the difference between the weighted average yield earned on interest-earning assets and the weighted average rate paid on interest-bearing liabilities, or interest rate spread, which savings institutions have traditionally used as an indicator of profitability. Another indicator of an institutions profitability is its net interest margin, which is its net interest income divided by the average balance of interest-earning assets. Net interest income is affected by the interest rate spread and by the relative amounts of interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income (dollars in thousands):
The following table sets forth information regarding the extent to which changes in interest rates and changes in volume of interest related assets and liabilities have affected Carver Federals interest income and expense during the fiscal years ended March 31 (in thousands):
For each category of interest-earning assets and interest-bearing liabilities, information is provided for changes attributable to: (1) changes in volume (changes in volume multiplied by prior rate); (2) changes in rate (change in rate multiplied by old volume). Changes in rate/volume variance are allocated proportionately between changes in rate and changes in volume.
Comparison of Financial Condition at March 31, 2009 and 2008
At March 31, 2009 total assets decreased $4.8 million, or 0.6%, to $791.4 million compared to $796.2 million at March 31, 2008, primarily as a result of decreases of $14.1 million of cash and cash equivalents, $7.1 million of goodwill and $26.1 million of other assets, partially offset by increases of $36.5 million of investment securities and $6.1 million of total loans receivable, net.
Total loans receivable, net, including loans held-for-sale, increased $4.1 million, or 0.6%, to $655.1 million at March 31, 2009 compared to $651.0 million at March 31, 2008. The increase was primarily the result of an increase of $34.9 million in commercial real estate loans and $5.3 million in commercial business loans, offset by decreases in one-to-four family loans of $18.8 million and construction loans of $14.6 million. The increase in commercial real estate loans and commercial business loans is reflective of the Bank focus on the origination of these of loans due to their higher yields and shorter maturities than one-to-four family residential properties. However, under the current economic environment, the Bank has strengthened its underwriting guidelines.
At March 31, 2009, construction loans totaled $144.3 million, a decrease of $14.6 million, or 9.2%, over fiscal 2008. Construction loans represents 22.5% of the loan portfolio and approximately 68.9% of the Banks construction loans are participations in loans originated by Community Preservation Corporation. CPC is a non-profit mortgage lender whose mission is to enhance the quality and quantity of affordable housing in the New York, New Jersey, and Connecticut tri-state area. The Banks construction lending activity is concentrated in the New York City market. The decrease in construction loans is consistent with the Banks objective of deemphasizing construction loans and allow the remaining principal balances amortize down.
Other assets decreased $26.1 million, or 63.2%, to $15.3 million at March 31, 2009 compared to $41.4 million at March 31, 2008, primarily due to a deconsolidation of a $19.2 million minority interest in a community development subsidiary in connection with the Companys participation in the NMTC Program.
Cash and cash equivalents decreased $14.1 million, or 51.5%, to $13.3 million at March 31, 2009 compared to $27.4 million at March 31, 2008 as the Bank utilized excess liquidity for purchases of securities and origination of loans.
Total securities increased $36.6 million, or 95.8%, to $74.8 million at March 31, 2009 compared to $38.2 million at March 31, 2008. Available-for-sale securities increased $39.1 million, or 187.1%, to $60.0 million at March 31, 2009 compared to $20.9 million at March 31, 2008, primarily due to purchases of U.S. government guaranteed mortgage-backed securities. The Bank has utilized capital from TARP CPP to purchased mortgage-backed securities to offset the cost of the preferred dividends. Held-to-maturity securities decreased $2.5 million, or 14.5%, to $14.8 million at March 31, 2009 compared to $17.3 million at March 31, 2008, primarily due to normal principal repayments and maturities of securities.
The Banks investment in FHLB-NY stock increased by $2.6 million, or 159.6%, to $4.2 million at March 31, 2009 compared to $1.6 million at March 31, 2008. The FHLB-NY requires banks to own membership stock as well as borrowing activity-based stock. The increase in investment in FHLB-NY stock was the result of new FHLB-NY borrowings resulting in the purchase of stock during the period.
Liabilities and Stockholders Equity
At March 31, 2009, total liabilities increased $3.9 million, or 0.5%, to $727.1 million at March 31, 2009 compared to $723.1 million at March 31, 2008. The increase in total liabilities was primarily the result of an increase of $56.4 million in advances from the FHLB-NY and other borrowed money offset by a $51.3 million reduction in deposits. While the Bank has been successful in retaining deposits, management made a strategic decision to allow higher cost certificates of deposit to run off and replaced them with lower cost borrowings.
Deposits decreased $51.3 million, or 7.8%, to $603.4 million at March 31, 2009 compared to $654.7 million at March 31, 2008. The decrease in deposit balances was primarily the result of decreases in certificates of deposit of $65.2 million, savings accounts of $8.4 million and money market accounts of $2.3 million, which were partially offset by an increase of $20.2 million in NOW accounts and demand accounts of $5.0 million.
Advances from the FHLB-NY and other borrowed money increased $56.4 million, or 96.2%, to $115.0 million at March 31, 2009 compared to $58.6 million at March 31, 2008. The increase in advances and other borrowed money was primarily the result of an increase of $56.4 million in FHLB-NY advances to replace higher cost certificates of deposit and to leverage the capital obtained in the TARP CPP.
Minority Interest decreased $19.1 million as a result of deconsolidation of a subsidiary related to the New Markets Tax Credits program.
Total stockholders equity increased $10.4 million, or 19.4%, to $64.3 million at March 31, 2009 compared to $53.9 million at March 31, 2008. The increase in total stockholders equity was primarily attributable to capital obtained in the TARP CPP of $18.9 million, offset by a $7.0 million net loss for fiscal 2009, dividends paid of $1.0 million and a decrease in accumulated other comprehensive income of $0.1 million. The Banks capital levels exceed regulatory requirements of a well-capitalized financial institution.
Comparison of Operating Results for the Years Ended March 31, 2009 and 2008
The Company reported net loss of $7.0 million and a loss per share of $(2.87) for fiscal 2009 compared to net income of $4.0 million and diluted earnings per share of $1.55 for fiscal 2008. The net loss for fiscal 2009 was the result of an increases in non-interest expense of $8.0 million and provision for loan losses of $2.5 million, a decrease in non-interest income of $2.7 million, partially offset by an increase in income tax benefit of $2.3 million. The increase in non-interest expense is primarily the result of a non-cash goodwill impairment charge of $7.1 million.
Interest income decreased $6.1 million, or 12.7%, to $42.0 million in fiscal 2009 compared to $48.1 million for the prior year period. The decrease was primarily the result of decreases in interest income on loans of $5.3 million and interest income on investment securities of $1.2 million, partially offset by an increase in interest income on mortgage-backed securities of $0.4 million. The decrease in interest income reflects a reduction in the yield on interest-earning assets of 98 basis points to 5.85% compared to 6.83% for the prior year period. The decrease in yield on interest earning assets was primarily the result of a 100 basis points reduction in the yield on loans as LIBOR and prime rate based construction loans repriced at lower rates. The decrease in interest income on investment securities was primarily the result of a decline in the average balance of investment securities from $22.9 million in the prior year period to $5.7 million. The higher level of interest income on mortgage-backed securities was primarily the result of an increase in the average balance of mortgage backed securities from $39.1 million to $50.0 million.
Interest income on loans decreased by $5.3 million, or 11.9%, to $39.2 million for fiscal 2009 compared to $44.5 million for fiscal 2008. These results were primarily driven by a yield decrease of 100 basis points to 5.96% for fiscal 2009 compared to 6.96% for fiscal 2008.
