VALLEY NATIONAL BANCORP 10-Q

Item 2. Management’s Discussion and Analysis (MD&A) of Financial Condition and Results of Operations The following MD&A should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. The words "Valley," the "Company," "we," "our" and "us" refer to Valley National Bancorp and its wholly owned subsidiaries, unless we indicate otherwise. Additionally, Valley’s principal subsidiary, Valley National Bank, is commonly referred to as the “Bank” in this MD&A. The MD&A contains supplemental financial information, described in the sections that follow, which has been determined by methods other than U.S. generally accepted accounting principles (U.S. GAAP) that management uses in its analysis of our performance. Management believes these non-GAAP financial measures provide information useful to investors in understanding our underlying operational performance, our business and performance trends and facilitate comparisons with the performance of others in the financial services industry. These non-GAAP financial measures should not be considered in isolation or as a substitute for or superior to financial measures calculated in accordance with U.S. GAAP. These non-GAAP financial measures may also be calculated differently from similar measures disclosed by other companies. Cautionary Statement Concerning Forward-Looking Statements This Quarterly Report on Form 10-Q, both in the MD&A and elsewhere, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about management’s confidence and strategies and management’s expectations about new and existing programs and products, acquisitions, relationships, opportunities, taxation, technology, market conditions and economic expectations, including the potential effects of the COVID-19 pandemic on our businesses and financial results and conditions. These statements may be identified by such forward-looking terminology as “should,” “expect,” “believe,” “view,” “will,” “opportunity,” “allow,” “continues,” “would,” “could,” “typically,” “usually,” “anticipate,” or similar statements or variations of such terms. Such forward-looking statements involve certain risks and uncertainties and our actual results may differ materially from such forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements, include, but are not limited to: • the impact of COVID-19 on the U.S. and the global economies, including business disruptions, reductions in employment and an increase in business failures, specifically among our clients; 51 • the impact of COVID-19 on our employees and our ability to provide services to our customers and respond to their needs as more cases of COVID-19 arise in various locations, including Florida and Alabama; • potential judgments, claims, damages, penalties, fines and reputational damage resulting from pending or future litigation and regulatory and government actions, including as a result of our participation in and execution of government programs related to the COVID-19 pandemic or as a result of our action in response to, or failure to implement or effectively implement, federal, state and local laws, rules or executive orders requiring that we grant forbearances or not act to collect our loans; • the impact of forbearances or deferrals we are required or agree to as a result of customer requests and/or government actions, including, but not limited to our potential inability to recover fully deferred payments from the borrower or the collateral; • damage verdicts or settlements or restrictions related to existing or potential class action litigation or individual litigation arising from claims of violations of laws or regulations, contractual claims, breach of fiduciary responsibility, negligence, fraud, environmental laws, patent or trademark infringement, employment related claims, and other matters; • a prolonged downturn in the economy, mainly in New Jersey, New York, Florida and Alabama, as well as an unexpected decline in commercial real estate values within our market areas; • higher or lower than expected income tax expense or tax rates, including increases or decreases resulting from changes in uncertain tax position liabilities, tax laws, regulations and case law; • the inability to grow customer deposits to keep pace with loan growth; • a material change in our allowance for credit losses under CECL due to forecasted economic conditions and/or unexpected credit deterioration in our loan and investment portfolios; • the need to supplement debt or equity capital to maintain or exceed internal capital thresholds; • greater than expected technology related costs due to, among other factors, prolonged or failed implementations, additional project staffing and obsolescence caused by continuous and rapid market innovations; • the loss of or decrease in lower-cost funding sources within our deposit base, including our inability to achieve deposit retention targets under Valley's branch transformation strategy; • cyber-attacks, computer viruses or other malware that may breach the security of our websites or other systems to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage our systems; • results of examinations by the Office of the Comptroller of the Currency (OCC), the Federal Reserve Bank (FRB), the Consumer Financial Protection Bureau (CFPB) and other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for credit losses, write-down assets, reimburse customers, change the way we do business, or limit or eliminate certain other banking activities; • our inability or determination not to pay dividends at current levels, or at all, because of inadequate earnings, regulatory restrictions or limitations, changes in our capital requirements or a decision to increase capital by retaining more earnings; • unanticipated loan delinquencies, loss of collateral, decreased service revenues, and other potential negative effects on our business caused by severe weather, the COVID-19 pandemic or other external events; • unexpected significant declines in the loan portfolio due to the lack of economic expansion, increased competition, large prepayments, changes in regulatory lending guidance or other factors; and • the failure of other financial institutions with whom we have trading, clearing, counterparty and other financial relationships. A detailed discussion of factors that could affect our results is included in our SEC filings, including the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2019 and in Item 1A of this report. 52 Critical Accounting Policies and Estimates We identified our policies on the allowance for credit losses, goodwill and other intangible assets, and income taxes to be critical accounting policies because management has to make subjective and/or complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. Determining the allowance for loan losses has historically been identified as a critical accounting estimate. On January 1, 2020, we adopted new accounting guidance which requires entities to estimate and recognize an allowance for lifetime expected credit losses for loans, unfunded credit commitments and held to maturity debt securities measured at amortized cost. Previously, an allowance for credit losses on loans was recognized based on probable incurred losses. See Notes 5, 7 and 8 to the consolidated financial statements for further discussion of our accounting policies and methodologies for establishing the allowance for credit losses. The accounting estimates relating to the allowance for credit losses remains a "critical accounting estimate" for the following reasons: • Changes in the provision for credit losses can materially affect our financial results; • Estimates relating to the allowance for credit losses require us to project future borrower performance, delinquencies and charge-offs, along with, when applicable, collateral values, based on a reasonable and supportable forecast period utilizing forward-looking economic scenarios in order to estimate probability of default and loss given default; • The allowance for credit losses is influenced by factors outside of our control such as industry and business trends, geopolitical events and the effects of laws and regulations as well as economic conditions such as trends in housing prices, interest rates, gross domestic product (GDP), inflation, energy prices and unemployment; and • Judgment is required to determine whether the models used to generate the allowance for credit losses produce an estimate that is sufficient to encompass the current view of lifetime expected credit losses. Our estimation process is subject to risks and uncertainties, including a reliance on historical loss and trend information that may not be representative of current conditions and indicative of future performance. Changes in such estimates could significantly impact our allowance and provision for credit losses. Accordingly, our actual credit loss experience may not be in line with our expectations. As discussed further in the "Allowance for Credit Losses" section in this MD&A, we incorporated a multi-scenario economic forecast for estimating lifetime expected credit losses at June 30, 2020 . As a result of the deterioration in economic conditions caused by the COVID-19 pandemic during the first half of 2020 and the related increase in economic uncertainty, we increased our probability weighting for the most severe economic scenario as compared to those at January 1, 2020. As a result, over 40 percent of the provision of credit losses for loans totaling $75.0 million for the six months ended June 30, 2020 reflected the impact of the adverse economic forecast within Valley's lifetime expected credit loss estimate. Details regarding our critical accounting policies for goodwill and other intangible assets, and income taxes are described in detail in Part II, Item 7 in Valley’s Annual Report on Form 10-K for the year ended December 31, 2019 . New Authoritative Accounting Guidance See Note 5 to the consolidated financial statements for a description of new authoritative accounting guidance, including the respective dates of adoption and effects on results of operations and financial condition. 53 Executive Summary Company Overview. At June 30, 2020 , Valley had consolidated total assets of approximately $41.7 billion , total net loans of $32.0 billion , total deposits of $31.4 billion and total shareholders’ equity of $4.5 billion . Our commercial bank operations include branch office locations in northern and central New Jersey, the New York City Boroughs of Manhattan, Brooklyn, Queens, and Long Island, Florida and Alabama. Of our current 236 branch network, 59 percent , 16 percent , 18 percent and 7 percent of the branches are in New Jersey, New York, Florida and Alabama, respectively. Despite targeted branch consolidation activity, we have significantly grown both in asset size and locations over the past several years primarily through bank acquisitions, including our acquisition of Oritani Financial Corp. (Oritani) on December 1, 2019. See Note 2 to the consolidated financial statements for more information regarding the Oritani acquisition. Impact of COVID-19. The widespread outbreak of the novel Coronavirus Disease 2019 (COVID-19) has created a global public health crisis that has resulted in unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity, including in the markets that we serve. Our markets within Florida and Alabama have experienced a recent increase in COVID-19 infection rates and such negative trends could hamper reopening and economic recovery in these markets. Uncertainties and disruptions from COVID-19 have slowed our traditional new commercial loan volumes and many consumer loan products, such as automobile loans during the second quarter 2020. Any sustained economic downturn or other long-term changes in consumer and business behaviors from COVID-19 may also adversely impact the value of assets that serve as collateral for our loans. The $659 billion Paycheck Protection Program (PPP) provided for in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, as supplemented by the Paycheck Protection Program and Health Care Enhancement Act (Enhancement Act), was designed to aid small- and medium-sized businesses through federally guaranteed loans distributed through banks. These loans are intended to guarantee 8 to 24 weeks of payroll and other costs to help those businesses remain viable and allow their workers to pay their bills. Valley National Bank is a certified Small Business Administration (SBA) lender and during the second quarter of 2020 dedicated significant staff and other resources to help our customers complete and submit their applications and supporting documentation for loans offered under the program, obtain SBA approval and receive funding as quickly as possible. To date, Valley has facilitated over 12,800 SBA-approved PPP loans and had over $2.2 billion of these loans outstanding as of June 30, 2020. We expect the majority of these loans to be forgiven in accordance with rules, application and documentation requirements for this program, some of which have only recently been released. The loan forgiveness rules may be subject to further revisions and additional SBA guidance in the coming months. During the latter part of second quarter 2020, we have taken steps to reopen most branches in New Jersey and New York that had been either temporarily closed or had reduced lobby services due to COVID-19, while acting with an abundance of caution in order to safeguard the health and wellness of our customers and employees. We will continue to closely monitor local conditions in the areas we serve and will take actions as circumstances warrant, which may necessitate resumption of certain branch or other office closures and reduced lobby services. Our business continuity plan continues to remain in effect and a significant portion of our non-customer facing employees continue to work remotely as we work through our return to work plans and monitor the level of the health crisis in our primary markets. In response to the COVID-19 pandemic and its economic impact on certain customers, Valley implemented short-term loan modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant, when requested by customers. Generally, the modification terms allow for a deferral of payments for up to 90 days, which Valley may extend for an additional 90 days, for a maximum of 180 days on a cumulative and successive basis. To date, Valley has granted over 10,000 loan forbearances totaling approximately $4.6 billion in support of our customers. Of these, approximately 5,000 loans totaling $1.9 billion have completed the contractual deferral period and returned to regularly scheduled payments. 