VALLEY NATIONAL BANCORP 10-K

Item 7. Management’s Discussion and Analysis (MD&A) of Financial Condition and Results of Operations The purpose of this analysis is to provide the reader with information relevant to understanding and assessing Valley’s results of operations and financial condition for each of the past two years. In order to fully appreciate this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing under Item 8 of this report, and statistical data presented in this document. For comparison of our results of operations for the years ended December 31, 2019 and 2018, please refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of our Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 10, 2020. Cautionary Statement Concerning Forward-Looking Statements This report, both in 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 our business, new and existing programs and products, acquisitions, relationships, opportunities, taxation, technology, market conditions and economic expectations. These statements may be identified by such forward-looking terminology as “should,” “expect,” “believe,” “view,” “opportunity,” “allow,” “continues,” “reflects,” “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 in addition to those risk factors listed under the “Risk Factors” section in Part1, Item 1A of this Annual Report on Form 10-K include, but are not limited to: • the impact of COVID-19 on the U.S. and global economies, including business disruptions, reductions in employment and an increase in business failures, specifically among our clients; • 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 may arise in our primary markets; • 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 actions 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; 33 2020 Form 10-K • 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. Critical Accounting Policies and Estimates Our accounting and reporting policies conform, in all material respects, to U.S. GAAP. In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of financial condition and results of operations for the periods indicated. Actual results could differ materially from those estimates. Valley’s accounting policies are fundamental to understanding management’s discussion and analysis of its financial condition and results of operations. Our significant accounting policies are presented in Note 1 to the consolidated financial statements. We identified our policies for the allowance for credit losses, goodwill and other intangible assets, and income taxes to be critical 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. Management has reviewed the application of these policies with the Audit Committee of Valley’s Board of Directors. The judgments used by management in applying the critical accounting policies discussed below may be affected by significant changes in the economic environment, which may result in changes to future financial results. Specifically, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in material changes in the allowance for credit losses in future periods, and the inability to collect on outstanding loans could result in increased loan losses. Allowance for Credit Losses . Determining the allowance for credit losses for loans has historically been identified as a critical accounting estimate. On January 1, 2020, we ado pted 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 for loans was recognized based on probable incurred losses. See Notes 1, 4 and 5 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 is 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 2020 Form 10-K 34 • 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. Changes in Our Allowance for Credit Losses for Loans Valley considers it difficult to quantify the impact of changes in forecast on its allowance for credit losses. However, management believes the following discussion may enable investors to better understand the variables that drive the allowance for credit losses for loans, which amounted to $340.2 million at December 31, 2020. 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 December 31, 2020. As a result of the deterioration in economic conditions caused by the COVID-19 pandemic during 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, approximately $50.2 million of the $87.2 million increase in our allowance for credit losses for loans from January 1, 2020 reflected the impact of the adverse economic forecast within Valley's lifetime expected credit loss estimate, as well as other qualitative factors. Specific reserves, largely based upon management's valuation of collateral for collateral dependent loans and the present value of expected cash flows for certain troubled debt restructured loans, and quantitative reserves, based upon expected and actual transitions in the credit quality of our loan portfolio, represented $20.9 million and $16.1 million, respectively, of the remaining increase in reserves at December 31, 2020. In addition, the valuation of certain collateral dependent loans (including New York City taxi medallion loan valuations based on the estimated value of the underlying medallions) could be adversely impacted by illiquidity or dislocation in certain markets, resulting in depressed market valuations of the underlying collateral, thus leading to additional provisions for loan losses. Goodwill and Other Intangible Assets. We have significant goodwill and other intangible assets related to our acquisitions totaling $1.4 billion and $70.4 million at December 31, 2020, respectively. We record all assets, liabilities, and non-controlling interests in the target in purchase acquisitions, including goodwill and other intangible assets, at fair value as of the acquisition date, and expense all acquisition related costs as incurred as required by ASC Topic 805, “Business Combinations.” The initial recording of goodwill and other intangible assets requires subjective judgments concerning estimates of the fair value of the acquired assets and assumed liabilities. Goodwill is subject to annual tests for impairment or more often, if events or circumstances indicate it may be impaired. Our determination of whether or not goodwill is impaired requires us to make significant judgments and to use significant estimates and assumptions regarding estimated future cash flows. If we change our strategy or if market conditions shift, our judgments