Interest income on securities decreased by $0.8 million, or 22.9%, to $2.7 million for fiscal 2009 compared to $3.5 million for fiscal 2008. Interest income on mortgage-backed securities increased by $0.4 million, or 19.7%, to $2.5 million for fiscal 2009 compared to $2.1 million for fiscal 2008. The increase in interest income on mortgage-backed securities for fiscal 2009 was primarily the result of a $10.9 million, or 27.9%, higher average averages balances of mortgage-backed securities to $50.0 million, compared to $39.1 million for fiscal 2008. This was partially offset by a decrease in yield of mortgage-backed securities of 34 basis points to 4.96%, compared to 5.30% in fiscal 2008.
Additionally, the increase in interest income on mortgage-backed securities was partially offset by a decrease in investment securities interest of $1.2 million, or 83.3%, to $0.2 million for fiscal 2009 compared to $1.4 million for fiscal 2008. The decrease was primarily the result of a decrease in the yield on investment securities by 207 basis points to 4.19% compared to 6.26% in fiscal 2008. Also contributing to the decrease was the reduction of $17.2 million, or 75.1%, in the average balances of investment securities to $5.7 million compared to $22.9 million for fiscal 2008.
Interest expense decreased by $6.2 million, or 27.1%, to $16.5 million for fiscal 2009 compared to $22.7 million for fiscal 2008. The decrease in interest expense reflects a 98 basis point decrease in the average cost of interest-bearing liabilities to 2.51% in fiscal 2009 compared to 3.49% in fiscal 2008 partially offset by an increase in the average balance of interest-bearing liabilities of $9.6 million, or 1.5%, to $658.1 million for fiscal 2009 compared to $648.5 million for fiscal 2008.
Interest expense on deposits decreased $6.0 million, or 31.6%, to $12.9 million for fiscal 2009 compared to $18.9 million for fiscal 2008. This decrease was primarily the result of interest paid on certificates of deposit decreasing $5.1 million, or 30.9%, to $11.4 million for fiscal 2009 compared to $16.5 million for fiscal 2008. Additionally, a 101 basis point decrease in the rate paid on deposits to 2.27% in fiscal 2009 compared to 3.28% in fiscal 2008 contributed to the decrease. Historically, the Banks customer deposits have provided a relatively low cost funding source from which its net interest income and net interest margin have benefited. In addition, the Banks relationship with various government entities has been a source of relatively stable and low cost funding.
Interest expense on advances and other borrowed money decreased $0.2 million, or 5.3%, to $3.6 million for fiscal 2009 compared to $3.8 million for fiscal 2008. This was primarily the result of a 115 basis point decrease in the cost of borrowed money to 3.98% in fiscal 2009 compared to 5.13% in fiscal 2008 partially offset by a $16.5 million decrease in the average balance of outstanding borrowings to $90.4 million for fiscal 2009 compared to $73.9 million in fiscal 2008.
Net Interest Income Before Provision for Loan Losses
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends primarily upon the volume of interest-earning assets and interest-bearing liabilities and the corresponding interest rates earned and paid. The Companys net interest income is significantly impacted by changes in interest rate and market yield curves. See Discussion of Market RiskInterest Rate Sensitivity Analysis for further discussion on the potential impact of changes in interest rates on the results of operations.
Net interest income before the provision for loan losses remained flat at $25.5 million for fiscal 2009 and 2008.
Provision for Loan Losses and Asset Quality
The Bank provided $2.7 million in provision for loan losses for fiscal 2009 compared to $0.2 million for fiscal 2008, an increase of $2.5 million. The Bank records provisions for loan losses, which are charged to earnings, in order to maintain the allowance for loan losses at a level that is considered appropriate to absorb probable losses inherent in the existing loan portfolio. Factors considered when evaluating the adequacy of the allowance for loan losses include the volume and type of lending conducted, the Banks previous loan loss experience, the known and inherent risks in the loan portfolio, adverse situations that may affect the borrowers ability to repay, the estimated value of any underlying collateral, trends in the local and national economy and trends in the real estate market.
The Bank had net charge-offs of $0.5 million for fiscal 2009 compared to $0.8 million for fiscal 2008. At March 31, 2009 and 2008, the Banks allowance for loan losses was $7.0 million and $4.9 million, respectively. The ratio of the allowance for loan losses to non-performing loans was 28.17% at March 31, 2009 compared to 170.89% at March 31, 2008. The ratio of the allowance for loan losses to total loans was 1.06% at March 31, 2009 compared to 0.74% at March 31, 2008. Additionally, the level of non-performing loans to total loans receivable is 3.89%. The Banks future levels of non-performing loans will be influenced by economic conditions, including the impact of those conditions on the Banks customers, interest rates and other internal and external factors existing at the time. The Bank believes its reported allowance for loan losses at March 31, 2009 is adequate to provide for estimated probable losses in the loan portfolio. For further discussion of non-performing loans and allowance for loan losses, see Item 1BusinessGeneral Description of BusinessAsset Quality and Note 1 of Notes to the Consolidated Financial Statements.
Non-interest income is comprised of depository fees and charges, loan fees and service charges, fee income from banking services and charges, gains or losses from the sale of securities, loans and other assets and other non-interest income. Non-interest income decrease by $2.7 million, or 34.2%, to $5.2 million for fiscal 2009 compared to $7.9 for fiscal 2008. The decrease was primarily due to the loss of several one-time gains in the prior year primarily related to sale of securities and NMTC fees as well as lower loan fee income.
Non-interest expense increased by $7.9 million, or 26.5%, to $37.8 million for fiscal 2009 compared to $29.9 million for fiscal 2008. The increase was primarily due a $7.1 million non-cash goodwill impairment charge as well as increases of $1.2 million in occupancy and equipment expense, $0.4 million in FDIC insurance and $0.6 million in professional fees, partially offset by decreases of $1.6 million in consulting fees and $0.2 million in employee compensation and benefits.
Income Tax Expense
Income tax benefit was $3.2 million for fiscal 2009 compared to $0.9 million for fiscal 2008. The increase in tax benefit in fiscal 2009 is reflective of the net loss in fiscal 2009 as well recognition of $2.0 million of NMTC.
Comparison of Operating Results for the Years Ended March 31, 2008 and 2007
The Company reported net income of $4.0 million and diluted earnings per share of $1.55 for fiscal 2008 compared to net income of $2.1 million and diluted earnings per share of $0.81 for fiscal 2007. Net income rose $1.9 million, or 88.9%, to $4.0 million, primarily reflecting increases in net interest income of $3.0 million and non-interest income of $5.0 million, offset by an increase in non-interest expense of $5.8 million. The prior year period included special pre-tax charges of $1.3 million related to CCB acquisition costs and $1.3 million related to the balance sheet repositioning.
Interest income increased by $6.4 million, or 15.3%, to $48.1 million for fiscal 2008 compared to $41.7 million for fiscal 2007. Interest income increased as a result of an increase in total average balances of interest-earning assets of $49.5 million, which includes an increase in average loan balances of $81.5 million offset by decreases in average balances of mortgage-backed securities of $25.6 million, investment securities of $4.3 million and Federal funds sold of $2.1 million. Interest income increased as a result of an increase in average loan balances, acquisition of CCBs higher yielding portfolio and origination of higher yielding loans. Additionally, these results were pursuant to the Banks asset/liability strategy of increasing the average loan balances and its higher yields offset by a decline in average balances of mortgage-backed securities and investment securities. Yields on interest-earning assets increased 46 basis points to 6.83% for fiscal 2008 compared to 6.37% for the prior year period, reflecting increases in yields on loans of 28 basis points, mortgage-backed securities of 85 basis points and investment securities of 138 basis points, offset by a decrease in yields on Federal funds sold of 81 basis points.
Interest income on loans increased by $7.2 million, or 19.4%, to $44.5 million for fiscal 2008 compared to $37.3 million for fiscal 2007. These results were primarily driven by an increase in average loan balances of $81.5 million to $639.6 million for fiscal 2008 compared to $558.1 million for fiscal 2007, partly a reflection of the full year impact of the CCB acquisition. In addition, yield increased 28 basis points to 6.96% for fiscal 2008 compared to 6.68% for fiscal 2007, primarily due to growth in higher yielding construction and small business loans.