54 Significant uncertainties as to future economic conditions exist, and we have taken purposeful actions in response, including continued heightened levels of balance sheet liquidity during the second quarter 2020. Additionally, the economic pressures, coupled with the implementation of an expected loss methodology for determining our provision for credit losses as required by CECL, have contributed to an increased provision for credit losses for the first half of 2020. We continue to monitor the impact of COVID-19 closely, as well as any effects that may result from the CARES Act, Enhancement Act and other government stimulus or Federal Reserve actions. However, the extent to which the COVID-19 pandemic will impact our operations and financial results during the remainder of 2020 is highly uncertain. See the "Operating Environment" section and our risk factors under Part II Item 1A below for more details. Branch Transformation. As previously disclosed, Valley has embarked on a strategy to overhaul its retail network. Over one year ago, we established the foundation of what the transformation of our branch network would look like in coming years. At that time, we identified 74 branches that did not meet certain internal performance measures, including 20 branches that were closed and consolidated by the end of the first quarter 2019. For the remaining 54 branches, we implemented tailored action plans focused on improving profitability and deposit levels, as well as upgrades in staffing and training, within a defined timeline. During the first quarter 2020, we permanently closed an additional 9 branches located in New Jersey, including the consolidation of 6 acquired Oritani branches into nearby legacy Valley branches. We currently expect to permanently close 10 branches during the remainder of 2020. For the remaining branch network, we continue to monitor the operating performance of each branch and implement tailored action plans focused on improving profitability and deposit levels for those branches that underperform. At this time, we plan to reopen branches temporarily closed due to the impact of the COVID-19 pandemic, although the timing of reopening these branches is uncertain. Quarterly Results. Net income for the second quarter 2020 was $95.6 million , or $0.23 per diluted common share, compared to $76.5 million , or $0.22 per diluted common share, for the second quarter 2019 . The $19.1 million increase in quarterly net income as compared to the same quarter one year ago was largely due to: (i) a $62.3 million increase in net interest income driven by organic and Oritani acquired loan growth over the last 12 months combined with our ability to significantly reduce our deposit and other funding costs in the current low interest rate environment, (ii) a $17.2 million increase in non-interest income mainly caused by strong commercial loan customer swap fees, higher BOLI income and additional gains on the sales of residential mortgage loans, partially offset by (iii) a $39.1 million increase in our provision for credit losses for loans due to the adoption of CECL and the impact of the COVID-19 pandemic on the model results, (iv) a $15.4 million increase in non-interest expense due to our expanded franchise following the Oritani acquisition, higher technology consulting and certain additional expenses due to COVID-19, and (v) a $5.9 million increase in income tax expense. See the “Net Interest Income”, “Non-Interest Income”, “Non-Interest Expense”, and “Income Taxes” sections below for more details on the items above impacting our second quarter 2020 results, as well as other items discussed elsewhere in this MD&A, for more details on the impact of the items above on our second quarter 2020 results. Operating Environment. During the second quarter 2020, real gross domestic product declined 32.9 percent. COVID-19 and the measures taken to mitigate the health crisis have caused households and businesses to sharply reduce consumption and investment. As a result, job losses have increased sharply while prices for goods and services have fallen. The unemployment rate was 11.1 percent in June 2020 compared to 4.4 percent in March of this year. The ongoing public health crisis will weigh heavily on economic activity, employment and inflation. To support the flow of credit, the Federal Reserve reduced the target range for the federal funds rate earlier this year. In addition, the Federal Reserve began purchasing Treasury securities and agency residential and commercial mortgage-backed securities. Currently, the target range for the federal funds rate is between zero and 0.25 percent. The 10-year U.S. Treasury note yield ended the second quarter at 0.66 percent, 134 basis points lower compared with June 30, 2019. The current economic environment has weakened traditional commercial loan demand, while residential mortgage loan volumes for both purchased and refinanced activity are relatively solid in the early stages of the third quarter 2020. The low market interest rates for new loans will continue to put pressure on our overall loan yields and net interest margin. In parts of the Bank’s footprint, particularly Florida, the number have COVID-19 cases have 55 recently increased, which may hinder attempts to resume normal business activity in those regions. More broadly, the ongoing health crisis has caused household and business confidence to remain subdued which is likely to weigh on Valley’s financial results, as highlighted in the remaining MD&A discussion below. Loans . Loans increased $1.9 billion to approximately $32.3 billion at June 30, 2020 from March 31, 2020 largely due to approximately $2.2 billion of SBA PPP loan originations within the commercial and industrial loan category during the second quarter 2020 . Commercial real estate loans increased $181.6 million, or 4.4 percent on an annualized basis, to $16.6 billion at June 30, 2020 as compared to March 31, 2020 mainly due to our strong loan commitment pipeline at March 31, 2020 and slower repayment activity in the second quarter. Residential mortgage and the consumer loan categories all experienced moderate declines in the second quarter due to the impact of COVID-19 and our normal mortgage banking sales activity. During the second quarter 2020 , we originated $296 million of residential mortgage loans for sale rather than held for investment and sold approximately $237 million of these loans. Residential mortgage loans held for sale at fair value totaled $120.6 million and $58.9 million at June 30, 2020 and March 31, 2020 , respectively. See further details on our loan activities under the “Loan Portfolio” section below. Asset Quality. Total non-performing assets (NPAs), consisting of non-accrual loans, other real estate owned (OREO), other repossessed assets and non-accrual debt securities increased $3.7 million to $224.2 million at June 30, 2020 as compared to March 31, 2020 . Non-accrual loans increase d $4.7 million to $210.6 million at June 30, 2020 as compared to March 31, 2020 partially due to one commercial real estate loan which moved to non-accrual status during the second quarter 2020, as well as a moderately higher level of non-accrual consumer loans at June 30, 2020 . Non-accrual loans represented 0.65 percent of total loans at June 30, 2020 , as compared to 0.68 percent at March 31, 2020 . Total accruing past due loans (i.e., loans past due 30 days or more and still accruing interest) decreased $66.3 million to $93.1 million , or 0.29 percent of total loans, at June 30, 2020 as compared to $159.4 million , or 0.52 percent of total loans, at March 31, 2020 due to a decline in early stage delinquencies for all loan categories. Commercial real estate loans past due 30 to 59 days and 60 to 89 days decreased by $27.8 million and $14.4 million, respectively, as compared to March 31, 2020 . The improved performance within the 30 to 59 day category was mainly due to restored customer payments delayed by business disruptions caused by COVID-19 related factors at the end of the first quarter 2020. Commercial real estate loans past due 60 to 90 days at June 30, 2020 declined primarily due to the normal renewal of a $13.8 million performing matured loan reported in this category at March 31, 2020 . See further details in the "Non-performing Assets" section below. Deposits and Other Borrowings . Average non-interest bearing deposits; savings, NOW and money market deposits; and time deposits represented approximately 27 percent , 45 percent and 28 percent of total deposits as of June 30, 2020 , respectively. Overall, average deposits increased by $2.0 billion to $30.8 billion for the second quarter 2020 as compared to the first quarter 2020 . Our mix of the deposit categories of total average deposits for the second quarter 2020 as compared to the first quarter 2020 experienced a shift to non-interest bearing deposits largely due to new deposits resulting from the funding of customer PPP loans, as well as a continued migration of maturing retail CD customers into more flexible and lower-cost transaction account types. Actual ending balances for deposits increased $2.4 billion to approximately $31.4 billion at June 30, 2020 from March 31, 2020 largely due to increases of $2.0 billion and $666.6 million in non-interest bearing deposits and interest-bearing deposits without stated maturities, respectively. The increases were mostly driven by the aforementioned deposits from PPP loan customers, higher depositor balances due to the uncertain financial markets, as well as a partial shift to more liquid account types for maturing retail CD customers. As a result, time deposits decreased $294.3 million at June 30, 2020 as compared to March 31, 2020 . Total brokered deposits (consisting of both time and money market deposit accounts) were $3.6 billion at June 30, 2020 as compared to $3.4 billion at March 31, 2020 . While we believe the current operating environment will likely continue to be favorable for Valley’s deposit gathering initiatives, we cannot guarantee that we will be able to maintain deposit levels at or near those reported at June 30, 2020. Additionally, the vast majority of the PPP loan customers that are Valley depositors are expected to use the funds for qualifying payroll and other costs over an 8 to 24 week period to obtain loan 56 forgiveness. The resulting outflow of funds for such expenditures may contribute to lower levels of deposit balances in the second half of 2020. Average short-term borrowings increased $1.0 billion to $2.3 billion for the second quarter 2020 as compared to the first quarter 2020 driven by our prudent steps to increase our liquidity levels starting in the end of the first quarter 2020 in the face of the escalating economic crisis created by the COVID-19 pandemic. Average long-term borrowings (including junior subordinated debentures issued to capital trusts which are presented separately on the consolidated statements of financial condition) increased by $111.0 million to $2.9 billion for the second quarter 2020 as compared to the first quarter 2020 mostly due to $100 million of new long-term FHLB advances executed in March 2020 as part of our overall liquidity strategy. Actual ending balances for short-term borrowings moderately decreased by $12.8 million to $2.1 billion at June 30, 2020 as compared to March 31, 2020 . Long-term borrowings increased $101.9 million to $2.9 billion at June 30, 2020 as compared to March 31, 2020 mainly due to our $115.0 million issuance of 5.25 percent fixed-to-floating rate subordinated notes on June 5, 2020. Selected Performance Indicators. The following table presents our annualized performance ratios for the periods indicated: Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Return on average assets 0.92 % 0.94 % 0.92 % 1.17 % Return on average assets, as adjusted 0.92 0.96 0.93 0.95 Return on average shareholders’ equity 8.54 8.79 8.23 11.04 Return on average shareholders’ equity, as adjusted 8.57 9.05 8.29 8.94 Return on average tangible shareholders’ equity (ROATE) 12.66 13.16 12.26 16.65 ROATE, as adjusted 12.70 13.56 12.34 13.49 Adjusted return on average assets, adjusted return on average shareholders' equity, ROATE and adjusted ROATE included in the table above are non-GAAP measures. Management believes these measures provide information useful to management and investors in understanding our underlying operational performance, business and performance trends, and the measures facilitate comparisons of our prior performance with the performance of others in the financial services industry. These non-GAAP financial measures should not be considered in isolation or as a substitute for or superior to financial measures calculated in accordance with U.S. GAAP. These non-GAAP financial measures may also be calculated differently from similar measures disclosed by other companies. The non-GAAP measure reconciliations are presented below. 57 Adjusted net income is computed as follows: Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 (in thousands) Net income, as reported $ 95,601 $ 76,468 $ 182,869 $ 189,798 Add: Net impairment losses on securities (net of tax) — 2,078 — 2,078 Add: Losses (gains) on securities transactions (net of tax) 29 (8 ) 58 15 Add: Severance expense (net of tax) (1) — — — 3,433 Add: Tax credit investment impairment (net of tax) (2) — — — 1,757 Add: Merger related expenses (net of tax) (3) 263 25 1,199 25 Add: Income tax expense (4) — 223 — 12,323 Less: Gain on sale-leaseback transaction (net of tax) (5) — — — (55,707 ) Net income, as adjusted $ 95,893 $ 78,786 $ 184,126 $ 153,722 (1) Severance expense is included in salary and employee benefits expense. (2) Impairment is included in the amortization of tax credit investments. (3) Merger related expenses are primarily within salary and employee benefits expense, professional and legal fees, and other non-interest expenses. (4) Income tax expense related to reserves for uncertain tax positions. (5) The gain on sale leaseback transactions is included in net gains on the sales of assets within other non-interest income. Adjusted annualized return on average assets is computed by dividing adjusted net income by average assets, as follows: Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 ($ in thousands) Net income, as adjusted $ 95,893 $ 78,786 $ 184,126 $ 153,722 Average assets $ 41,503,514 $ 32,707,144 $ 39,800,441 $ 32,502,744 Annualized return on average assets, as adjusted 0.92 % 0.96 % 0.93 % 0.95 % Adjusted annualized return on average shareholders' equity is computed by dividing adjusted net income by average shareholders' equity, as follows: Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 ($ in thousands) Net income, as adjusted $ 95,893 $ 78,786 $ 184,126 $ 153,722 Average shareholders' equity $ 4,477,446 $ 3,481,519 $ 4,443,016 $ 3,438,344 Annualized return on average shareholders' equity, as adjusted 8.57 % 9.05 % 8.29 % 8.94 % 58 ROATE and adjusted ROATE are computed by dividing net income and adjusted net income, respectively, by average shareholders’ equity less average goodwill and average other intangible assets, as follows: Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 ($ in thousands) Net income $ 95,601 $ 76,468 $ 182,869 $ 189,798 Net income, as adjusted $ 95,893 $ 78,786 $ 184,126 $ 153,722 Average shareholders’ equity $ 4,477,446 $ 3,481,519 $ 4,443,016 $ 3,438,344 Less: Average goodwill and other intangible assets 1,456,781 1,156,703 1,458,885 1,158,596 Average tangible shareholders’ equity $ 3,020,665 $ 2,324,816 $ 2,984,131 $ 2,279,748 Annualized ROATE 12.66 % 13.16 % 12.26 % 16.65 % Annualized ROATE, as adjusted 12.70 % 13.56 % 12.34 % 13.49 % In addition to the items used to calculate net income, as adjusted, in the tables above, our net income is, from time to time, impacted by fluctuations in the level of net gains on sales of loans and swap fees recognized from commercial loan customer transactions. These amounts can vary widely from period to period due to, among other factors, the amount of residential mortgage loans originated for sale, bulk loan portfolio sales and commercial loan customer demand for certain products. See the “Non-Interest Income” section below for more details. 