Interest income on securities decreased by $0.7 million, or 16.6%, to $3.5 million for fiscal 2008 compared to $4.2 million for fiscal 2007. Interest income on mortgage-backed securities decreased by $0.8 million, or 28.0%, to $2.1 million for fiscal 2008 compared to $2.9 million for fiscal 2007. The decrease in interest income on mortgage-backed securities for fiscal 2008 was primarily the result of a $25.6 million, or 39.68%, reduction in the average balances of mortgage-backed securities to $39.1 million, compared to $64.7 million for fiscal 2007. The net decrease in the average balance of such securities demonstrates Managements commitment to invest proceeds received from the cash flows from the repayment of securities into higher yielding assets and the sale of lower yielding securities to reposition the balance sheet. The mortgage-backed securities yield increased by 85 basis points to 5.30%, compared to 4.45% in fiscal 2007.
Additionally, the decrease in interest income on mortgage-backed securities was partially offset by an increase in investment securities interest of $0.1 million, or 8.2%, to $1.4 million for fiscal 2008 compared to $1.3 million for fiscal 2007. The increase was primarily the result of an increase in the yield on investment securities by 138 basis points to 6.26% compared to 4.88% in fiscal 2007, as adjustable rate securities in the portfolio repriced to higher coupon rates. The increase in interest income on investment securities was offset by a reduction of $4.3 million, or 15.7%, in the average balances of investment securities to $22.9 million compared to $27.2 million for fiscal 2007.
Interest income on federal funds decreased by $0.2 million, or 51.0%, to $0.1 million for fiscal 2008 compared to $0.3 million for fiscal 2007. The decrease is primarily the result of $2.1 million decrease in the average balance of Federal funds year over year and an 81 basis point decrease in the average rate earned on federal funds. This decrease in the average rate earned on federal funds was realized as the FRB lowered the federal funds rate.
Interest expense increased by $3.5 million, or 17.8%, to $22.7 million for fiscal 2008 compared to $19.2 million for fiscal 2007. The increase in interest expense reflects a 28 basis point increase in the average cost of interest-bearing liabilities to 3.49% in fiscal 2008 compared to 3.21% in fiscal 2007 and growth in the average balance of interest-bearing liabilities of $49.6 million, or 8.3%, to $648.5 million for fiscal 2008 compared to $598.9 million for fiscal 2007. The increase in interest expense was primarily the result of growth in the average balance of certificates of deposit of $58.5 million over fiscal 2007 to $370.9 million.
Interest expense on deposits increased $3.7 million, or 10.5%, to $18.9 million for fiscal 2008 compared to $15.2 million for fiscal 2007. This increase was primarily the result of growth in the average balance of certificates of deposit of $58.4 million, or 18.7%, to $370.9 million for fiscal 2008 compared to $312.5 million for fiscal 2007. Interest paid on certificates of deposit increased $3.5 million, or 10.2%, to $16.5 million for fiscal 2008 compared to 13.0 million for fiscal 2007. Additionally, a 35 basis point increase in the rate paid on deposits to 3.28% in fiscal 2008 compared to 2.93% in fiscal 2007 contributed to the increase. Historically, the Banks customer deposits have provided a relatively low cost funding source from which its net interest income and net interest margin have benefited. In addition, the Banks relationship with various government entities has been a source of relatively stable and low cost funding.
Interest expense on advances and other borrowed money decreased $0.2 million, or 5.4%, to $3.8 million for fiscal 2008 compared to $4.0 million for fiscal 2007. The average balance of total borrowed money outstanding declined, primarily as a result of a $5.0 million decrease in the average balance of outstanding borrowings to $73.9 million for fiscal 2008 compared to $78.9 million in fiscal 2007. Partially offsetting the decrease in interest expense was a 5 basis point increase in the cost of borrowed money to 5.13% in fiscal 2008 compared to 5.08% in fiscal 2007. This was partially offset by an increased cost of debt service on the $13.0 million in floating rate junior subordinated notes issued by the Company in connection with issuance of trust preferred securities by Carver Statutory Trust I in September 2003. Cash distributions on the trust preferred debt securities are cumulative and payable at a floating rate per annum (reset quarterly) equal to 3.05% over the 3-month LIBOR, with a rate at March 31, 2008 of 5.85%.
Net Interest Income Before Provision for Loan Losses
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends primarily upon the volume of interest-earning assets and interest-bearing liabilities and the corresponding interest rates earned and paid. The Companys net interest income is significantly impacted by changes in interest rate and market yield curves. See Discussion of Market RiskInterest Rate Sensitivity Analysis for further discussion on the potential impact of changes in interest rates on the results of operations.
Net interest income before the provision for loan losses increased $3.0 million, or 13.2%, to $25.5 million for fiscal 2008 compared to $22.5 million for fiscal 2007. This increase was achieved as a result of an increase in both the average balance and the yield on average interest-earning assets of $49.5 million and 46 basis points, respectively. Offsetting the increase in net interest income was an increase in the average balance and cost of interest-bearing liabilities of $49.6 million and 28 basis points, respectively. The result was a 18 basis point increase in the interest rate spread to 3.34% for fiscal 2008 compared to 3.16% for fiscal 2007. The net interest margin also increased to 3.62% for fiscal 2008 compared to 3.44% for fiscal 2007.
Provision for Loan Losses and Asset Quality
The Bank provided $0.2 million in provision for loan losses for fiscal 2008 compared to $0.3 million for fiscal 2007, a decrease of $0.1 million. The Bank records provisions for loan losses, which are charged to earnings, in order to maintain the allowance for loan losses at a level that is considered appropriate to absorb probable losses inherent in the existing loan portfolio. Factors considered when evaluating the adequacy of the allowance for loan losses include the volume and type of lending conducted, the Banks previous loan loss experience, the known and inherent risks in the loan portfolio, adverse situations that may affect the borrowers ability to repay, the estimated value of any underlying collateral, trends in the local and national economy and trends in the real estate market.
The Bank had net charge-offs of $0.8 million for fiscal 2008 compared to $0.1 million for fiscal 2007. At March 31, 2008 and 2007, the Banks allowance for loan losses was $4.9 million and $5.4 million, respectively. The ratio of the allowance for loan losses to non-performing loans was 170.89% at March 31, 2008 compared to 119.9% at March 31, 2007. The ratio of the allowance for loan losses to total loans was 0.74% at March 31, 2008 compared to 0.89% at March 31, 2007. Additionally, at a 0.43% ratio, the level of non-performing loans to total loans receivable remains within the range the Bank has experienced over the trailing twelve quarters. The Banks future levels of non-performing loans will be influenced by economic conditions, including the impact of those conditions on the Banks customers, interest rates and other internal and external factors existing at the time. The Bank believes its reported allowance for loan losses at March 31, 2008 is adequate to provide for estimated probable losses in the loan portfolio. For further discussion of non-performing loans and allowance for loan losses, see Item 1BusinessGeneral Description of BusinessAsset Quality and Note 1 of Notes to the Consolidated Financial Statements.
On July 10, 2007, the OTS and other Federal bank regulatory authorities (the Agencies) published the final Interagency Statement on Subprime Lending (the Statement) to address emerging issues and questions relating to certain subprime mortgage lending practices. Although the Agencies did not provide a specific definition of a subprime loan in the Statement, the Statement did highlight the Agencies concerns with certain adjustable-rate mortgage products offered to subprime borrowers that have one or more of the following characteristics:
In the 2001 Expanded Guidance for Subprime Lending Programs, the Agencies determined that, generally, subprime borrowers will display a range of credit risk characteristics that may include one or more of the following:
The Bank has minimal exposure to the subprime loan market and, therefore, does not expect the Statement to have a material impact on the Company. At March 31, 2009, the Banks loan portfolio contained $1.2 million in subprime loans of which $1.0 million is non-performing loans.
Non-interest income is comprised of depository fees and charges, loan fees and service charges, fee income from banking services and charges, gains or losses from the sale of securities, loans and other assets and other non-interest income. Non-interest income increased by $5.0 million, or 174.0%, to $7.9 million for fiscal 2008 compared to $2.9 for fiscal 2007. The increase was primarily due to a NMTC transferred rights fee of $1.7 million, gain on sale of securities of $1.1 million, write-down for the prior year period of loans held for sale of $0.7 million, other income of $0.7 million and an increase in loan fees and service charges of $0.4 million. The Bank will receive additional non-interest income over approximately the next eight years from this transaction. Further, as a result of the NMTC transaction, other income increased by $0.2 million reflecting consolidation of income from minority interest. In addition, the prior year period included a $1.3 million charge associated with a balance sheet restructuring implemented to improve margins.
Non-interest expense increased by $5.8 million, or 23.9%, to $29.9 million for fiscal 2008 compared to $24.1 million for fiscal 2007. The increase was primarily due to increases in employee compensation and benefits of $2.9 million, consulting expense of $2.2 million, other expenses of $1.4 million and net occupancy expense of $0.9 million. The increase in employee compensation and benefits is primarily due to the Community Capital Bank acquisition and investments in new talent in the retail, lending and accounting units. The $2.2 million increase in consulting expense falls into three categories: regulatory requirements (preparation for compliance with Sarbanes-Oxley Act Section 404 and recent Inter-Agency Guidance on Allowances for Loan Losses); strengthening the Companys back office, including the accounting, lending and retail operations departments, by adding new staff and providing temporary expertise; and engaging consultants to assist the management team to analyze significant opportunities to improve financial results. For example, the Bank engaged consultants to conduct a rigorous business optimization review to help management identify further potential improvements in the Banks operations, in part through greater systems integration. The $1.4 million increase in other expense primarily consists of the cost of sub-servicing of loans, ATM expenses, charge-offs and regulatory reporting costs. The fiscal 2007 expense included $1.3 million in merger related expenses.
Income Tax Expense
Income tax benefit decreased by $0.2 million, or 18.8%, to $0.9 million for fiscal 2008 compared to $1.1 million for fiscal 2007, resulting in a net tax benefit of $0.9 million, which includes a minority interest tax expense of $0.1 million. The decrease in tax benefit reflects income before income taxes of $3.2 million for fiscal 2008 compared to $1.0 million for fiscal 2007. The income tax expense of $1.1 million for fiscal 2008 was offset by the tax benefit generated by the NMTC investment totaling $2.0 million. The Banks NMTC award received in June 2006 has been fully invested. The Company expects to receive additional NMTC tax benefits of approximately $12.1 million from its $40.0 million investment over approximately the next six years.
Liquidity and Capital Resources
Liquidity is a measure of the Banks ability to generate adequate cash to meet its financial obligations. The principal cash requirements of a financial institution are to cover potential deposit outflows, fund increases in its loan and investment portfolios and ongoing operating expenses. The Banks primary sources of funds are deposits, borrowed funds and principal and interest payments on loans, mortgage-backed securities and investment securities. While maturities and scheduled amortization of loans, mortgage-backed securities and investment securities are predictable sources of funds, deposit flows and loan and mortgage-backed securities prepayments are strongly influenced by changes in general interest rates, economic conditions and competition. Carver Federal monitors its liquidity utilizing guidelines that are contained in a policy developed by its management and approved by its Board of Directors. Carver Federals several liquidity measurements are evaluated on a frequent basis. The Bank was in compliance with this policy as of March 31, 2009.
Management believes Carver Federals short-term assets have sufficient liquidity to cover loan demand, potential fluctuations in deposit accounts and to meet other anticipated cash requirements. Additionally, Carver Federal has other sources of liquidity including the ability to borrow from the FHLB-NY utilizing unpledged mortgage-backed securities and certain mortgage loans, the sale of available-for-sale securities and the sale of certain mortgage loans. Net borrowings increased $56.4 million during fiscal 2009 primarily as a result of the bank allowing higher cost certificates of deposit to runoff and replaced them with lower cost borrowings. At March 31, 2009, the Bank had $115.0 million in borrowings with a weighted average rate of 2.99% maturing over the next three years. The Bank has the flexibility to either repay or rollover these borrowings as they mature. The continued disruption in the credit markets has not materially impacted the Companys ability to access borrowings. At March 31, 2009, based on available collateral held at the FHLB-NY, Carver Federal had the ability to borrow from the FHLB-NY an additional $37.3 million on a secured basis, utilizing mortgage-related loans and securities as collateral.
The Banks most liquid assets are cash and short-term investments. The level of these assets is dependent on the Banks operating, investing and financing activities during any given period. At March 31, 2009 and 2008, assets qualifying for short-term liquidity, including cash and short-term investments, totaled $13.3 million and $27.4 million, respectively.
The most significant liquidity challenge the Bank faces is variability in its cash flows as a result of mortgage refinance activity. When mortgage interest rates decline, customers refinance activities tend to accelerate, causing the cash flow from both the mortgage loan portfolio and the mortgage-backed securities portfolio to accelerate. In contrast, when mortgage interest rates increase, refinance activities tend to slow, causing a reduction of liquidity. However, in a rising rate environment, customers generally tend to prefer fixed rate mortgage loan products over variable rate products. Because Carver Federal generally sells its one-to-four family 15-year and 30-year fixed rate loan production into the secondary mortgage market, the origination of such products for sale does not significantly reduce Carver Federals liquidity.
The OTS requires that the Bank meet minimum capital requirements. Capital adequacy is one of the most important factors used to determine the safety and soundness of individual banks and the banking system. At March 31, 2009, the Bank exceeded all regulatory minimum capital requirements and qualified, under OTS regulations, as a well-capitalized institution. See -Regulatory Capital Position below for certain information relating to the Banks regulatory capital compliance at March 31, 2009.
The Consolidated Statements of Cash Flows present the change in cash from operating, investing and financing activities. During fiscal 2009, total cash and cash equivalents decreased by $14.0 million reflecting cash provided by financing activities of $22.9 million, and cash provided by operating of $11.7 million, offset by investing activities of $48.6 million.
Net cash provided by financing activities was $22.9 million, primarily resulting from increased borrowings of $56.4 million and capital from TARP CPP of $19.0 million, offset partially by reductions in deposits of $51.2 million and the payment of common dividends of $1.0 million. Net cash provided by operating activities during this period was $11.7 million and was primarily the result of a decrease in other assets of $6.4 million and changes in other non-cash charges. Net cash used in investing activities was $48.6 million, primarily representing purchases of available-for-sale securities of $46.6 million as the Bank leveraged the capital received from the TARP CPP.
Off-Balance Sheet Arrangements and Contractual Obligations
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business in order to meet the financing needs of its customers. These instruments involve, to varying degrees, elements of credit, interest rate and liquidity risk. In accordance with accounting principles generally accepted in the United States of America (GAAP), these instruments are not recorded in the consolidated financial statements. Such instruments primarily include lending commitments.
Lending commitments include commitments to originate mortgage and consumer loans and commitments to fund unused lines of credit. The Bank also has contractual obligations related to operating leases. Additionally, the Bank has a contingent liability related to a standby letter of credit. See Note 14 of Notes to Consolidated Financial Statements for the Banks outstanding lending commitments and contractual obligations at March 31, 2009.