59 Net Interest Income Net interest income consists of interest income and dividends earned on interest earning assets, less interest expense on interest bearing liabilities, and represents the main source of income for Valley. Net interest income on a tax equivalent basis totaling $283.5 million for the second quarter 2020 increased $62.1 million as compared to the second quarter 2019 and increased $17.2 million as compared to the first quarter 2020 . The increase as compared to the first quarter 2020 was largely driven by our ability to significantly reduce our deposit and other funding costs in the current low interest rate environment and a $2.0 billion increase in average loan balances largely resulting from PPP loan originations. Interest expense of $66.0 million for the second quarter 2020 decreased $32.5 million as compared to the first quarter 2020 largely due to the overall lower cost of funds, partially offset by the interest cost associated with higher average interest-bearing deposits without stated maturities and other borrowings. However, interest income on a tax equivalent basis decreased $15.3 million to $349.5 million for the second quarter 2020 as compared to the first quarter 2020 . The decrease was mainly due to overall lower loan yields caused, in part, by normal repayments of higher yielding loans, variable rate loan resets and a $3.1 million decline in loan discount accretion in second quarter 2020 due to lower prepayments for certain loans. Average interest earning assets increased $7.9 billion to $37.8 billion for the second quarter 2020 as compared to the second quarter 2019 primarily due to $3.8 billion of interest earning assets acquired from Oritani and organic loan growth over the 12-month period, including $2.2 billion of PPP loans originated in the second quarter 2020 . As compared to the first quarter 2020 , average interest earning assets increased by $3.1 billion from $34.7 billion largely due to the PPP loan originations and higher overnight funds resulting from our increased liquidity levels in response to the COVID-19 pandemic. Average interest bearing liabilities increased $5.3 billion to $27.6 billion for the second quarter 2020 as compared to the second quarter 2019 mainly due to deposits and borrowings totaling a combined $3.4 billion assumed in the Oritani acquisition, organic growth of retail deposits and additional long-term borrowings caused by the funding of loan growth and our increased liquidity in response to COVID-19. As compared to the first quarter 2020 , average interest bearing liabilities increased by $1.4 billion in the second quarter 2020 primarily due to increased levels of short-term borrowings and growth in deposits driven by PPP loan customers and organic growth from higher depositor balances partly caused by the uncertain financial markets. See additional information under "Deposits and Other Borrowings" in the Executive Summary section above. Our net interest margin on a tax equivalent basis of 3.00 percent for the second quarter 2020 increased by 4 basis points from 2.96 percent in second quarter 2019 and decreased by 7 basis points from 3.07 percent for the first quarter 2020 . The yield on average interest earning assets decreased by 51 basis points on a linked quarter basis mostly due to the impact of the lower interest rate environment. The yield on average loans decreased by 42 basis points to 4.02 percent for the second quarter 2020 as compared to the first quarter 2020 largely due to the repayment of higher yielding loans, lower yielding variable and new loans, including the origination of $2.2 billion of PPP loans in second quarter 2020 , and an increase in excess liquidity held in low yield overnight investments. The overall cost of average interest bearing liabilities decreased 54 basis points to 0.96 percent for the second quarter 2020 as compared to the linked first quarter 2020 due to the significantly lower interest rates paid on deposits and borrowings. During the first half of 2020, we also benefited from the prepayment of $635 million high cost FHLB advances in December 2019. Our cost of total average deposits was 0.60 percent for the second quarter 2020 as compared to 1.07 percent for the first quarter 2020 . 60 The following table reflects the components of net interest income for the three months ended June 30, 2020 , March 31, 2020 and June 30, 2019 : Quarterly Analysis of Average Assets, Liabilities and Shareholders’ Equity and Net Interest Income on a Tax Equivalent Basis Three Months Ended June 30, 2020 March 31, 2020 June 30, 2019 Average Balance Interest Average Rate Average Balance Interest Average Rate Average Balance Interest Average Rate ($ in thousands) Assets Interest earning assets: Loans (1)(2) $ 32,041,200 $ 321,883 4.02 % $ 29,999,428 $ 333,068 4.44 % $ 25,552,415 $ 296,934 4.65 % Taxable investments (3) 3,673,090 22,539 2.45 3,557,913 25,334 2.85 3,453,676 25,284 2.93 Tax-exempt investments (1)(3) 562,172 4,673 3.32 585,987 4,970 3.39 658,727 5,514 3.35 Interest bearing deposits with banks 1,501,925 411 0.11 530,747 1,465 1.10 212,566 1,168 2.20 Total interest earning assets 37,778,387 349,506 3.70 34,674,075 364,837 4.21 29,877,384 328,900 4.40 Allowance for loan losses (284,184 ) (256,675 ) (156,747 ) Cash and due from banks 424,625 293,276 265,015 Other assets 3,540,513 3,378,372 2,744,661 Unrealized gains (losses) on securities available for sale, net 44,173 8,316 (23,169 ) Total assets $ 41,503,514 $ 38,097,364 $ 32,707,144 Liabilities and shareholders’ equity Interest bearing liabilities: Savings, NOW and money market deposits $ 13,788,951 $ 16,627 0.48 % $ 13,219,896 $ 34,513 1.04 % $ 11,293,885 $ 38,020 1.35 % Time deposits 8,585,782 29,857 1.39 8,897,934 42,814 1.92 7,047,319 40,331 2.29 Total interest bearing deposits 22,374,733 46,484 0.83 22,117,830 77,327 1.40 18,341,204 78,351 1.71 Short-term borrowings 2,317,992 1,980 0.34 1,322,699 4,707 1.42 2,380,294 14,860 2.50 Long-term borrowings (4) 2,886,016 17,502 2.43 2,775,049 16,420 2.37 1,607,046 14,297 3.56 Total interest bearing liabilities 27,578,741 65,966 0.96 26,215,578 98,454 1.50 22,328,544 107,508 1.93 Non-interest bearing deposits 8,463,230 6,694,102 6,358,034 Other liabilities 984,097 779,099 539,047 Shareholders’ equity 4,477,446 4,408,585 3,481,519 Total liabilities and shareholders’ equity $ 41,503,514 $ 38,097,364 $ 32,707,144 Net interest income/interest rate spread (5) $ 283,540 2.74 % $ 266,383 2.71 % $ 221,392 2.47 % Tax equivalent adjustment (981 ) (1,044 ) (1,158 ) Net interest income, as reported $ 282,559 $ 265,339 $ 220,234 Net interest margin (6) 2.99 % 3.06 % 2.95 % Tax equivalent effect 0.01 % 0.01 % 0.01 % Net interest margin on a fully tax equivalent basis (6) 3.00 % 3.07 % 2.96 % 61 The following table reflects the components of net interest income for the six months ended June 30, 2020 and 2019 : Six Months Ended June 30, 2020 June 30, 2019 Average Balance Interest Average Rate Average Balance Interest Average Rate ($ in thousands) Assets Interest earning assets: Loans (1)(2) $ 31,020,314 $ 654,951 4.22 % $ 25,404,396 $ 585,211 4.61 % Taxable investments (3) 3,615,502 47,873 2.65 3,422,317 51,334 3.00 Tax-exempt investments (1)(3) 574,080 9,643 3.36 674,116 11,595 3.44 Interest bearing deposits with banks 1,016,336 1,876 0.37 220,186 2,261 2.05 Total interest earning assets 36,226,232 714,343 3.94 29,721,015 650,401 4.38 Allowance for loan losses (270,430 ) (154,864 ) Cash and due from banks 358,951 276,170 Other assets 3,459,443 2,694,473 Unrealized gains (losses) on securities available for sale, net 26,245 (34,050 ) Total assets $ 39,800,441 $ 32,502,744 Liabilities and shareholders’ equity Interest bearing liabilities: Savings, NOW and money market deposits $ 13,504,424 $ 51,140 0.76 % $ 11,371,980 $ 74,303 1.31 % Time deposits 8,741,858 72,671 1.66 7,130,628 78,502 2.20 Total interest bearing deposits 22,246,282 123,811 1.11 18,502,608 152,805 1.65 Short-term borrowings 1,820,346 6,687 0.73 2,196,880 27,409 2.50 Long-term borrowings (4) 2,830,533 33,922 2.40 1,636,755 28,870 3.53 Total interest bearing liabilities 26,897,161 164,420 1.22 22,336,243 209,084 1.87 Non-interest bearing deposits 7,578,666 6,238,159 Other liabilities 881,598 489,998 Shareholders’ equity 4,443,016 3,438,344 Total liabilities and shareholders’ equity $ 39,800,441 $ 32,502,744 Net interest income/interest rate spread (5) $ 549,923 2.72 % $ 441,317 2.51 % Tax equivalent adjustment (2,025 ) (2,435 ) Net interest income, as reported $ 547,898 $ 438,882 Net interest margin (6) 3.02 % 2.95 % Tax equivalent effect 0.02 % 0.02 % Net interest margin on a fully tax equivalent basis (6) 3.04 % 2.97 % (1) Interest income is presented on a tax equivalent basis using a 21 percent federal tax rate. (2) Loans are stated net of unearned income and include non-accrual loans. (3) The yield for securities that are classified as available for sale is based on the average historical amortized cost. (4) Includes junior subordinated debentures issued to capital trusts which are presented separately on the consolidated statements of financial condition. (5) Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis. (6) Net interest income as a percentage of total average interest earning assets. 62 The following table demonstrates the relative impact on net interest income of changes in the volume of interest earning assets and interest bearing liabilities and changes in rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in volume and rates are allocated to the categories in proportion to the absolute dollar amounts of the change in each category. Change in Net Interest Income on a Tax Equivalent Basis Three Months Ended June 30, 2020 Compared to June 30, 2019 Six Months Ended June 30, 2020 Compared to June 30, 2019 Change Due to Volume Change Due to Rate Total Change Change Due to Volume Change Due to Rate Total Change (in thousands) Interest Income: Loans* $ 68,741 $ (43,792 ) $ 24,949 $ 121,530 $ (51,790 ) $ 69,740 Taxable investments 1,533 (4,278 ) (2,745 ) 2,787 (6,248 ) (3,461 ) Tax-exempt investments* (803 ) (38 ) (841 ) (1,686 ) (266 ) (1,952 ) Interest bearing deposits with banks 1,265 (2,022 ) (757 ) 2,709 (3,094 ) (385 ) Total increase (decrease) in interest income 70,736 (50,130 ) 20,606 125,340 (61,398 ) 63,942 Interest Expense: Savings, NOW and money market deposits 7,019 (28,412 ) (21,393 ) 12,126 (35,289 ) (23,163 ) Time deposits 7,570 (18,044 ) (10,474 ) 15,654 (21,485 ) (5,831 ) Short-term borrowings (379 ) (12,501 ) (12,880 ) (4,050 ) (16,672 ) (20,722 ) Long-term borrowings and junior subordinated debentures 8,791 (5,586 ) 3,205 16,367 (11,315 ) 5,052 Total increase (decrease) in interest expense 23,001 (64,543 ) (41,542 ) 40,097 (84,761 ) (44,664 ) Total increase in net interest income $ 47,735 $ 14,413 $ 62,148 $ 85,243 $ 23,363 $ 108,606 * Interest income is presented on a tax equivalent basis using 21 percent as the federal tax rate. 63 Non-Interest Income Non-interest income increased $17.2 million and $49.0 million for the three and six months ended June 30, 2020 as compared to the same periods of 2019 . The following table presents the components of non-interest income for the three and six months ended June 30, 2020 and 2019 : Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 (in thousands) Trust and investment services $ 2,826 $ 3,096 $ 6,239 $ 6,000 Insurance commissions 1,659 2,649 3,610 5,174 Service charges on deposit accounts 3,557 5,827 9,237 11,730 (Losses) gains on securities transactions, net (41 ) 11 (81 ) (21 ) Net impairment losses on securities recognized in earnings — (2,928 ) — (2,928 ) Fees from loan servicing 2,227 2,367 4,975 4,797 Gains on sales of loans, net 8,337 3,930 12,887 8,506 (Losses) gains on sales of assets, net (299 ) (564 ) (178 ) 77,156 Bank owned life insurance 5,823 2,205 8,965 4,092 Other 20,741 11,010 40,573 20,770 Total non-interest income $ 44,830 $ 27,603 $ 86,227 $ 135,276 Insurance commissions declined $1.0 million and $1.6 million for the three and six months ended June 30, 2020 as compared to the corresponding periods in 2019 mainly due to lower volumes of business generated by the Bank's insurance agency subsidiary. Service charges on deposit accounts decreased by $2.3 million and $2.5 million for the three and six months ended June 30, 2020 , respectively, as compared to the corresponding periods in 2019 mostly due to waived fees related to COVID-19 customer relief efforts in the second quarter 2020. The other-than-temporary impairment losses on securities for the three and six months ended June 30, 2019 related to one special revenue bond in default of its contractual payments starting in the second quarter 2019. Our net gains on sales of loans for each period are comprised of both gains on sales of residential mortgages and the net change in the mark to market gains and losses on our loans originated for sale and carried at fair value at each period end. The net gains from the change in the fair value of loans held for sale totaled $3.2 million and $4.0 million for the three and six months ended June 30, 2020 , respectively, as compared to $225 thousand and $549 thousand for the three and six months ended June 30, 2019 . During the second quarter 2020 , we sold approximately $237 million of residential mortgage loans as compared to $223 million during the second quarter 2019 . See further discussions of our residential mortgage loan origination activity under the “Loan Portfolio” section of this MD&A below. Net gains on sales of assets decreased $77.3 million for the six months ended June 30, 2020 , primarily due to a $78.5 million gain on the sale (and leaseback) of 26 locations recognized during the first quarter 2019. Bank owned life insurance income increased $3.6 million and $4.9 million for the three and six months ended June 30, 2020 , respectively as compared to the same periods in 2019 due to income from bank owned life insurance acquired from Oritani during the fourth quarter 2019 and death benefits received in the 2020 periods. Other non-interest income increased $9.7 million and $19.8 million for the three and six months ended June 30, 2020 as compared to the same periods in 2019 . The increase was primarily due to swap fee income related to 64 derivative interest rate swaps executed with commercial loan customers totaling $14.7 million and $5.4 million for the three months ended June 30, 2020 and June 30, 2019, respectively and $28.9 million and $9.5 million for the six months ended June 30, 2020 and June 30, 2019 , respectively. Non-Interest Expense Non-interest expense increased $15.4 million and $23.3 million for the three and six months ended June 30, 2020 as compared to the same periods of 2019 . The following table presents the components of non-interest expense for the three and six months ended June 30, 2020 and 2019 : Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 (in thousands) Salary and employee benefits expense $ 78,532 $ 76,183 $ 164,260 $ 159,288 Net occupancy and equipment expense 33,217 29,700 65,658 57,586 FDIC insurance assessment 6,135 4,931 10,011 11,052 Amortization of other intangible assets 6,681 4,170 12,151 8,481 Professional and legal fees 7,797 4,145 13,884 9,416 Amortization of tax credit investments 3,416 4,863 6,644 12,036 Telecommunications expense 2,866 2,351 5,153 4,619 Other 18,522 15,394 35,061 27,054 Total non-interest expense $ 157,166 $ 141,737 $ 312,822 $ 289,532 Salary and employee benefits expense increased $2.3 million and $5.0 million for the three and six months ended June 30, 2020 , respectively. As compared to second quarter 2019 , the increase was largely due to additional salaries related to bank branch and other operational staff retained from the Oritani acquisition and higher accrued cash incentive compensation. These additional expenses were partially offset by cost reductions from our ongoing branch transformation efforts and other operational improvements over the last 12 months. The increase for the six months ended June 30, 2020 as compared to the same period in 2019 was also partly driven by a $1.8 million special bonus paid to hourly employees impacted by COVID-19 that was incurred in the first quarter of 2020. Net occupancy and equipment expense increased $3.5 million and $8.1 million for the three and six months ended June 30, 2020 , respectively, as compared to the same periods of 2019 . These increases were mostly due to additional costs associated with branches and other facilities acquired from Oritani, which were partially offset by costs savings from branch closures over the last 12 months. During the three and six months ended June 30, 2020 , we incurred higher expenses for equipment and certain other COVID-19 related expenses which included additional cleaning services for facilities to maintain employee and customer safety. In addition, the increase for the six months June 30, 2020 was driven by rental expenses resulting from a sale leaseback transaction completed towards the end of the first quarter of 2019. Amortization of other intangibles increased $2.5 million and $3.7 million for the three and six months ended June 30, 2020 , respectively, as compared to the same periods of 2019 largely due to higher amortization expense of loan servicing rights and core deposit intangible amortization acquired in the recent Oritani acquisition. See Note 9 to the consolidated financial statements for more details. Professional and legal fees increased $3.7 million and $4.5 million for the three and six months ended June 30, 2020 , respectively, as compared to the same periods of 2019 , largely due to higher costs from technology transformation consulting services and remote work readiness costs incurred in the second quarter 2020. Amortization of tax credit investments decreased $1.4 million and $5.4 million for the three and six months ended June 30, 2020 , respectively, as compared to the same periods of 2019 . The first half of 2019 included a $2.4 million impairment charge related to investments in three federal renewable energy tax credit funds sponsored by DC Solar. The remainder of the variances from the prior periods were mainly due to normal differences in the timing and 65 amount of such investments and recognition of the related tax credits. Tax credit investments, while negatively impacting the level of our operating expenses and efficiency ratio, produce tax credits that reduce our income tax expense and effective tax rate. See Note 14 to the consolidated financial statements