The Bank has contractual obligations at March 31, 2009 as follows (in thousands):
Variable Interest Entities
The Holding Companys subsidiary, Carver Statutory Trust I, is not consolidated with Carver Bancorp Inc. for financial reporting purposes in accordance with Financial Accounting Standards Board, or FASB, revised interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, or FIN 46(R). Carver Statutory Trust I was formed in 2003 for the purpose of issuing $13.0 million aggregate liquidation amount of floating rate Capital Securities due September 17, 2033 (Capital Securities) and $0.4 million of common securities (which are the only voting securities of Carver Statutory Trust I), which are 100% owned by Carver Bancorp Inc., and using the proceeds to acquire Junior Subordinated Debentures issued by Carver Bancorp Inc. Carver Bancorp Inc. has fully and unconditionally guaranteed the Capital Securities along with all obligations of Carver Statutory Trust I under the trust agreement relating to the Capital Securities.
The Banks subsidiary, Carver Community Development Corporation (CCDC), was formed to facilitate its participation in local economic development and other community-based activities. Per the NMTC Awards Allocation Agreement between the CDFI Fund and CCDC, CCDC is permitted to form and sub-allocate credits to subsidiary Community Development Entities (CDEs) to facilitate investments in separate development projects. The Bank was originally awarded $59.0million of NMTC. In fiscal 2008, the Bank transferred rights to an investor in a NMTC project totaling $19.2 million and recognized a gain on the transfer of rights of $1.7 million. The Bank was required to maintain a .01% interest in the entity with the investor owning the remaining 99.99%. The entity was called CDE-10. For financial reporting purposes, the $19.2 million transfer of rights to an investor in a NMTC project was reflected in the other assets and the minority interest sections of the balance sheet as the entity to which the rights were transferred was required to be consolidated under FIN 46(R) based on an evaluation of certain contractual arrangements between the Bank and the investor. In fiscal 2009, following certain amendments to the agreement between CCDC and the investor that resulted in a reconsideration event under FIN 46(R), the Bank deconsolidated the entity for financial statement reporting purposes. However, under the current arrangement, the Bank has a contingent obligation to reimburse the investor for any loss or shortfall incurred as a result of the NTMC project not being in compliance with certain regulations that would void the investors ability to otherwise utilize tax credits stemming from the award. The maximum possible loss to Carver from such an arrangement is approximately $7.4 million. At March 31, 2009, Carver has not recorded any liability with respect to this obligation in accordance with SFAS No. 5 Accounting for Contingencies.
With respect to the remaining $40 million of NMTC awards, the Bank has established various special purpose entities through which its investments in NMTC eligible activities are conducted. As the Bank is exposed to all of the expected losses and residual returns from these investments, the Bank is deemed the primary beneficiary under FIN 46(R). Accordingly, all of these special purpose entities are consolidated in the Banks Statement of Financial Condition as of March 31, 2009 and 2008, resulting in the consolidation of assets of approximately $36.9 million and $30.7 million, respectively.
Regulatory Capital Position
The Bank must satisfy three minimum capital standards established by the OTS. For a description of the OTS capital regulation, see Item 1Regulation and SupervisionFederal Banking RegulationCapital Requirements.
The Bank presently exceeds all capital requirements as currently promulgated. At March 31, 2009, the Bank had tangible equity ratio, core capital ratio, and total risk-based capital ratio of 9.51%, 9.52% and 12.78%, respectively, and was considered well capitalized. For additional information regarding Carver Federals Regulatory Capital and Ratios, refer to Note 12 of Notes to Consolidated Financial Statements, Stockholders Equity.
Impact of Inflation and Changing Prices
The financial statements and accompanying notes appearing elsewhere herein have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of Carver Federals operations. Unlike most industrial companies, nearly all the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a greater impact on Carver Federals performance than do the effects of the general level of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required by this item appears under the caption Discussion of Market RiskInterest Rate Sensitivity Analysis in Item 7, incorporated herein by reference. The Company believes that there has been no material change in the Companys market risk at March 31, 2009 as compared to March 31, 2008.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Carver Bancorp, Inc.:
We have audited the accompanying consolidated statements of financial condition of Carver Bancorp, Inc. and subsidiaries as of March 31, 2009 and 2008, and the related consolidated statements of operations, changes in stockholders equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended March 31, 2009. These consolidated financial statements are the responsibility of the Companys 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 Carver Bancorp, Inc. and subsidiaries as of March 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended March 31, 2009, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
New York, New York
July 2, 2009
CARVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In thousands, except per share data)
CARVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
CARVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME (LOSS)
CARVER BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements
CARVER BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION
Nature of operations
Carver Bancorp, Inc. (on a stand-alone basis, the Holding Company or Registrant), was incorporated in May 1996 and its principal wholly-owned subsidiary is Carver Federal Savings Bank (the Bank or Carver Federal), Alhambra Holding Corp., an inactive Delaware corporation, and Carver Federals wholly-owned subsidiaries, CFSB Realty Corp., Carver Community Development Corp. (CCDC) and CFSB Credit Corp. which is currently inactive. The Bank has a majority owned interest in Carver Asset Corporation, a real estate investment trust formed in February 2004.
Carver, the Company, we, us or our refers to the Holding Company along with its consolidated subsidiaries. The Bank was chartered in 1948 and began operations in 1949 as Carver Federal Savings and Loan Association, a federally chartered mutual savings and loan association. The Bank converted to a federal savings bank in 1986. On October 24, 1994, the Bank converted from mutual to stock form and issued 2,314,275 shares of its common stock, par value $0.01 per share. On October 17, 1996, the Bank completed its reorganization into a holding company structure (the Reorganization) and became a wholly owned subsidiary of the Holding Company. Collectively, the Holding Company, the Bank and the Holding Companys other direct and indirect subsidiaries are referred to herein as the Company or Carver.
In September 2003, the Holding Company formed Carver Statutory Trust I (the Trust) for the sole purpose of issuing trust preferred securities and investing the proceeds in an equivalent amount of floating rate junior subordinated debentures of the Holding Company. In accordance with Financial Accounting Standards Board Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, Carver Statutory Trust I is not consolidated for financial reporting purposes.
Carver Federals principal business consists of attracting deposit accounts through its branches and investing those funds in mortgage loans and other investments permitted by federal savings banks. The Bank has nine branches located throughout the City of New York that primarily serve the communities in which they operate.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of consolidated financial statement presentation
The consolidated financial statements include the accounts of the Holding Company, the Bank and the Banks wholly-owned or majority owned subsidiaries, Carver Asset Corporation, CFSB Realty Corp., Carver Community Development Corporation, and CFSB Credit Corp. All significant intercompany accounts and transactions have been eliminated in consolidation.
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statement of financial condition and revenues and expenses for the period then ended. Amounts subject to significant estimates and assumptions are items such as the allowance for loan losses, realization of deferred tax assets, goodwill and intangibles, pensions and the fair value of financial instruments. Management believes that prepayment assumptions on mortgage-backed securities and mortgage loans are appropriate and the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses or future write downs of real estate owned may be necessary based on changes in economic conditions in the areas where Carver Federal has extended mortgages and other credit instruments. Actual results could differ significantly from those assumptions. Current market conditions increase the risk and complexity of the judgments in these estimates.
In addition, the Office of Thrift Supervision (OTS), Carver Federals regulator, as an integral part of its examination process, periodically reviews Carver Federals allowance for loan losses and, if applicable, real estate owned valuations. The OTS may require Carver Federal to recognize additions to the allowance for loan losses or additional write downs of real estate owned based on their judgments about information available to them at the time of their examination.
Cash and cash equivalents
For the purpose of reporting cash flows, cash and cash equivalents include cash, amounts due from depository institutions, federal funds sold and other short-term instruments with original maturities of three months or less. Federal funds sold are generally sold for one-day periods. The amounts due from depository institutions include a non-interest bearing account held at the Federal Reserve Bank (FRB) where any additional cash reserve required on demand deposits would be maintained. Currently, this reserve requirement is zero since the Banks vault cash satisfies cash reserve requirements for deposits.
When purchased, securities are designated as either securities held-to-maturity or securities available-for-sale. Securities are classified as held-to-maturity and carried at amortized cost only if the Bank has a positive intent and ability to hold such securities to maturity. Securities held-to-maturity are carried at cost, adjusted for the amortization of premiums and the accretion of discounts using the level-yield method over the remaining period until maturity.
If not classified as held-to-maturity, securities are classified as available-for-sale demonstrating managements ability to sell in response to actual or anticipated changes in interest rates and resulting prepayment risk or any other factors. Available-for-sale securities are reported at fair value. Estimated fair values of securities are based on either published or security dealers market value if available. If quoted or dealer prices are not available, fair value is estimated using quoted or dealer prices for similar securities. Unrealized holding gains or losses for securities available-for-sale are excluded from earnings and reported net of deferred income taxes in accumulated other comprehensive income (loss), a component of Stockholders Equity. Any impairment in the available-for-sale securities deemed other-than-temporary, is written down against the cost basis and charged to earnings. During fiscal 2009, the Company recognized $52 thousand in other than temporary impairment on a security. No impairment charge was recorded for fiscal 2008 or 2007. Gains or losses on sales of securities of all classifications are recognized based on the specific identification method.
The Company conducts periodic reviews to identify and evaluate each investment that has an unrealized loss, in accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, FASB Staff Position FAS No. 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (FSP FAS 115-1), and FASB Staff Position EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 99-20. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. Unrealized losses on available-for-sale securities that are determined to be temporary in nature are recorded, net of tax, in accumulated other comprehensive loss (AOCL). Unrealized losses identified as other than temporary are charged directly against earnings in the Consolidated Statement of Income and Comprehensive Income.
Loans held-for-sale are carried at the lower of cost or market value as determined on an aggregate loan basis. Premiums paid and discounts obtained on such loans held-for-sale are deferred as an adjustment to the carrying value of the loans until the loans are sold.
Loans receivable are carried at unpaid principal balances plus unamortized premiums, purchase accounting mark-to-market adjustments, certain deferred direct loan origination costs and deferred loan origination fees and discounts, less the allowance for loan losses.
The Bank defers loan origination fees and certain direct loan origination costs and accretes such amounts as an adjustment of yield over the expected lives of the related loans using methodologies which approximate the interest method. Premiums and discounts on loans purchased are amortized or accreted as an adjustment of yield over the contractual lives, of the related loans, adjusted for prepayments when applicable, using methodologies which approximate the interest method.
Loans are placed on non-accrual status when they are past due 90 days or more as to contractual obligations or when other circumstances indicate that collection is questionable. When a loan is placed on non-accrual status, any interest accrued but not received is reversed against interest income. Payments received on a non-accrual loan are either applied to the outstanding principal balance or recorded as interest income, depending on an assessment of the ability to collect the loan. A non-accrual loan is restored to accrual status when principal and interest payments become less than 90 days past due and its future collectibility is reasonably assured.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level considered adequate to provide for probable loan losses inherent in the portfolio as of March 31, 2009. Management is responsible for determining the adequacy of the allowance for loan losses and the periodic provisioning for estimated losses included in the consolidated financial statements. The evaluation process is undertaken on a quarterly basis, but may increase in frequency should conditions arise that would require managements prompt attention, such as business combinations and opportunities to dispose of non-performing and marginally performing loans by bulk sale or any development which may indicate an adverse trend.
Carver Federal maintains a loan review system, which calls for a periodic review of its loan portfolio and the early identification of potential problem loans. Such system takes into consideration, among other things, delinquency status, size of loans, type of collateral and financial condition of the borrowers. Loan loss allowances are established for problem loans based on a review of such information and/or appraisals of the underlying collateral. On the remainder of its loan portfolio, loan loss allowances are based upon a combination of factors including, but not limited to, actual loan loss experience, composition of loan portfolio, current economic conditions and managements judgment. Although management believes that adequate loan loss allowances have been established, actual losses are dependent upon future events and, as such, further additions to the level of the loan loss allowance may be necessary in the future.
The methodology employed for assessing the appropriateness of the allowance consists of the following criteria:
All new loan originations are assigned a credit risk grade which commences with loan officers and underwriters grading the quality of their loans one to five under a nine-category risk classification scale, the first five categories of which represent performing loans. All loans are subject to continuous review and monitoring for changes in their credit grading. Grading that falls into criticized or classified categories (credit grading six through nine) are further evaluated and reserved amounts are established for each loan based on each loans potential for loss and includes consideration of the sufficiency of collateral. Any adverse trend in real estate markets could seriously affect underlying values available to protect against loss.
Other evidence used to support the amount of the allowance and its components includes:
A loan is considered to be impaired, as defined by SFAS No. 114, Accounting by Creditors for Impairment of a Loan (SFAS 114), when it is probable that Carver Federal will be unable to collect all principal and interest amounts due according to the contractual terms of the loan agreement. Carver Federal tests loans covered under SFAS 114 for impairment if they are on non-accrual status or have been restructured. Consumer credit non-accrual loans are not tested for impairment because they are included in large groups of smaller-balance homogeneous loans that, by definition, are excluded from the scope of SFAS 114. Impaired loans are required to be measured based upon (i) the present value of expected future cash flows, discounted at the loans initial effective interest rate, (ii) the loans market price, or (iii) fair value of the collateral if the loan is collateral dependent. If the loan valuation is less than the recorded value of the loan, an allowance must be established for the difference. The allowance is established by either an allocation of the existing allowance for loan losses or by a provision for loan losses, depending on various circumstances. Allowances are not needed when credit losses have been recorded so that the recorded investment in an impaired loan is less than the loan valuation.
In accordance with Statement of Financial Accounting Standard No. 131, Disclosures about Segments of an Enterprise and Related Information, the Company has determined that all of its activities constitute one reportable operating segment.
Concentration of Risk
The Banks principal lending activities are concentrated in loans secured by real estate, a substantial portion of which is located in New York City. Accordingly, the ultimate collectibility of a substantial portion of the Companys loan portfolio is susceptible to changes in New Yorks real estate market conditions.
Office Properties and Equipment
Office properties and equipment are comprised of land, at cost, and buildings, building improvements, furnishings and equipment and leasehold improvements, at cost, less accumulated depreciation and amortization. Depreciation and amortization charges are computed using the straight-line method over the following estimated useful lives:
Maintenance, repairs and minor improvements are charged to non-interest expense in the period incurred.
Federal Home Loan Bank Stock
The Federal Home Loan Bank of New York (FHLB-NY) has assigned to the Bank a mandated membership stock purchase, based on the Banks asset size. In addition, for all borrowing activity, the Bank is required to purchase shares of FHLB-NY non-marketable capital stock at par. Such shares are redeemed by FHLB-NY at par with reductions in the Banks borrowing levels. The Bank carries this investment at historical cost.
Bank Owned Life Insurance
Bank Owned Life Insurance (BOLI) is carried at its cash surrender value on the balance sheet and is classified as a non-interest-earning asset. Death benefits proceeds received in excess of the policys cash surrender value are recognized in income. Returns on the BOLI assets are added to the carrying value and included as non-interest income in the consolidated statement of income. Any receipt of benefit proceeds is recorded as a reduction to the carrying value of the BOLI asset. At March 31, 2009, Carver held no policy loans against its BOLI cash surrender values or restrictions on the use of the proceeds.
Mortgage Servicing Rights
Effective April 1, 2007, the Company adopted SFAS, No. 156, Accounting for Servicing of Financial Assets an amendment of FASB Statement No. 140. SFAS No. 156 requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable. For subsequent measurements, entities are permitted to choose either the amortization method, which is consistent with the prior requirements of SFAS No. 140, or the fair value method. Upon adoption of SFAS No. 156, the Company elected to retain the amortization method for measurements of mortgage servicing rights (MSR).