for more details on our tax credit investments. Other non-interest expense increased $3.1 million and $8.0 million for the three and six months ended June 30, 2020 , respectively, as compared to the same periods of 2019 . The increases were primarily due to incrementally higher operating expenses in several categories due to the expansion of our operations both organically and through the acquisition of Oritani in the fourth quarter 2020, certain PPP loan costs, such as advertising, and other COVID-19 related costs. Net gains on the sales of OREO properties also declined $583 thousand and $1.3 million for the three and six months ended June 30, 2020, respectively, as compared to the same periods of 2019. Efficiency Ratio The efficiency ratio measures total non-interest expense as a percentage of net interest income plus total non-interest income. We believe this non-GAAP measure provides a meaningful comparison of our operational performance and facilitates investors’ assessments of business performance and trends in comparison to our peers in the banking industry. Our overall efficiency ratio, and its comparability to some of our peers, is negatively impacted by the amortization of tax credit investments, as well as infrequent charges within non-interest income and expense. The following table presents our efficiency ratio and a reconciliation of the efficiency ratio adjusted for certain items during the three and six months ended June 30, 2020 and 2019 : Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 ($ in thousands) Total non-interest expense $ 157,166 $ 141,737 $ 312,822 $ 289,532 Less: Severance expense (pre-tax) — — — 4,838 Less: Amortization of tax credit investments (pre-tax) 3,416 4,863 6,644 12,036 Less: Merger related expenses (pre-tax) 366 35 1,668 35 Total non-interest expense, adjusted $ 153,384 $ 136,839 $ 304,510 $ 272,623 Net interest income $ 282,559 $ 220,234 $ 547,898 $ 438,882 Total non-interest income 44,830 27,603 86,227 135,276 Less: Gain on sale-leaseback transaction (pre-tax) — — — 78,505 Add: Losses (gains) on securities transactions, net (pre-tax) 41 (11 ) 81 21 Add: Net impairment losses on securities (pre-tax) — 2,928 — 2,928 Total net interest income and non-interest income $ 327,430 $ 250,754 $ 634,206 $ 498,602 Efficiency ratio 48.01 % 57.19 % 49.33 % 50.43 % Efficiency ratio, adjusted 46.84 % 54.57 % 48.01 % 54.68 % Income Taxes Income tax expense totaled $33.5 million for the second quarter 2020 as compared to $29.1 million and $27.5 million for the first quarter 2020 and second quarter 2019 , respectively. Our effective tax rate was 25.9 percent , 25.0 percent and 26.5 percent for the second quarter 2020 , first quarter 2020 and second quarter 2019 , respectively. The slightly higher effective tax rate in the second quarter 2020 as compared to the first quarter 2020 was primarily attributable to higher pre-tax income in second quarter 2020 . The CARES Act did not have a material impact on our reported income tax expense for the six months ended June 30, 2020. U.S. GAAP requires that any change in judgment or change in measurement of a tax position taken in a prior annual period be recognized as a discrete event in the quarter in which it occurs, rather than being recognized as a change in effective tax rate for the current year. Our adherence to these tax guidelines may result in volatile effective income tax rates in future quarterly and annual periods. Factors that could impact management’s judgment include changes in income, tax laws and regulations, and tax planning strategies. Business Segments We have four business segments that we monitor and report on to manage our business operations. These segments are consumer lending, commercial lending, investment management, and corporate and other adjustments. Our reportable segments have been determined based upon Valley’s internal structure of operations and lines of business. Each business segment is reviewed routinely for its asset growth, contribution to income before income taxes and return on average interest earning assets and impairment (if events or circumstances indicate a possible inability to realize the carrying amount). Expenses related to the branch network, all other components of retail banking, along with the back office departments of our subsidiary bank are allocated from the corporate and other adjustments segment to each of the other three business segments. Interest expense and internal transfer expense (for general corporate expenses) are allocated to each business segment utilizing a transfer pricing methodology, which involves the allocation of operating and funding costs based on each segment's respective mix of average earning assets and/or liabilities outstanding for the period. The financial reporting for each segment contains allocations and reporting in line with our operations, which may not necessarily be comparable to any other financial institution. The accounting for each segment includes internal accounting policies designed to measure consistent and reasonable financial reporting and may result in income and expense measurements that differ from amounts under U.S. GAAP. Furthermore, changes in management structure or allocation methodologies and procedures may result in changes in reported segment financial data. The following tables present the financial data for each business segment for the three months ended June 30, 2020 and 2019 : Three Months Ended June 30, 2020 Consumer Lending Commercial Lending Investment Management Corporate and Other Adjustments Total ($ in thousands) Average interest earning assets $ 7,214,368 $ 24,826,832 $ 5,737,187 $ — $ 37,778,387 Income (loss) before income taxes 29,561 102,567 7,530 (10,591 ) 129,067 Annualized return on average interest earning assets (before tax) 1.64 % 1.65 % 0.52 % N/A 1.37 % Three Months Ended June 30, 2019 Consumer Lending Commercial Lending Investment Management Corporate and Other Adjustments Total ($ in thousands) Average interest earning assets $ 6,756,322 $ 18,796,093 $ 4,324,969 $ — $ 29,877,384 Income (loss) before income taxes 18,658 90,652 6,917 (12,227 ) 104,000 Annualized return on average interest earning assets (before tax) 1.10 % 1.93 % 0.64 % N/A 1.39 % Consumer Lending This segment, representing approximately 22.1 percent of our loan portfolio at June 30, 2020 , is mainly comprised of residential mortgage loans and automobile loans, and to a lesser extent, home equity loans, secured personal lines of credit and other consumer loans (including credit card loans). The duration of the residential mortgage loan 66 portfolio (which represented 13.6 percent of our loan portfolio at June 30, 2020 ) is subject to movements in the market level of interest rates and forecasted prepayment speeds. The weighted average life of the automobile loans (representing 4.2 percent of total loans at June 30, 2020 ) is relatively unaffected by movements in the market level of interest rates. However, the average life may be impacted by new loans as a result of the availability of credit within the automobile marketplace and consumer demand for purchasing new or used automobiles. The consumer lending segment also includes the Wealth Management and Insurance Services Division, comprised of trust, asset management, and insurance services. Average interest earning assets in this segment increased $458.0 million to $7.2 billion for the three months ended June 30, 2020 as compared to the second quarter 2019 . The increase was largely due to approximately $255 million of loans acquired from Oritani, loan growth from residential mortgage loan originations for investment over most of the last 12 month period, as well as solid demand for both automobile loans and collateralized personal lines of credit prior to the second quarter 2020 economic slowdown due to the COVID-19 pandemic. Income before income taxes generated by the consumer lending segment increased $10.9 million to $29.6 million for the second quarter 2020 as compared to the second quarter 2019 largely due to an $11.1 million increase in net interest income mainly driven by lower funding costs and the increase in average loans. The increase in net interest income was partially offset by increases of $2.2 million and $2.0 million in the provision for loan losses and non-interest expense, respectively. The increase in non-interest expense was partly due to higher amortization expense of loan servicing rights for the three months ended June 30, 2020 as compared to the second quarter 2019 . The increase in the provision for loan losses for the second quarter 2020 as compared to the second quarter 2019 was mainly due to the impact of the adverse economic forecast caused by COVID-19 included in our estimate of lifetime expected credit losses for this segment. See further details in the "Allowance for Credit Losses" section of this MD&A. The net interest margin on the consumer lending portfolio increased 44 basis points to 3.05 percent for the second quarter 2020 as compared to the second quarter 2019 mainly due to a 74 basis point decrease in the costs associated with our funding sources, partially offset by a 30 basis point decrease in the yield on average loans. The decrease in our funding costs was mainly due to both deposits and borrowings continuing to reprice at lower interest rates and the prepayment of the $635 million high cost FHLB advances in December 2019. The 30 basis point decrease in loan yield was largely due to lower yielding new loan volumes. See the "Executive Summary" and the "Net Interest Income" sections above for more details on our net interest margin and funding sources. Commercial Lending The commercial lending segment is comprised of floating rate and adjustable rate commercial and industrial loans and construction loans, as well as fixed rate owner occupied and commercial real estate loans. Due to the portfolio’s interest rate characteristics, commercial lending is Valley’s business segment that is most sensitive to movements in market interest rates. Commercial and industrial loans totaled approximately $6.9 billion and represented 21.3 percent of the total loan portfolio at June 30, 2020 . Commercial real estate loans and construction loans totaled $18.3 billion and represented 56.6 percent of the total loan portfolio at June 30, 2020 . Average interest earning assets in this segment increased approximately $6.0 billion to $24.8 billion for the three months ended June 30, 2020 as compared to the second quarter 2019 . The increase was mostly due to strong organic loan growth within the commercial and industrial and commercial real estate loan portfolios over most of the last 12-month period, including $2.2 billion of PPP loans originated in the second quarter 2020 , as well as loans acquired from Oritani during the fourth quarter 2019. For the three months ended June 30, 2020 , income before income taxes for the commercial lending segment increased $11.9 million to $102.6 million as compared to the same quarter 2019 mainly due to increases in both net interest income and non-interest income. Net interest income increased $50.3 million to $214.5 million for the second quarter 2020 as compared to the same period in 2019 largely due to higher average loan balances. Non-interest income increased $8.5 million to $16.2 million during the three months ended June 30, 2020 as compared to 67 the second quarter 2019 mainly due to a $9.3 million increase in swap fee income related to derivative interest rate swaps executed with commercial loan customers. The positive impact of the aforementioned items was partially offset by a $36.8 million increase in the provision for credit losses mainly due to the adverse economic forecast for lifetime expected credit losses, higher specific reserves associated with our tax medallion loan portfolio and additional qualitative management adjustments to reflect the potential for higher levels of credit stress for COVID-19 impacted borrowers. Internal transfer expense also increase d $13.1 million for the second quarter 2020 as compared to the second quarter 2019 partly due to acquired and organic growth in our business since June 30, 2019. The net interest margin for this segment decreased 3 basis points to 3.46 percent for the second quarter 2020 as compared to the first quarter 2019 largely due to a 77 basis point decrease in the yield on average loans, partially offset by a 74 basis point decrease in the cost of our funding sources. I nvestment Management The investment management segment generates a large portion of our income through investments in various types of securities and interest-bearing deposits with other banks. These investments are mainly comprised of fixed rate securities and, depending on our liquid cash position, federal funds sold and interest-bearing deposits with banks (primarily the Federal Reserve Bank of New York) as part of our asset/liability management strategies. The fixed rate investments are one of Valley’s least sensitive assets to changes in market interest rates. However, a portion of the investment portfolio is invested in shorter-duration securities to maintain the overall asset sensitivity of our balance sheet. See the “Asset/Liability Management” section below for further analysis. Average interest earning assets in this segment increased $1.4 billion during the second quarter 2020 as compared to the second quarter 2019 primarily due to a $1.3 billion increase in average interest bearing deposits with banks and, to a lesser extent, an increase in the investment securities portfolio. The increase in average overnight interest bearing deposits with banks was primarily caused by our prudent strategy to increase our excess liquidity during second quarter 2020 , as well as the normal timing of loan and investment activity, including SBA PPP loan originations within the commercial lending segment. For the quarter ended June 30, 2020 , income before income taxes for the investment management segment increased $613 thousand to $7.5 million as compared to the second quarter 2019 mainly due to a $923 thousand increase in net interest income. The net interest margin for this segment decreased 29 basis points to 1.28 percent for the second quarter 2020 as compared to the same quarter 2019 largely due to a 103 basis point decrease in the yield on average investments, partially offset by a 74 basis point decrease in costs associated with our funding sources. The decrease in the yield on average investments as compared to the second quarter 2019 was mainly due to repayment and prepayment of higher yield residential mortgage-backed securities, increased premium amortization and lower yielding new investments purchased over the last 12 months, and higher levels of average overnight investments at a yield of 11 basis points during the second quarter 2020. Corporate and other adjustments The amounts disclosed as “corporate and other adjustments” represent income and expense items not directly attributable to a specific segment, including net securities gains and losses not reported in the investment management segment above, interest expense related to subordinated notes, amortization and impairment of tax credit investments, as well as non-core items, including merger expenses. The corporate segment recognized a $10.6 million and $12.2 million pre-tax loss for the three months ended June 30, 2020 and 2019 , respectively. Lower pre-tax loss for the second quarter 2020 was mainly due to a $1.3 million increase in non-interest income. Non-interest expense increased $16.0 million and was more than offset by a $16.4 million increase in internal transfer income for the three months ended June 30, 2020 from the second quarter 2019 . See further details in the "Non-Interest Income" and "Non-Interest Expense" sections of this MD&A. 68 The following tables present the financial data for each business segment for the six months ended June 30, 2020 and 2019 : Six Months Ended June 30, 2020 Consumer Lending Commercial Lending Investment Management Corporate and Other Adjustments Total ($ in thousands) Average interest earning assets $ 7,215,756 $ 23,804,558 $ 5,205,918 $ — $ 36,226,232 Income (loss) before income taxes 45,802 205,362 15,360 (21,060 ) 245,464 Annualized return on average interest earning assets (before tax) 1.27 % 1.73 % 0.59 % N/A 1.36 % Six Months Ended June 30, 2019 Consumer Lending Commercial Lending Investment Management Corporate and Other Adjustments Total ($ in thousands) Average