Real Estate Owned
Real estate acquired by foreclosure or deed in lieu of foreclosure is recorded at the fair value at the date of acquisition and thereafter carried at the lower of cost or fair value less estimated selling costs. The fair value of such assets is determined based primarily upon independent appraisals and other relevant factors. The amounts ultimately recoverable from real estate owned could differ from the net carrying value of these properties because of economic conditions. Costs incurred to improve properties or prepare them for sale are capitalized. Revenues and expenses related to the holding and operating of properties are recognized in operations as earned or incurred. Gains or losses on sale of properties are recognized as incurred.
Identifiable Intangible Assets
In accordance with Statement of Financial Accounting Standards No.142, Goodwill and Other Intangible Assets goodwill and intangible assets with indefinite useful lives are no longer amortized, rather they are assessed, at least annually, for impairment (See Note 3).
Identifiable intangible assets relate primarily to core deposit premiums, resulting from the valuation of core deposit intangibles acquired in the purchase of branches of other financial institutions. These identifiable intangible assets are amortized using the straight-line method over a period of 5 years but not exceeding the estimated average remaining life of the existing customer deposits acquired. Amortization periods for intangible assets are monitored to determine if events and circumstances require such periods to be reduced.
Income tax expense (benefit) consists of income taxes currently payable/(receivable) and deferred income taxes. Temporary differences between the basis of assets and liabilities for financial reporting and tax purposes are measured as of the balance sheet date. Deferred tax liabilities or recognizable deferred tax assets are calculated on such differences, using current statutory rates, which result in future taxable or deductible amounts. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
Effective January 1, 2008, the Company adopted the provisions of FIN 48, Accounting for Uncertainty in Income Taxes- An Interpretation of FASB Statement No 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entitys financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 also prescribes a specified recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The new interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The adoption of FIN 48 did not have a material impact on the Companys financial statements.
Earnings (Loss) per Common Share
Basic earnings (loss) per share (EPS) is computed by dividing income (loss) available to common stockholders by the weighted-average number of common shares outstanding. Diluted earnings per common share includes any additional common shares as if all potentially dilutive common shares were issued (for instance, stock options with an exercise price that is less than the average market price of the common shares for the periods stated). For the purpose of these calculations, unreleased Employee Stock Ownership Program (ESOP) shares are not considered to be outstanding. For the year ended March 31, 2009 the Bank sustained net losses, therefore, the effects of stock options were not considered in computing fully diluted earnings per common share as they would be anti-dilutive.
Treasury stock is recorded at cost and is presented as a reduction of stockholders equity.
The Companys pension benefit and post-retirement health and welfare benefit obligations, and the related costs, are calculated using actuarial concepts, within the framework of SFAS No. 87, Employers Accounting for Pensions and SFAS No. 106, Employers Accounting for Post-retirement Benefits Other than Pensions, respectively. The measurement of such obligations and expenses requires that certain assumptions be made regarding several factors, most notably including the discount rate and the expected return on plan assets. The Company evaluates these critical assumptions on an annual basis. Other factors considered by the Company include retirement patterns, mortality, turnover, and the rate of compensation increase.
Under Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefits Pension and Other Post-retirement Plans- an amendment of SFAS Statement Nos. 87, 88, 106 and 132(R), actuarial gain and losses, prior services cost or credits, and any remaining transition assets or obligations that have not been recognized under previous accounting standards must be recognized in accumulated other comprehensive income or loss, net of taxes effects, until they are amortized as a component of net of periodic benefit cost. In addition, under SFAS No. 158 the measurement date (i.e., the date at which plan assets and the benefit obligation are measured for financial reporting purposes) is required to be the companys fiscal year end. The company presently uses a December 31 measurement date for its pension, as permitted by SFAS Nos. 87 and 106. In accordance with SFAS No. 158, the Company has adopted a fiscal year-end measurement date on March 31, 2009.
Certain amounts in the consolidated financial statements presented for prior years have been reclassified to conform to the current year presentation.
Impact of Recent Accounting Standards and Interpretations
In April 2009, the FASB issued three final FSPs that are intended to provide additional application guidance and to enhance disclosures regarding fair value measurements and impairments of securities. FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, provides guidelines for making fair value measurements more consistent with the principles presented in SFAS No. 157. FSP FAS No. 107-1 and Accounting Principle Board (APB) 28-1, Interim Disclosures about Fair Value of Financial Instruments enhances consistency in financial reporting by increasing the frequency of fair value disclosures. FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments provide additional guidance that was designed to create greater clarity and consistency in accounting for, and presenting, impairment losses on securities.
FSP FAS 157-4 addresses the determination of fair values when there is no active market or where the price inputs being used represent distressed sales. It reaffirms the objective of fair value measurement, as set forth in SFAS No. 157, i.e., to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements and under current market conditions. It specifically reaffirms the need to use judgment in ascertaining if a formerly active market has become inactive and in determining fair values when markets have become inactive.
FSP FAS 107-1 and APB 28-1 relate to fair value disclosures for any financial instruments that are not currently reflected on a companys balance sheet at fair value. Prior to issuing this FSP, fair values for such assets and liabilities were disclosed only once a year. The FSP now requires quarterly disclosures that provide qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value.
FSP FAS 115-2 and FAS 124-2, which relate to other-than-temporary impairment, are intended to bring greater consistency to the timing of impairment recognition, and to provide greater clarity to investors about the credit and non-credit components of impaired debt securities that are not expected to be sold. The measure of impairment in comprehensive income remains fair value. The FSP also requires increased and more timely disclosure regarding expected cash flows, credit losses, and the aging of securities with unrealized losses. A cumulative effect adjustment is required to be recorded at the FSPs adoption date with respect to certain previously recognized other-than-temporary impairment losses.
Each of the aforementioned FSPs is effective for interim and annual periods ending after June 15, 2009, but entities may adopt these FSPs for the interim and annual periods ending after March 15, 2009. The Company did not adopt these FSPs for the interim period ended March 31, 2009.
In October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active, with an immediate effective date, including prior periods for which financial statements have not been issued. FSP FAS 157-3 amends SFAS No. 157 to clarify the application of fair value in inactive markets and allows for the use of managements internal assumptions about future cash flows, with appropriately risk-adjusted discount rates, when relevant observable market data does not exist. The objective of SFAS No. 157 has not changed and continues to be the determination of the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date. The adoption of FSP FAS 157-3 has not had a material effect on the Companys financial position or results of operations. FSP FAS 157-3 will be superseded upon adoption of FSP FAS 157-4 in the second quarter of 2009.
In December 2008, the FASB issued Staff Position, or FSP, No. FAS 132(R)-1, Employers Disclosures about Postretirement Benefit Plan Assets, which amends SFAS No. 132 (revised 2003), Employers Disclosures about Pensions and Other Postretirement Benefits, to provide guidance on an employers disclosures about plan assets of a defined benefit pension or other postretirement plan. The FSP clarifies that the objectives of the disclosures about postretirement benefit plan assets are to provide users of financial statements with an understanding of: (1) how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies; (2) the major categories of plan assets; (3) the inputs and valuation techniques used to measure the fair value of plan assets; (4) the effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period; and (5) significant concentrations of risk within plan assets. In addition, the FSP expands the disclosures related to these overall objectives. The disclosures about plan assets required by this FSP are effective for fiscal years ending after December 15, 2009. Upon initial application, the disclosures are not required for earlier periods that are presented for comparative purposes, although earlier application is permitted.
In December 2007, the FASB issued SFAS No. 141R, Business Combinations (revised 2007). SFAS No. 141R improves reporting by creating greater consistency in the accounting and financial reporting of business combinations, resulting in more complete, comparable, and relevant information for investors and other users of financial statements. To achieve this goal, the new standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose the information necessary to evaluate and understand the nature and financial effect of the business combination. SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first fiscal year that commences after December 15, 2008. The Company will apply SFAS No. 141R to any business combinations that may occur after the effective date, and believes that the standard could have a material impact on its accounting for such acquisitions.