interest earning assets $ 6,788,511 $ 18,615,885 $ 4,316,619 $ — $ 29,721,015 Income before income taxes 37,713 173,164 15,659 47,990 274,526 Annualized return on average interest earning assets (before tax) 1.11 % 1.86 % 0.73 % N/A 1.85 % Consumer Lending Average interest earning assets in this segment increased $427.2 million to $7.2 billion for the six months ended June 30, 2020 as compared to the same period in 2019 . The increase was largely due to approximately $255 million of loans acquired from Oritani, loan growth from residential mortgage loan originations for investment over most of the last 12 month period, as well as solid demand for both automobile loans and collateralized personal lines of credit prior to the second quarter 2020 economic slowdown due to the COVID-19 pandemic. Income before income taxes generated by the consumer lending segment increased $8.1 million to $45.8 million for the six months ended June 30, 2020 as compared to the same period in 2019 largely due to increases of $14.2 million and $5.0 million in net interest income and non-interest income, respectively. The increase in net interest income was mainly driven by lower funding costs and the increase in average loans. The increase in non-interest income was largely attributable to higher net gains on sales of loans for the six months ended June 30, 2020 as compared to the same period in 2019 . The positive impact of the aforementioned items was partially offset by increases of $6.9 million and $3.2 million in provision for loan losses and non-interest expense, respectively. The increase in the provision for loan losses for the first half of 2020 as compared to the same period of 2019 was mainly due to the adverse economic forecast caused by COVID-19 included in our estimate of lifetime expected credit losses for this segment. See further details in the "Allowance for Credit Losses" section of this MD&A. The net interest margin on the consumer lending portfolio increased 23 basis points to 2.88 percent for the six months ended June 30, 2020 as compared to the same period one year ago mainly due to a 49 basis point decrease in the costs associated with our funding sources, partially offset by a 26 basis point decrease in the yield on average loans. The decrease in our funding costs was mainly due to both deposits and borrowings continuing to reprice at lower interest rates and the prepayment of the $635 million high cost FHLB advances in December 2019. The 26 basis point decrease in loan yield was largely due to lower yielding new loan volumes. 69 Commercial Lending Average interest earning assets in this segment increased $5.2 billion to $23.8 billion for the six months ended June 30, 2020 as compared to the same period in 2019 . This increase was primarily due to organic loan growth over most of the last 12-month period, including SBA PPP loans originations of $2.2 billion in the second quarter 2020 , and loans acquired from Oritani. For the six months ended June 30, 2020 , income before income taxes for the commercial lending segment increased $32.2 million to $205.4 million as compared to the same period in 2019 . Net interest income increased $93.6 million to $417.2 million for the six months ended June 30, 2020 as compared to the same period in 2019 largely due to the higher average loan balances. Non-interest income also increased $17.3 million for the six months ended June 30, 2020 as compared to the same period in 2019 due, in part, to a $19.4 million increase in fee income related to derivative interest rate swaps executed with commercial loan customers. The positive impact of the aforementioned items was partially offset by a $58.0 million increase in the provision for credit losses to $65.1 million during the six months ended June 30, 2020 as compared to $7.1 million for the same period in 2019 . The increase in the provision for credit losses mainly due to the adverse economic forecast for lifetime expected credit losses during the first half of 2020, higher specific reserves for tax medallion loans and qualitative adjustments for potential credit stress related to COVID-19 impacted borrowers. See further details in the "Allowance for Credit Losses" section in this MD&A. The net interest margin for this segment increased 3 basis points to 3.51 percent for the six months ended June 30, 2020 as compared to the same period in 2019 due to a 49 basis point decrease in the cost of our funding sources, partially offset by a 46 basis point decrease in yield on average loans. I nvestment Management Average interest earning assets in this segment increased $889.3 million during the six months ended June 30, 2020 as compared to the same period in 2019 largely due to increases of $796.2 million and $93.1 million in average interest bearing deposits with banks and average investments, respectively. The increase in overnight investments and deposits with other banks was largely due to our higher levels of excess liquidity during the second quarter 2020. For the six months ended June 30, 2020 , income before income taxes for the investment management segment moderately decreased $299 thousand to $15.4 million as compared to the same period in 2019 . Net interest income increase d $934 thousand during the six months ended June 30, 2020 as compared to the same period of 2019 but was partially offset by a $800 thousand provision for credit losses for debt securities held to maturity during the first half of 2020 under the new CECL standard. Non-interest income increased $4.3 million to $9.0 million for the six months ended June 30, 2020 as compared to the same period of 2019 partly due to higher bank owned life insurance income. However, internal transfer expense increase d $4.0 million for the six months ended June 30, 2020 as compared to the same period of 2019. The net interest margin for this segment decreased 25 basis points to 1.42 percent for the six months ended June 30, 2020 as compared to the same period in 2019 largely due to a 74 basis point decrease in the yield on average investments, partially offset by a 49 basis point decrease in costs associated with our funding sources. The decrease in the yield on average investments as compared to the same period of 2019 was mainly due to repayment and prepayment of higher yield residential mortgage-backed securities, increased premium amortization and lower yielding new investments purchased over the last 12 months, and low yielding excess liquidity held in overnight investments. Corporate and other adjustments The pre-tax net loss for the corporate segment totaled $21.1 million for the six months ended June 30, 2020 as compared to the net income of $48.0 million for the same period in 2019 . The negative change of $69.1 million was mainly due to a decrease in non-interest income coupled with an increase in non-interest expense. The non-interest 70 income decreased $75.7 million to $13.6 million for the six months ended June 30, 2020 as compared to the same period in 2019 primarily due to a $78.5 million gain on the sale (and leaseback) of several bank locations recognized during the first half of 2019. Non-interest expense increased $23.5 million to $224.1 million for the six months ended June 30, 2020 as compared to the six months ended June 30, 2019 largely due to increases in net occupancy and equipment expense, salaries and employee benefits expenses and professional and legal fees. (See further details in the "Non-Interest Expense" section above). Internal transfer income increased $29.8 million to $199.5 million for the six months ended June 30, 2020 as compared to the same period in 2019 . ASSET/LIABILITY MANAGEMENT Interest Rate Sensitivity Our success is largely dependent upon our ability to manage interest rate risk. Interest rate risk can be defined as the exposure of our interest rate sensitive assets and liabilities to the movement in interest rates. Our Asset/Liability Management Committee is responsible for managing such risks and establishing policies that monitor and coordinate our sources and uses of funds. Asset/Liability management is a continuous process due to the constant change in interest rate risk factors. In assessing the appropriate interest rate risk levels for us, management weighs the potential benefit of each risk management activity within the desired parameters of liquidity, capital levels and management’s tolerance for exposure to income fluctuations. Many of the actions undertaken by management utilize fair value analysis and attempt to achieve consistent accounting and economic benefits for financial assets and their related funding sources. We have predominantly focused on managing our interest rate risk by attempting to match the inherent risk and cash flows of financial assets and liabilities. Specifically, management employs multiple risk management activities such as optimizing the level of new residential mortgage originations retained in our mortgage portfolio through increasing or decreasing loan sales in the secondary market, product pricing levels, the desired maturity levels for new originations, the composition levels of both our interest earning assets and interest bearing liabilities, as well as several other risk management activities. We use a simulation model to analyze net interest income sensitivity to movements in interest rates. The simulation model projects net interest income based on various interest rate scenarios over a 12-month and 24-month period. The model is based on the actual maturity and re-pricing characteristics of rate sensitive assets and liabilities. The model incorporates certain assumptions which management believes to be reasonable regarding the impact of changing interest rates and the prepayment assumptions of certain assets and liabilities as of June 30, 2020 . The model assumes immediate changes in interest rates without any proactive change in the composition or size of the balance sheet, or other future actions that management might undertake to mitigate this risk. In the model, the forecasted shape of the yield curve remains static as of June 30, 2020 . The impact of interest rate derivatives, such as interest rate swaps, is also included in the model. Our simulation model is based on market interest rates and prepayment speeds prevalent in the market as of June 30, 2020 . Although the size of Valley’s balance sheet is forecasted to remain static as of June 30, 2020 in our model, the composition is adjusted to reflect new interest earning assets and funding originations coupled with rate spreads utilizing our actual originations during the second quarter 2020 . The model also utilizes an immediate parallel shift in market interest rates at June 30, 2020 . The assumptions used in the net interest income simulation are inherently uncertain. Actual results may differ significantly from those presented in the table below due to the frequency and timing of changes in interest rates and changes in spreads between maturity and re-pricing categories. Overall, our net interest income is affected by changes in interest rates and cash flows from our loan and investment portfolios. We actively manage these cash flows in conjunction with our liability mix, duration and interest rates to optimize the net interest income, while structuring the balance sheet in response to actual or potential changes in interest rates. Additionally, our net interest income is impacted by the level of competition within our marketplace. Competition can negatively impact the level of interest rates attainable on loans and increase the cost of deposits, which may result in downward pressure on our net interest margin in future periods. Other factors, including, but not limited to, the slope of the yield curve and 71 projected cash flows will impact our net interest income results and may increase or decrease the level of asset sensitivity of our balance sheet. Convexity is a measure of how the duration of a financial instrument changes as market interest rates change. Potential movements in the convexity of bonds held in our investment portfolio, as well as the duration of the loan portfolio may have a positive or negative impact on our net interest income in varying interest rate environments. As a result, the increase or decrease in forecasted net interest income may not have a linear relationship to the results reflected in the table below. Management cannot provide any assurance about the actual effect of changes in interest rates on our net interest income. The following table reflects management’s expectations of the change in our net interest income over the next 12- month period in light of the aforementioned assumptions. While an instantaneous and severe shift in interest rates was used in this simulation model, we believe that any actual shift in interest rates would likely be more gradual and would therefore have a more modest impact than shown in the table below. Estimated Change in Future Net Interest Income Changes in Interest Rates Dollar Change Percentage Change (in basis points) ($ in thousands) +200 $ 63,164 5.55 % +100 35,521 3.12 –100 (21,298 ) (1.87 ) As noted in the table above, a 100 basis point immediate increase in interest rates combined with a static balance sheet where the size, mix, and proportions of assets and liabilities remain unchanged is projected to increase net interest income over the next 12 months by 3.12 percent. Valley's sensitivity to changes in market rates as compared to March 31, 2020 is mostly due to the significant changes in items included in interest income and Valley's slightly asset sensitive profile. Management believes the interest rate sensitivity remains within an acceptable tolerance range at June 30, 2020 and sees the likelihood of rates decreasing further as a minimal risk whereas an increase in rates longer term has a higher probability of occurrence. However, the level of net interest income sensitivity may increase or decrease in the future as a result of changes in deposit and borrowings strategies, the slope of the yield curve and projected cash flows. Liquidity Bank Liquidity Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A bank’s liquidity reflects its ability to meet loan demand, to accommodate possible outflows in deposits and to take advantage of interest rate opportunities in the marketplace. Liquidity management is carefully performed and routinely reported by our Treasury Department to the Investment Committee established by the Board of Directors and also to the Asset and Liability Committee. Among other actions, Treasury reviews historical funding requirements, current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments. Our goal is to maintain sufficient liquidity to cover current and potential funding requirements. The Bank has no required regulatory liquidity ratios to maintain; however, it adheres to an internal liquidity policy. The current policy maintains that we may not have a ratio of loans to deposits in excess of 110 percent or reliance on wholesale funding greater than 25 percent of total funding. The Bank was in compliance with the foregoing policies at June 30, 2020 . During March 2020, Valley activated a contingent funding plan to prudently increase our liquidity position in response to the financial and public health crisis caused by the COVID-19 pandemic. At June 30, 2020 , our cash 72 and cash equivalents totaled $1.9 billion, an increase from $1.0 billion at March 31, 2020. In the early stage of the third quarter 2020, we continue to believe that holding excess liquidity is prudent given the uncertain environment that we currently face. Going forward, we will closely monitor external events and adjust our mix and levels of funding accordingly. See the "Deposits and Other Borrowings" section and Note 10 to the consolidated financial statements for more information. On the asset side of the balance sheet, the Bank has numerous sources of liquid funds in the form of cash and due from banks, interest bearing deposits with banks (including the Federal Reserve Bank of New York), investment securities held to maturity that are maturing within 90 days or would otherwise qualify as maturities if sold (i.e., 85 percent of original cost basis has been repaid), investment securities available for sale, loans held for sale, and from time to time, federal funds sold and receivables related to unsettled securities transactions. Total liquid assets were approximately $3.8 billion , representing 10.1 percent of earning assets at June 30, 2020 and $2.2 billion , representing 6.4 percent of earning assets at December 31, 2019 . Of the $3.8 billion of liquid assets at June 30, 2020 , approximately $1.1 billion of various investment securities were pledged to counterparties to support our earning asset funding strategies. We anticipate the receipt of approximately $1.1 billion in principal payments from securities in the total investment portfolio over the next 12 months due to normally scheduled principal repayments and expected prepayments of certain securities, primarily residential mortgage-backed securities. Additional liquidity is derived from scheduled loan payments of principal and interest, as well as prepayments received. Loan principal payments (including loans held for sale at June 30, 2020 ) are projected in accordance with their scheduled contractual terms to be approximately $8.8 billion over the next 12 months. As a contingency plan for any liquidity constraints, liquidity could also be derived from the sale of conforming residential mortgages from our loan portfolio or alleviated from the temporary curtailment of lending activities. On the liability side of the balance sheet, we utilize multiple sources of funds to meet liquidity needs, including retail and commercial deposits, brokered and municipal deposits, and short-term and long-term borrowings. Our core deposit base, which generally excludes fully insured brokered deposits and both retail and brokered certificates of deposit over $250 thousand, represents the largest of these sources. Average core deposits totaled approximately $24.8 billion and $20.4 billion for the six months ended June 30, 2020 and for the year ended December 31, 2019 , respectively, representing 68.3 percent and 66.8 percent of average earning assets for the respective periods. The level of interest bearing deposits is affected by interest rates offered, which is often influenced by our need for funds and the need to match the maturities of assets and liabilities. Additional funding may be provided through deposit gathering networks and in the form of federal funds purchased through our well established relationships with numerous correspondent banks. While there are no firm lending commitments currently in place, management believes that we could borrow approximately $1.2 billion for a short term from these banks on a collective basis. The Bank is also a member of the Federal Home Loan Bank of New York (FHLB) and has the ability to borrow from them in the form of FHLB advances secured by pledges of certain eligible collateral, including but not limited to U.S. government and agency mortgage-backed securities and a blanket assignment of qualifying first lien mortgage loans, consisting of both residential mortgage and commercial real estate loans. Furthermore, we can obtain overnight borrowings from the FRB via the discount window as a contingency for additional liquidity. At June 30, 2020 , our traditional borrowing capacity, excluding PPP loans, under the Federal Reserve's discount window was $1.6 billion . We also have access to other short-term and long-term borrowing sources to support our asset base, such as repos (i.e., securities sold under agreements to repurchase). Short-term borrowings (consisting of FHLB advances, repos, and from time to time, federal funds purchased) increased approximately $1.0 billion to $2.1 billion at June 30, 2020 , as compared to December 31, 2019 . The increase in both short-term borrowings was primarily driven by our goal to increase liquidity levels in response to the COVID-19 crisis, as well as funding of SBA PPP loan originations in the second quarter 2020. As of June 30, 2020 , the short-term borrowings mainly consisted of FHLB advances totaling $1.2 billion with a weighted interest rate of 0.55 percent and federal funds purchased totaling $678.9 million. 73 Average short-term FHLB advances exceeded 30 percent of total shareholders' equity at June 30, 2020 and December 31, 2019 , respectively. The following table sets forth information regarding Valley’s short-term FHLB advances at the dates and for the year to date periods ended June 30, 2020 and December 31, 2019 : June 30, 2020 December 31, 2019 ($ in thousands) FHLB advances: Average balance outstanding $ 1,383,104 $ 1,681,844 Maximum outstanding at any month-end during the period 1,930,000 2,510,000 Balance outstanding at end of period 1,235,000 940,000 Weighted average interest rate during the period 0.28 % 1.88 % Weighted average interest rate at the end of the period 0.55 1.85 Corporation Liquidity Valley’s recurring cash requirements primarily consist of dividends to preferred and common shareholders and interest expense on subordinated notes and junior subordinated debentures issued to capital trusts. As part of our on-going asset/liability management strategies, Valley could also use cash to repurchase shares of its outstanding common stock under its share repurchase program or redeem its callable junior subordinated debentures. These cash needs are routinely satisfied by dividends collected from the Bank. Projected cash flows from the Bank are expected to be adequate to pay preferred and common dividends, if declared, and interest expense payable to subordinated note holders and capital trusts, given the current capital levels and current profitable operations of the Bank. In addition to dividends received from the Bank, Valley can satisfy its cash requirements by utilizing its own cash and potential new funds borrowed from outside sources or capital issuances. Valley also has the right to defer interest payments on the junior subordinated debentures, and therefore distributions on its trust preferred securities for consecutive quarterly periods up to five years, but not beyond the stated maturity dates, and subject to other conditions. Valley's ability to maintain quarterly dividends to its preferred and common shareholders is heavily dependent on the ability of its principal subsidiary, the Bank, to pay dividends to Valley. However, we cannot accurately predict the extent of the economic decline due to COVID-19 or other factors that may result in inadequate earnings (primarily by the Bank), regulatory restrictions and limitations, changes in our capital requirements, or a decision to increase capital by retention of earnings, that may result in Valley's inability or determination by its Board not to pay dividends at current levels, or at all. Investment Securities Portfolios As of June 30, 2020 , we had $54.4 million , $1.7 billion and $2.1 billion in equities, available for sale debt securities and held to maturity debt securities, respectively. Our equity securities portfolio was comprised of a money market mutual fund and, to a lesser extent, investments in public and private Community Reinvestment Act funds. Our held to maturity and available for sale debt securities portfolios were comprised of U.S. Treasury securities, U.S. government agency securities, tax-exempt and taxable issuances of states and political subdivisions (including special revenue bonds), residential mortgage-backed securities, single-issuer trust preferred securities principally issued by bank holding companies, and high quality corporate bonds issued by banks at June 30, 2020 . There were no securities in the name of any one issuer exceeding 10 percent of shareholders’ equity, except for residential mortgage-backed securities issued by Ginnie Mae and Fannie Mae. Additionally, certain securities with limited marketability and/or restrictions, such as FHLB and FRB stocks, are carried at cost and are included in other assets. See Note 7 to the consolidated financial statements for additional information. Allowance for Credit Losses and Impairment Analysis Effective January 1, 2020, Valley adopted ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments", which requires an estimate of lifetime expected credit 74 losses for held to maturity debt securities established as an allowance for credit losses and replaces the other-than-temporarily impaired model for available for sale debt securities. Available for sale debt securities. The new guidance in ASC Topic 326-30 requires credit losses to be presented as an allowance, rather than as a write-down if management does not intend to sell an available for sale debt security before recovery of its amortized cost basis. Available for sale debt securities in unrealized loss positions are evaluated for impairment related to credit losses at least quarterly. In assessing whether a credit loss exists, we compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount the fair value is less than amortized cost basis. Declines in fair value that have not been recorded through an allowance for credit losses, such as declines due to changes in market interest rates, are recorded through other comprehensive income, net of applicable taxes. We have evaluated all available for sale debt securities that are in an unrealized loss position as of June 30, 2020 and determined that the declines in fair value are mainly attributable to changes in market volatility, due to factors such as interest rates and spread factors, but not attributable to credit quality or other factors. Based on a comparison of the present value of expected cash flows to the amortized cost, management recognized no impairment charges during the three and six months ended June 30, 2020 and, as a result, no allowance for credit losses for available for sale debt securities at June 30, 2020 . Held to maturity debt securities. As discussed in Note 7 to the consolidated financial statements, Valley has a zero loss expectation for certain securities within the held to maturity portfolio, including, U.S. Treasury securities, U.S. agency securities, residential mortgage-backed securities issued by Ginnie Mae, Fannie Mae and Freddie Mac, and collateralized municipal bonds. To measure the expected credit losses on held to maturity debt securities that have loss expectations, Valley estimates the expected credit losses using a discounted cash flow model developed by a third party. Assumptions used in the model for pools of securities with common risk characteristics include the historical lifetime probability of default and severity of loss in the event of default, with the model incorporating several economic cycles of loss history data to calculate expected credit losses given default at the individual security level. At June 30, 2020 , held to maturity debt securities were carried net of allowance for credit losses totaling $1.6 million . We recorded a provision of $41 thousand and $800 thousand during three and six months ended June 30, 2020 , respectively, and no net charge-offs of debt securities in the respective periods. See Note 7 to the consolidated financial statements for additional information regarding our available for sale and held to maturity securities. The investment grades in the table below reflect the most current independent analysis performed by third parties of each security as of the date presented and not necessarily the investment grades at the date of our purchase of the securities. For many securities, the rating agencies may not have performed an independent analysis of the tranches owned by us, but rather an analysis of the entire investment pool. For this and other reasons, we believe the assigned investment grades may not accurately reflect the actual credit quality of each security and should not be viewed in isolation as a measure of the quality of our investment portfolio. 75 The following table presents the held to maturity and available for sale investment securities portfolios by investment grades at June 30, 2020 : June 30, 2020 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (in thousands) Held to maturity investment grades: * AAA Rated $ 1,802,760 $ 61,704 $ (309 ) $ 1,864,155 AA Rated 199,665 6,870 — 206,535 A Rated 16,032 462 — 16,494 BBB Rated 5,000 348 — 5,348 Non-investment grade 5,686 — (232 ) 5,454 Not rated 104,284 403 (7,797 ) 96,890 Total investment securities held to maturity $ 2,133,427 $ 69,787 $ (8,338 ) $ 2,194,876 Available for sale investment grades: * AAA Rated $ 1,471,623 $ 46,898 $ (955 ) $ 1,517,566 AA Rated 53,538 864 (28 ) 54,374 A Rated 17,777 416 — 18,193 BBB Rated 24,389 588 (21 ) 24,956 Non-investment grade 11,828 51 (475 ) 11,404 Not rated 62,122 1,168 (395 ) 62,895 Total investment securities available for sale $ 1,641,277 $ 49,985 $ (1,874 ) $ 1,689,388 * Rated using external rating agencies. Ratings categories include the entire range. For example, “A rated” includes A+, A, and A-. Split rated securities with two ratings are categorized at the higher of the rating levels. The investment securities held to maturity portfolio includes $104.3 million in investments not rated by the rating agencies with aggregate unrealized losses of $7.8 million at June 30, 2020 . The unrealized losses for this category included $7.5 million of unrealized losses related to four single-issuer bank trust preferred issuances with a combined amortized cost of $36.0 million . 76 Loan Portfolio The following table reflects the composition of the loan portfolio as of the dates presented: June 30, 2020 March 31, 2020 December 31, 2019 September 30, 2019 June 30, 2019 ($ in thousands) Loans Commercial and industrial $ 6,884,689 $ 4,998,731 $ 4,825,997 $ 4,695,608 $ 4,615,765 Commercial real estate: Commercial real estate 16,571,877 16,390,236 15,996,741 13,365,454 12,798,017 Construction 1,721,352 1,727,046 1,647,018 1,537,590 1,528,968 Total commercial real estate 18,293,229 18,117,282 17,643,759 14,903,044 14,326,985 Residential mortgage 4,405,147 4,478,982 4,377,111 4,133,331 4,072,450 Consumer: Home equity 471,115 481,751 487,272 489,808 501,646 Automobile 1,369,489 1,436,734 1,451,623 1,436,608 1,362,466 Other consumer 890,942 914,587 913,446 908,760 922,850 Total consumer loans 2,731,546 2,833,072 2,852,341 2,835,176 2,786,962 Total loans * $ 32,314,611 $ 30,428,067 $ 29,699,208 $ 26,567,159 $ 25,802,162 As a percent of total loans: Commercial and industrial 21.3 % 16.5 % 16.2 % 17.7 % 17.9 % Commercial real estate 56.6 59.5 59.5 56.1 55.5 Residential mortgage 13.6 14.6 14.7 15.5 15.8 Consumer loans 8.5 9.4 9.6 10.7 10.8 Total 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % * Includes net unearned discount and deferred loan fees of $131.3 million and $76.4 million at June 30, 2020 and March 31, 2020 , respectively, and net unearned premiums and deferred loan fees of $12.6 million , $18.3 million and $19.6 million at December 31, 2019 , September 30, 2019 and June 30, 2019, respectively. Net unearned discounts and deferred loan fees at June 30, 2020 and March 31, 2020 include the non-credit discount on PCD loans as well as $62.1 million of net unearned fees related to SBA PPP loans at June 30, 2020 . Loans increased $1.9 billion to approximately $32.3 billion at June 30, 2020 from March 31, 2020 largely due to approximately $2.2 billion of SBA PPP loan originations within the commercial and industrial loan category during the second quarter 2020 , partially offset by moderate declines in residential mortgage and the consumer loan categories. During the second quarter 2020 , we originated $296 million of residential mortgage loans for sale (rather than held for investment) and sold approximately $237 million . Residential mortgage loans held for sale totaled $120.6 million and $58.9 million at June 30, 2020 and March 31, 2020 , respectively. Total commercial and industrial loans increased $1.9 billion from March 31, 2020 to approximately $6.9 billion at June 30, 2020 largely due to the $2.2 billion of SBA PPP loan originations in the second quarter. Excluding the SBA PPP loans, commercial and industrial loans decreased $328.4 million, or 26.3 percent on an annualized basis, at June 30, 2020 compared to March 31, 2020 as the lack of economic activity has weighed on loan demand in our markets. Additionally, commercial and industrial line utilization moderately declined from March 31, 2020 . Commercial real estate loans (excluding construction loans) increased $181.6 million , or 4.4 percent on an annualized basis, to $16.6 billion at June 30, 2020 from March 31, 2020 mainly due to a strong refinance market driven by historic low interest rates and slower repayment activity in the second quarter 2020. Construction loans decreased $5.7 million to $1.7 billion at June 30, 2020 from March 31, 2020 mainly due to migration of completed existing construction projects to permanent financing during the second quarter 2020. 