In June 2008, the FASB issued FSP No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities, which addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing EPS under the two-class method described in SFAS No. 128, Earnings per Share. The FSP concluded that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and shall be included in the computation of EPS pursuant to the two-class method. The Companys restricted stock awards are considered participating securities. FSP No. EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period EPS data presented shall be adjusted retrospectively to conform with the provisions of the FSP. Early application is not permitted. FSP No. EITF 03-6-1 is not expected to have a material impact on the Companys computation of EPS.
In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements, an amendment of ARB No. 51. SFAS No. 160 amends Accounting Research Bulletin No. 51, Consolidated Financial Statements to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Among other things, SFAS No. 160 clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. SFAS No. 160 also amends SFAS No. 128 so that earnings per share calculations in consolidated financial statements will continue to be based on amounts attributable to the parent. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 and is applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements which are to be applied retrospectively for all periods presented. SFAS No. 160 is not expected to have a material impact on the Companys financial condition or results of operations.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133. SFAS No. 161 amends and expands the disclosure requirements of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, to provide users of financial statements with an enhanced understanding of: (1) how and why an entity uses derivative instruments; (2) how derivative instruments and related hedged items are accounted for; and (3) how such items affect an entitys financial position, performance and cash flows. SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivative instruments, quantitative disclosures about fair value amounts of, and gains and losses on, derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. SFAS No. 161 also encourages, but does not require, disclosures for earlier periods presented for comparative purposes at initial adoption. Since the provisions of SFAS No. 161 are disclosure related, the Companys adoption of SFAS No. 161 will not have an impact on its financial condition or results of operations.
NOTE 3. IMPAIRMENT AND GOODWILL
The company reported Goodwill from its acquisition of Community Capital Bank in 2006 in the amount of $7.1 million. In accordance with Statement of Financial Accounting Standards No.142, Goodwill and Other Intangible Assets (SFAS No.142) goodwill and intangible assets with indefinite useful lives are no longer amortized, rather they are assessed, at least annually, for impairment. The Company tests goodwill for impairment on an annual basis as of January 31, or more often if events or circumstances indicate there may be impairment. The Company has determined that all of its activities constitute one reporting and operating segment.
As outlined in SFAS No.142 the Goodwill impairment analysis involves a two-step test. The first step, used to identify potential impairment, involves comparing the fair value of the reporting unit to its carrying value including goodwill. If the fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired. If the carrying value exceeds fair value, there is an indication of impairment and the second step is performed to measure the amount of impairment. The second step involves calculating an implied fair value of goodwill for the reporting unit, in the same manner as the amount of goodwill recognized in a business combination, which is the excess of the fair value of the reporting unit, as determined in the first step, over the aggregate fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill exceeds the carrying value of reporting unit goodwill, there is no impairment. If the carrying value of reporting unit goodwill exceeds the implied fair value of the goodwill, an impairment charge is recorded in earnings for the excess. Subsequent reversal of goodwill impairment losses is not permitted.
The Company commenced an interim goodwill impairment analysis during the second quarter of fiscal year 2009, based on indications that the fair value of the Companys reporting unit may have declined below its carrying value as a result of factors previously defined such as the further decline in the Companys market capitalization relative to the book value of shareholders equity and the adverse market conditions impacting the financial services sector generally. This analysis, which incorporates the second step test noted above, was completed during the third quarter ended December 31, 2008. A valuation specialist was engaged to assist management in its fair value assessment of goodwill. As a result of the finalization of the goodwill impairment analysis, the Company determined that goodwill was impaired and recorded an impairment charge of $7.1 million in fiscal 2009.
NOTE 4. SECURITIES
The following is a summary of securities at March 31, 2009 (in thousands):
The following is a summary of securities at March 31, 2008 (in thousands):
The following is a summary regarding securities sales and/or calls of the available-for-sale portfolio at March 31, 2009 (in thousands):
The Banks investment portfolio is comprised primarily of fixed rate mortgage-backed securities guaranteed by a Government Sponsored Enterprise (GSE) as issuer. Carver Federal maintains a portfolio of mortgage-backed securities in the form of Government National Mortgage Association (GNMA) pass-through certificates, Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corp (FHLMC) participation certificates. GNMA pass-through certificates are guaranteed as to the payment of principal and interest by the full faith and credit of the United States Government while FNMA and FHLMC certificates are each guaranteed by their respective agencies as to principal and interest. Based on the high quality of the Banks investment portfolio, current market conditions have not significantly impacted the pricing of the portfolio or the Banks ability to obtain reliable prices.
The net unrealized gain on available-for-sale securities was $0.2 million ($110,000 after taxes) at March 31, 2009 and $0.1 million ($36,000 after taxes) at March 31, 2008. On November 30, 2002 the Bank transferred $22.8 million of mortgage-backed securities from available-for-sale to held-to-maturity as a result of managements intention to hold these securities in portfolio until maturity. A related unrealized gain of $0.5 million was recorded as a separate component of stockholders equity and is being amortized over the remaining lives of the securities as an adjustment to yield. As of March 31, 2009 the carrying value of these securities was $8.1 million and a related net unrealized gain of $90,000 continues to be reported. There were no sales of held-to-maturity securities in fiscal 2009. At March 31, 2009 the Bank pledged securities of $37.1 million as collateral for advances from the FHLB-NY.
The following is a summary of the carrying value (amortized cost) and fair value of securities at March 31, 2009, by remaining period to contractual maturity (ignoring earlier call dates, if any). Actual maturities may differ from contractual maturities because certain security issuers have the right to call or prepay their obligations. The table below does not consider the effects of possible prepayments or unscheduled repayments.
The unrealized losses and fair value of securities in an unrealized loss position at March 31, 2009 for less than 12 months and 12 months or longer were as follows (in thousands):
The unrealized losses and fair value of securities in an unrealized loss position at March 31, 2008 were as follows (in thousands):
A total of 31 securities had an unrealized loss at March 31, 2009 compared to 29 at March 31, 2008, based on estimated fair value. All the securities in an unrealized loss position were Government National Mortgage Association Mortgage backed securities, which represents 72.8% and 32.4% of total securities at March 31, 2009 and 2008, respectively. The cause of the temporary impairment is directly related to changes in interest rates. In general, as interest rates decline, the fair value of securities will rise, and conversely as interest rates rise, the fair value of securities will decline. Management considers fluctuations in fair value as a result of interest rate changes to be temporary, which is consistent with the Banks experience. The impairments are deemed temporary based on the direct relationship of the rise in fair value to movements in interest rates, the life of the investments and their high credit quality. Unrealized losses identified as other than temporary are charged directly against earnings in the Consolidated Statement of Income and Comprehensive Income. At March 31, 2009, the Bank held a private label mortgage-backed security which was determined to be other than temporarily impaired in the amount of $52,000.
Among the factors considered in determining that an unrealized loss is temporary in nature is managements intent and ability to hold each investment for a period of time sufficient to allow for an anticipated recovery in fair value. With the exception of the one security discussed above , management has determined that the unrealized losses are temporary in nature, given that it has the positive intent and ability to hold each investment until the earlier of its anticipated recovery or maturity. Other factors considered in determining whether a loss is temporary include the length of time and the extent to which fair value has been below cost; the severity of the impairment; the cause of the impairment; the financial condition and near-term prospects of the issuer; activity in the market of the issuer which may indicate adverse credit conditions; and the forecasted recovery period using current estimates of volatility in market interest rates (including liquidity and risk premiums).
Managements assertion regarding its intent and ability to hold investments considers a number of factors, including a quantitative estimate of the expected recovery period (which may extend to maturity), and managements intended strategy with respect to the identified security or portfolio.
NOTE 5. LOANS RECEIVABLE, NET
The following is a summary of loans receivable, net of allowance for loan losses at March 31 (dollars in thousands):