77 Total residential mortgage loans decreased $73.8 million to approximately $4.4 billion at June 30, 2020 from March 31, 2020 largely due to higher mortgage banking sales activity. New and refinanced residential mortgage loan originations totaled approximately $494.2 million for the second quarter 2020 , as compared to $358.9 million and $347.1 million for the first quarter 2020 and second quarter 2019 , respectively. Of the total originations for the second quarter 2020 , $296 million of residential mortgage loans were originated for sale rather than held for investment and sold approximately $237 million of these loans. We expect to continue to sell a large portion of our new fixed rate residential mortgage loan originations during the remainder of 2020 assuming the low level of market interest rates continues and we are able to maintain an appropriate mix of residential mortgage loans on our balance sheet. Home equity loans totaled $471.1 million at June 30, 2020 , and decreased $10.6 million from March 31, 2020 largely due to normal repayments that outpaced new loan origination and line activity. Automobile loans decreased by $67.2 million to $1.4 billion at June 30, 2020 as compared to March 31, 2020 . The second quarter annualized decline was 18.7 percent due to lower application volumes as compared to the first quarter 2020 largely due to the COVID-19 impact. During the second quarter 2020, auto dealerships in our primary market areas were largely shut down as a result of shelter-in-place restrictions in connection with the pandemic. Our Florida dealership network contributed $14.3 million in auto loan originations, representing approximately 20 percent of Valley's total new auto loan production during the second quarter 2020 , as compared to $28.3 million, representing approximately 21 percent, during the first quarter 2020 . Other consumer loans decreased $23.6 million to $890.9 million at June 30, 2020 , as compared to $914.6 million at March 31, 2020 mostly due to lower volumes of new collateralized personal lines of credit as compared to the first quarter 2020 . Most of our lending is in northern and central New Jersey, New York City, Long Island and Florida, except for smaller auto and residential mortgage loan portfolios derived from other neighboring states of New Jersey, which could present a geographic and credit risk due to the recent economic downturn within these regions caused by the COVID-19 pandemic and the uncertain path forward to restart the U.S. economy. To mitigate our geographic risks, we make efforts to maintain a diversified portfolio as to type of borrower and loan, to guard against a potential downward turn in any one economic sector. During the second quarter COVID-related economic shutdowns in our markets have slowed both new loan originations and contractual principal and interest payments. As traditional commercial origination activity has slowed, we focused additional resources on assisting our clients through the economic crisis and managing the demands of the SBA PPP loan forgiveness. As of mid-July 2020, we had originated approximately 12,800 PPP loans with an aggregate balance of $2.3 billion before unearned loan fees and costs. Our expectation is that approximately 75 percent of loans made under this program will be either fully or partially forgiven and are expected to come off our balance sheet over the next 12 months. During the early stages of the third quarter 2020, we have seen some improved levels of commercial loan activity, solid new and refinanced residential mortgage loan volumes, as well as better auto loan applications activity from borrowers with strong credit scores. 78 Non-performing Assets Prior to our adoption of the CECL standard on January 1, 2020, our past due loans and non-accrual loans discussed further below excluded those loans which were classified as Purchased Credit-Impaired (PCI) loans. Under previous U.S. GAAP, the PCI loans (acquired at a discount that is due, in part, to credit quality) were accounted for on a pool basis and not subject to delinquency classification in the same manner as loans originated by Valley. Under the CECL standard, Valley's former PCI loan pools are accounted for as purchased credit deteriorated (PCD) loans on a loan level basis and, if applicable, are reported in our past due and non-accrual loans at June 30, 2020 and March 31, 2020 . Non-performing assets include non-accrual loans, other real estate owned (OREO), other repossessed assets (which primarily consists of automobiles and taxi medallions) and non-accrual debt securities at June 30, 2020 . Loans are generally placed on non-accrual status when they become past due in excess of 90 days as to payment of principal or interest. Exceptions to the non-accrual policy may be permitted if the loan is sufficiently collateralized and in the process of collection. OREO is acquired through foreclosure on loans secured by land or real estate. OREO and other repossessed assets are reported at the lower of cost or fair value, less estimated cost to sell. Our non-performing assets increased $3.7 million to $224.2 million at June 30, 2020 as compared to March 31, 2020 , mainly due to a $4.7 million increase in non-accrual loans, partially offset by a decline in OREO during the second quarter 2020. Non-performing assets as a percentage of total loans and non-performing assets totaled 0.69 percent and 0.72 percent at June 30, 2020 and March 31, 2020 , respectively (as shown in the table below). For additional details, see the "Credit quality indicators" section in Note 8 to the consolidated financial statements. Our lending strategy is based on underwriting standards designed to maintain high credit quality and we remain optimistic regarding the overall future performance of our loan portfolio. However, due to the potential for future credit deterioration caused by the recent downturn in economic conditions impacted by the COVID-19 pandemic and a number of our borrowers performing under short-term forbearance agreements, management cannot provide assurance that our non-performing assets will not increase substantially from the levels reported at June 30, 2020 . 79 The following table sets forth by loan category accruing past due and non-performing assets on the dates indicated in conjunction with our asset quality ratios: June 30, 2020 March 31, 2020 December 31, 2019 September 30, 2019 June 30, 2019 ($ in thousands) Accruing past due loans: * 30 to 59 days past due: Commercial and industrial $ 6,206 $ 9,780 $ 11,700 $ 5,702 $ 14,119 Commercial real estate 13,912 41,664 2,560 20,851 6,202 Construction — 7,119 1,486 11,523 — Residential mortgage 35,263 38,965 17,143 12,945 19,131 Total Consumer 12,962 19,508 13,704 13,079 11,932 Total 30 to 59 days past due 68,343 117,036 46,593 64,100 51,384 60 to 89 days past due: Commercial and industrial 4,178 7,624 2,227 3,158 4,135 Commercial real estate 1,543 15,963 4,026 735 354 Construction — 49 1,343 7,129 1,342 Residential mortgage 4,169 9,307 4,192 4,417 3,635 Total Consumer 3,786 2,309 2,527 1,577 1,484 Total 60 to 89 days past due 13,676 35,252 14,315 17,016 10,950 90 or more days past due: Commercial and industrial 5,220 4,049 3,986 4,133 3,298 Commercial real estate — 161 579 1,125 — Residential mortgage 3,812 1,798 2,042 1,347 1,054 Total Consumer 2,082 1,092 711 756 359 Total 90 or more days past due 11,114 7,100 7,318 7,361 4,711 Total accruing past due loans $ 93,133 $ 159,388 $ 68,226 $ 88,477 $ 67,045 Non-accrual loans: * Commercial and industrial $ 130,876 $ 132,622 $ 68,636 $ 75,311 $ 76,216 Commercial real estate 43,678 41,616 9,004 9,560 6,231 Construction 3,308 2,972 356 356 — Residential mortgage 25,776 24,625 12,858 13,772 12,069 Total Consumer 6,947 4,095 2,204 2,050 1,999 Total non-accrual loans 210,585 205,930 93,058 101,049 96,515 Other real estate owned (OREO) 8,283 10,198 9,414 6,415 7,161 Other repossessed assets 3,920 3,842 1,276 2,568 2,358 Non-accrual debt securities 1,365 531 680 680 680 Total non-performing assets (NPAs) $ 224,153 $ 220,501 $ 104,428 $ 110,712 $ 106,714 Performing troubled debt restructured loans $ 53,936 $ 48,024 $ 73,012 $ 79,364 $ 74,385 Total non-accrual loans as a % of loans 0.65 % 0.68 % 0.31 % 0.38 % 0.37 % Total NPAs as a % of loans and NPAs 0.69 0.72 0.35 0.41 0.41 Total accruing past due and non-accrual loans as a % of loans 0.94 1.20 0.54 0.71 0.63 Allowance for loan losses as a % of non-accrual loans 147.03 137.59 173.83 160.17 160.71 * Past due loans and non-accrual loans presented in periods prior to March 31, 2020 exclude PCI loans. PCI loans were accounted for on a pool basis and are were not subject to delinquency classification. Loans past due 30 to 59 days decreased $48.7 million to $68.3 million at June 30, 2020 as compared to March 31, 2020 due to improved performance across most categories. Commercial real estate loan delinquencies within this category decreased by $27.8 million as compared to March 31, 2020 mainly due to restored customer payments delayed by business disruptions caused by COVID-19 related factors at the end of the first quarter 2020. In addition, commercial real estate and construction loans decreased mainly due to matured performing commercial real estate and 80 construction loans totaling $4.3 million and $5.0 million, respectively, that were in the normal process of renewal reported in this category at March 31, 2020 . Loans past due 60 to 89 days decreased $21.6 million to $13.7 million at June 30, 2020 as compared to March 31, 2020 mainly due to matured performing commercial real estate and commercial and industrial loans totaling $13.8 million and $4.5 million, respectively, that were in the normal process of renewal reported in this category at March 31, 2020 . Loans past due 90 days or more and still accruing interest increased $4.0 million to $11.1 million at June 30, 2020 as compared to $7.1 million at March 31, 2020 . All of the loans past due 90 days or more and still accruing are considered to be well secured and in the process of collection. Non-accrual loans increased $4.7 million to $210.6 million at June 30, 2020 as compared to $205.9 million at March 31, 2020 . The increase in non-accrual loans was partially due to one commercial real estate loan which moved to non-accrual status during the second quarter 2020, as well as a moderately higher level of non-accrual consumer loans at June 30, 2020 . Non-accrual loans represented 0.65 percent of total loans at June 30, 2020 compared to 0.68 percent at March 31, 2020 . During the second quarter 2020 , we continued to closely monitor our New York City and Chicago taxi medallion loans totaling $99.8 million and $7.0 million, respectively, within the commercial and industrial loan portfolio at June 30, 2020 . Due to continued negative trends in market valuations of the underlying taxi medallion collateral, a weak operating environment and uncertain borrower performance, the remainder of our previously accruing taxi medallion loans were placed on non-accrual status during the first quarter 2020. At June 30, 2020 , non-accrual taxi medallion loans totaling $106.8 million had related reserves of $61.6 million within the allowance for loan losses as compared to $109.8 million with related reserves of $56.8 million at March 31, 2020 . Valley's historical taxi medallion lending criteria had been conservative regarding capping the loan amounts in relation to market valuations, as well as obtaining personal guarantees and other collateral in certain instances. However, the severe decline in the market valuation of taxi medallions has adversely affected the estimated fair valuation of these loans and, as a result, increased the level of our allowance for loan losses at June 30, 2020 (See the "Allowance for Credit Losses" section below). Potential further declines in the market valuation of taxi medallions and the stressed operating environment within both New York City and Chicago due to COVID-19 could also negatively impact the future performance of this portfolio. For example, a 25 percent decline in our current estimated market value of the taxi medallions would require additional allocated reserves of $16.0 million within the allowance for loan losses based upon the impaired taxi medallion loan balances at June 30, 2020 . OREO properties decreased $1.9 million to $8.3 million at June 30, 2020 from $10.2 million at March 31, 2020 due to sales of several properties. Sales of OREO properties resulted in net gains of $274 thousand and $431 thousand for the three and six months ended June 30, 2020 , respectively, as compared to net gains of $857 thousand and $1.7 million for the three and six months ended June 30, 2019 , respectively. The residential mortgage and consumer loans secured by residential real estate properties for which formal foreclosure proceedings are in process totaled $1.8 million at June 30, 2020 . TDRs represent loan modifications for customers experiencing financial difficulties where a concession has been granted. Performing TDRs (i.e., TDRs not reported as loans 90 days or more past due and still accruing or as non-accrual loans) increased $5.9 million to $53.9 million at June 30, 2020 as compared to $48.0 million at March 31, 2020 . Performing TDRs consisted of 87 loans at June 30, 2020 . On an aggregate basis, the $53.9 million in performing TDRs at June 30, 2020 had a modified weighted average interest rate of approximately 4.92 percent as compared to a pre-modification weighted average interest rate of 4.72 percent . Loan Forbearance. In response to the COVID-19 pandemic and its economic impact to certain customers, Valley implemented short-term loan modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant, when requested by customers. Generally, the modification terms allow for a 81 deferral of payments for up to 90 days, which Valley may extend for an additional 90 days, for a maximum of 180 days on a cumulative and successive basis. To date, Valley has granted over 10,000 loan forbearances totaling approximately $4.6 billion in support of our customers. Of these, approximately 5,000 loans totaling $1.9 billion have completed the contractual deferral period and returned to regularly scheduled payments. Higher Risk COVID-19 Credit Exposures . Valley has identified certain borrower industries as being potentially exposed to the effects of economic shutdowns related to COVID-19. These industries include doctor and surgery centers, retail trade, hotels and hospitality, restaurants and food service, and entertainment and recreation. As of June 30, 2020, Valley had outstanding loans of approximately $2.1 billion to borrowers in these industries representing approximately 7 percent of total outstanding loans. Industries that may have secondary exposure to the COVID-19 pandemic include nursing and residential care, wholesale trade, manufacturing, and child care and education. As of June 30, 2020, Valley had outstanding loans of approximately $2.4 billion to borrowers in these industries representing approximately 7.8 percent of total outstanding loans. The large majority of loans to the aforementioned industries were pass-rated under Valley’s internal risk rating system as of June 30, 2020. As of July 10, 2020, Valley had loans in forbearance representing approximately 12 percent of our loans in the aforementioned industries. Allowance for Credit Losses for Loans The allowance for credit losses for loans consists of the allowance for loan losses and the reserve for unfunded credit commitments. Effective January 1, 2020, we adopted the new CECL standard, which is based on lifetime expected credit losses rather than incurred losses. At adoption, Valley recorded a $99.6 million increase to its allowance for credit losses for loans, including reserves of $61.6 million related to PCD loans. See Note 5 to the consolidated financial statements for further details on the Day 1 CECL adoption. Our methodology to establish the allowance for loan losses has two basic components: (1) a collective (pooled) reserve component for estimated expected credit losses for pools of loans that share similar risk characteristics and (2) an individual reserve component for loans that do not share risk characteristics, consisting of collateral dependent, TDR, and expected TDR loans. Valley also maintains a separate allowance for unfunded credit commitments mainly consisting of undisbursed non-cancellable lines of credit, new loan commitments and commercial letters of credit. In estimating the component of the allowance on a collective basis we use a transition matrix model which calculates an expected life of loan loss percentage for each loan pool by generating probability of default and loss given default metrics. The metrics are based on the migration of loans from performing to loss by credit quality rating or delinquency categories using historical life-of-loan analysis periods for each loan portfolio pool and the severity of loss based on the aggregate net lifetime losses incurred. The model's expected losses based on loss history are adjusted for qualitative factors. Among other things, these adjustments include and account for differences in: (i) lending policies and procedures, (ii) current business conditions and economic developments that affect the loan collectability; (iii) concentration risks by size, type, and geography (iv) the potential volume and migration of of loan forbearances to non-performing s tatus , and (v) the effect of external factors such as legal and regulatory requirements on the level of estimated credit losses in the existing portfolio. Valley utilizes a two-year reasonable and supportable forecast period followed by a one-year period over which estimated losses revert to historical loss experience for the remaining life of the loan. The forecasts consist of a multi-scenario economic forecast model to estimate future credit losses and is governed by a cross-functional committee. The committee meets each quarter to determine which economic scenarios developed by Moody's will be incorporated into the model, as well as the relative probability weightings of the selected scenarios, based upon all readily available information. The model projects economic variables under each scenario based on detailed statistical analyses. We have identified and selected key variables that most closely correlated to our historical credit performance, which include: GDP, unemployment and the Case-Shiller Home Price Index. 82 For the second quarter 2020, we continued to incorporate a probability weighted three-scenario economic forecast, including Moody's Baseline, S-3 and S-4 scenarios. The S-4 forecast is the most severe economic scenario and includes the following assumptions: • Assumes that the COVID-19 crisis will persist and continue to meaningfully impact the economy; • National unemployment rate will remain elevated throughout the remainder of the year and peak at 13.2 percent in the fourth quarter 2021; • Federal funds interest rates will remain at or near zero for foreseeable future; and • A prolonged downturn in the economy until the fourth quarter 2021. The allowance for credit losses for loans methodology and accounting policy are fully described in Note 8 to the consolidated financial statements. 83 The table below summarizes the relationship among loans, loans charged-off, loan recoveries, the provision for credit losses and the allowance for credit losses for loans for the periods indicated. Three Months Ended Six Months Ended June 30, 2020 March 31, 2020 June 30, 2019 June 30, 2020 June 30, 2019 ($ in thousands) Average loans outstanding $ 32,041,200 $ 29,999,428 $ 25,552,415 $ 31,020,314 $ 25,404,396 Beginning balance - Allowance for credit losses for loans 293,361 164,604 158,961 164,604 156,295 Impact of ASU No. 2016-13 adoption on January 1, 2020 (1) — 37,989 — 37,989 — Allowance for purchased credit deteriorated (PCD) loans (1) — 61,643 — 61,643 — Beginning balance, adjusted 293,361 264,236 158,961 264,236 156,295 Loans charged-off: (2) Commercial and industrial (14,024 ) (3,360 ) (3,073 ) (17,384 ) (7,355 ) Commercial real estate (27 ) (44 ) — (71 ) — Residential mortgage (5 ) (336 ) — (341 ) (15 ) Total Consumer (2,601 ) (2,565 ) (1,752 ) (5,166 ) (3,780 ) Total charge-offs (16,657 ) (6,305 ) (4,825 ) (22,962 ) (11,150 ) Charged-off loans recovered: Commercial and industrial 799 569 1,195 1,368 1,678 Commercial real estate 31 73 22 104 43 Construction 20 20 — 40 — Residential mortgage 545 50 9 595 10 Total Consumer 509 794 617 1,303 1,103 Total recoveries 1,904 1,506 1,843 3,410 2,834 Net charge-offs (14,753 ) (4,799 ) (2,982 ) (19,552 ) (8,316 ) Provision charged for credit losses 41,115 33,924 2,100 75,039 10,100 Ending balance - Allowance for credit for losses $ 319,723 $ 293,361 $ 158,079 $ 319,723 $ 158,079 Components of allowance for credit losses for loans: Allowance for loan losses $ 309,614 $ 283,342 $ 155,105 $ 309,614 $ 155,105 Allowance for unfunded credit commitments 10,109 10,019 2,974 10,109 2,974 Allowance for credit losses for loans $ 319,723 $ 293,361 $ 158,079 $ 319,723 $ 158,079 Components of provision for credit losses for loans: Provision for credit losses for loans $ 41,025 $ 33,851 $ 3,706 $ 74,876 $ 11,562 Provision for unfunded credit commitments (3) 90 73 (1,606 ) 163 (1,462 ) Total provision for credit losses for loans $ 41,115 $ 33,924 $ 2,100 $ 75,039 $ 10,100 Annualized ratio of net charge-offs to average loans outstanding 0.18 % 0.06 % 0.05 % 0.13 % 0.07 % (1) The adjustment represents an increase in the allowance for credit losses for loans as a result of the adoption of ASU 2016-13 effective January 1, 2020. (2) Charge-offs and recoveries presented for periods prior to March 31, 2020 exclude loans formerly accounting for as PCI loans. (3) Periods prior to March 31, 2020 represent the allowance and provision for unfunded letters of credit only . 84 Net loan charge-offs totaled $14.8 million for the second quarter 2020 as compared to $4.8 million and $3.0 million for the first quarter 2020 and second quarter 2019 , respectively. The increase in net loan charge-offs was largely due to the partial charge-off of one commercial and industrial loan totaling $7.8 million for the second quarter 2020 . Additionally, gross loan charge-offs related to taxi medallion loans totaled $3.2 million, $1.3 million and $2.3 million for the second quarter 2020 , first quarter 2020 and second quarter 2019 , respectively. The overall level of loan charge-offs (as presented in the above table) continues to trend within management's expectations for the credit quality of the loan portfolio. During the second quarter 2020 , we recorded a $41.1 million provision for credit losses as compared to $33.9 million and $2.1 million for the first quarter 2020 and the second quarter 2019 , respectively. The second quarter 2020 provision mainly reflects the reserve build caused by deterioration in Valley's view of the macroeconomic outlook since the end of the first quarter, higher specific reserves associated with our taxi medallion loan portfolio and additional qualitative management adjustments to reflect the potential for higher levels of credit stress for COVID-19 impacted borrowers. The following table summarizes the allocation of the allowance for credit losses for loans to loan portfolio categories and the allocations as a percentage of each loan category: June 30, 2020 March 31, 2020 June 30, 2019 Allowance Allocation * Allocation as a % of Loan Category Allowance Allocation* Allocation as a % of Loan Category Allowance Allocation* Allocation as a % of Loan Category ($ in thousands) Loan Category: Commercial and Industrial loans $ 132,039 1.92 % $ 127,437 2.55 % $ 94,384 2.11 % Commercial real estate loans: Commercial real estate 117,743 0.71 % 97,876 0.60 % 23,796 0.19 % Construction 13,959 0.81 % 13,709 0.79 % 25,182 1.65 % Total commercial real estate loans 131,702 0.72 % 111,585 0.62 % 48,978 0.34 % Residential mortgage loans 29,630 0.67 % 29,456 0.66 % 5,219 0.13 % Consumer loans: Home equity 4,766 1.01 % 4,463 0.93 % 505 0.10 % Auto and other consumer 11,477 0.51 % 10,401 0.44 % 6,019 0.26 % Total consumer loans 16,243 0.59 % 14,864 0.52 % 6,524 0.23 % Total allowance for loan losses 309,614 0.96 % 283,342 0.93 % 155,105 0.60 % Allowance for unfunded credit commitments 10,109 10,019 2,974 Total allowance for credit losses for loans $ 319,723 $ 293,361 $ 158,079 Allowance for credit losses for loans as a % loans 0.99 % 0.96 % 0.61 % * CECL was adopted January 1, 2020. Prior periods reflect the allowance for credit losses for loans under the incurred loss model. The allowance for credit losses for loans, comprised of our allowance for loan losses and unfunded credit commitments, as a percentage of total loans was 0.99 percent , 0.96 percent and 0.61 percent at June 30, 2020 , March 31, 2020 and June 30, 2019 , respectively. At June 30, 2020 , the allowance allocations for credit losses as a percentage of total loans increased for most loan categories as compared to March 31, 2020 . However, the allocated reserves as a percentage of commercial and industrial loans declined by 0.63 percent due to $2.2 billion of SBA PPP loans with no related allowance at June 30, 2020 . PPP loans originated in the second quarter 2020 are 100 percent guaranteed by the SBA and totaled approximately $2.2 billion at June 30, 2020 . Our allowance of credit losses for loans as a percentage of non-PPP loans was 1.06 percent at June 30, 2020 . 85 Capital Adequacy A significant measure of the strength of a financial institution is its shareholders’ equity. At June 30, 2020 and December 31, 2019 , shareholders’ equity totaled approximately $4.5 billion and $4.4 billion , which represented 10.7 percent and 11.7 percent of total assets, respectively. During the six months ended June 30, 2020 , total shareholders’ equity increased by $90.3 million primarily due to (i) net income of $182.9 million , (ii) an increase in other comprehensive income of $27.3 million , and (iii) a $4.4 million increase attributable to the effect of our stock incentive plan. These positive changes were partially offset by (i) cash dividends declared on common and preferred stock totaling a combined $96.1 million , and (ii) a $28.2 million net cumulative effect adjustment to retained earnings for the adoption of new accounting guidance as of January 1, 2020. Valley and Valley National Bank are subject to the regulatory capital requirements administered by the FRB and the OCC. Quantitative measures established by regulation to ensure capital adequacy require Valley and Valley National Bank to maintain minimum amounts and ratios of common equity Tier 1 capital, total and Tier 1 capital to risk-weighted assets, and Tier 1 capital to average assets, as defined in the regulations. We are required to maintain common equity Tier 1 capital to risk-weighted assets ratio of 4.5 percent , Tier 1 capital to risk-weighted assets ratio of 6.0 percent , ratio of total capital to risk-weighted assets of 8.0 percent , and minimum leverage ratio of 4.0 percent , plus a 2.5 percent capital conservation buffer added to the minimum requirements for capital adequacy purposes. As of June 30, 2020 and December 31, 2019 , Valley and Valley National Bank exceeded all capital adequacy requirements (see tables below). For regulatory capital purposes, in connection with the Federal Reserve Board’s final interim rule as of April 3, 2020, 100 percent of the CECL Day 1 impact to shareholders' equity equaling $28.2 million after-tax will be deferred over a two-year period ending January 1, 2022, at which time it will be phased in on a pro-rata basis over a three-year period ending January 1, 2025. Additionally, 25 percent of the reserve build (i.e., provision for credit losses less net charge-offs) net of taxes for the six months ended June 30, 2020 will be phased in over the same time frame. 86 The following table presents Valley’s and Valley National Bank’s actual capital positions and ratios under Basel III risk-based capital guidelines at June 30, 2020 and December 31, 2019 : Actual Minimum Capital Requirements To Be Well Capitalized Under Prompt Corrective Action Provision Amount Ratio Amount Ratio Amount Ratio ($ in thousands) As of June 30, 2020 Total Risk-based Capital Valley $ 3,672,021 12.19 % $ 3,162,478 10.50 % N/A N/A Valley National Bank 3,688,957 12.25 3,161,772 10.50 $ 3,011,211 10.00 % Common Equity Tier 1 Capital Valley 2,864,828 9.51 2,108,319 7.00 N/A N/A Valley National Bank 3,385,605 11.24 2,107,848 7.00 1,957,287 6.50 Tier 1 Risk-based Capital Valley 3,079,669 10.23 2,560,101 8.50 N/A N/A Valley National Bank 3,385,605 11.24 2,559,530 8.50 2,408,969 8.00 Tier 1 Leverage Capital Valley 3,079,669 7.70 1,599,880 4.00 N/A N/A Valley National Bank 3,385,605 8.47 1,599,569 4.00 1,999,461 5.00 As of December 31, 2019 Total Risk-based Capital Valley $ 3,427,134 11.72 % $ 3,070,687 10.50 % N/A N/A Valley National Bank 3,416,674 11.69 3,069,894 10.50 $ 2,923,709 10.00 % Common Equity Tier 1 Capital Valley 2,754,524 9.42 2,047,125 7.00 N/A N/A Valley National Bank 3,152,070 10.78 2,046,596 7.00 1,900,411 6.50 Tier 1 Risk-based Capital Valley 2,968,530 10.15 2,485,795 8.50 N/A N/A Valley National Bank 3,152,070 10.78 2,485,153 8.50 2,338,967 8.00 Tier 1 Leverage Capital Valley 2,968,530 8.76 1,355,378 4.00 N/A N/A Valley National Bank 3,152,070 9.31 1,354,693 4.00 1,693,366 5.00 Tangible book value per common share is computed by dividing shareholders’ equity less preferred stock, goodwill and other intangible assets by common shares outstanding as follows: June 30, 2020 December 31, 2019 ($ in thousands, except for share data) Common shares outstanding 403,795,699 403,278,390 Shareholders’ equity $ 4,474,488 $ 4,384,188 Less: Preferred stock 209,691 209,691 Less: Goodwill and other intangible assets 1,453,330 1,460,397 Tangible common shareholders’ equity $ 2,811,467 $ 2,714,100 Tangible book value per common share $ 6.96 $ 6.73 Book value per common share $ 10.56 $ 10.35 87 Management believes the tangible book value per common share ratio provides information useful to management and investors in understanding our underlying operational performance, our business and performance trends and facilitates comparisons with the performance of others in the financial services industry. This non-GAAP financial measure should not be considered in isolation or as a substitute for or superior to financial measures calculated in accordance with U.S. GAAP. This non-GAAP financial measure may also be calculated differently from similar measures disclosed by other companies. Typically, our primary source of capital growth is through retention of earnings. Our rate of earnings retention is derived by dividing undistributed earnings per common share by earnings (or net income available to common stockholders) per common share. Our retention ratio was approximately 50.0 percent for the six months ended June 30, 2020 as compared to 49.4 percent for the year ended December 31, 2019 . Cash dividends declared amounted to $0.22 per common share for each of the six months ended June 30, 2020 and 2019 . The Board is committed to examining and weighing relevant facts and considerations, including its commitment to shareholder value, each time it makes a cash dividend decision. The Federal Reserve has cautioned all bank holding companies about distributing dividends which may reduce the level of capital or not allow capital to grow considering the increased capital levels as required under the Basel III rules. Prior to the date of this filing, Valley has received no objection or adverse guidance from the FRB or the OCC regarding the current level of its quarterly common stock dividend. However, the FRB recently reiterated its long-standing guidance that banking organizations should consult them before declaring dividends in excess of earnings for the corresponding quarter. The renewed guidance was largely due to the increased risk of the COVID-19 pandemic negatively impacting the future level of bank earnings. See the risk factors at Part II, Item 1A of this report for additional information. Off-Balance Sheet Arrangements, Contractual Obligations and Other Matters For a discussion of Valley’s off-balance sheet arrangements and contractual obligations see information included in Valley’s Annual Report on Form 10-K for the year ended December 31, 2019 in the MD&A section - “Contractual Obligations and Off-Balance Sheet Arrangements” and Notes 12 and 13 to the consolidated financial statements included in this report. Item 3. Quantitative and Qualitative Disclosures About Market Risk Market risk refers to potential losses arising from changes in interest rates, foreign exchange rates, equity prices, and commodity prices. Valley’s market risk is composed primarily of interest rate risk. See page 71 for a discussion of interest rate sensitivity.