may change, which may result in adjustments to the recorded goodwill balance. Other intangible assets are amortized over their estimated useful lives and are subject to impairment tests if events or circumstances indicate a possible inability to realize the carrying amount. Such evaluation of other intangible assets is based on undiscounted cash flow projections. On January 1, 2020, we adopted ASU No. 2017-04 intended to simplify the goodwill impairment test by eliminating a second step which required an entity to determine the implied fair value of the reporting unit’s goodwill. Instead, an impairment loss is now recognized if the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, with the impairment loss not to exceed the amount of goodwill recorded. We perform our annual goodwill impairment test in the second quarter of each year, or more often if events or circumstances warrant. In addition to the annual impairment test, we assessed the impact of the COVID-19 pandemic on macroeconomic variables and economic forecasts and how those might impact the fair value of our reporting units each quarter end. After consideration of these variables and other possible triggering events or circumstances, as well as our operating results, we determined it was more-likely-than-not that the fair values of our four reporting units, wealth management, consumer lending, commercial lending, and investment management, were in excess of their carrying values during 2020. Therefore, we concluded there were no triggering events that would require additional goodwill impairment test of the reporting units during 2020. Based upon Valley’s 2020 annual goodwill impairment testing, the fair values of its four reporting units were in excess of their carrying values. In 2021, we will continue to monitor and evaluate the impact of COVID-19 and its impact on our market capitalization, overall economic conditions, and any triggering events that may indicate a possible impairment of goodwill allocated to our reporting units. While not expected at this time, we may be required to record a charge to earnings should there 35 2020 Form 10-K be a deficiency in our estimated fair value of one or more of our reporting units during our subsequent annual (or more frequent) impairment tests. See the "Business Segments" section for more information regarding our business segments/reporting units. Fair value is determined using certain discounted cash flow and market multiple methods. Estimated cash flows may extend far into the future and, by their nature, are difficult to determine over an extended timeframe. Factors that may materially affect the estimates include, among others, impact of the COVID-19 pandemic on macroeconomic variables and economic forecasts, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, and changes in discount rates, growth rate, terminal values, and specific industry or market sector conditions. To assist in assessing the impact of potential goodwill or other intangible assets impairment charges at December 31, 2020, the impact of a five percent impairment charge on these intangible assets would result in a reduction in pre-tax income of approximately $72.6 million. See Note 8 to the consolidated financial statements for additional information regarding goodwill and other intangible assets. Income Taxes. We are subject to the income tax laws of the U.S., its states and municipalities. The income tax laws of the jurisdictions in which we operate are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities. In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws to our business activities, as well as the timing of when certain items may affect taxable income. Our interpretations may be subject to review during examination by taxing authorities and disputes may arise over the respective tax positions. We attempt to resolve these disputes during the tax examination and audit process and ultimately through the court systems when applicable. We monitor relevant tax authorities and revise our estimate of accrued income taxes due to changes in income tax laws and their interpretation by the courts and regulatory authorities on a quarterly basis. Revisions of our estimate of accrued income taxes also may result from our own income tax planning and from the resolution of income tax controversies. Such revisions in our estimates may be material to our operating results for any given quarter. The provision for income taxes is composed of current and deferred taxes. Deferred taxes arise from differences between assets and liabilities measured for financial reporting versus income tax return purposes. Deferred tax assets are recognized if, in management’s judgment, their realizability is determined to be more likely than not. We perform regular reviews to ascertain the realizability of our deferred tax assets. These reviews include management’s estimates and assumptions regarding future taxable income, which also incorporate various tax planning strategies. In connection with these reviews, if we determine that a portion of the deferred tax asset is not realizable, a valuation allowance is established. Management determined it is more likely than not that Valley will realize its net deferred tax assets, except for immaterial valuation allowances, as of December 31, 2020 and 2019. We also maintain a reserve related to certain tax positions that management believes contain an element of uncertainty. An uncertain tax position is measured based on the largest amount of benefit that management believes is more likely than not to be realized. During 2020 and 2019, our income tax expense reflected $1.5 million and $31.1 million increases to our tax provision related to reserve for uncertain tax liability positions and/or accrued interest related to such positions at December 31, 2020 and 2019, respectively, as compared to a $3.3 million net state tax benefit in 2018 related to the reduction of reserves at December 31, 2018 caused by the expiration of the statute of limitations for certain tax positions. See Notes 1 and 13 to the consolidated financial statements and the "Executive Summary" and “Income Taxes” sections in this MD&A for an additional discussion on the accounting for income taxes. New Authoritative Accounting Guidance. See Note 1 of the consolidated financial statements for a description of recent accounting pronouncements including the dates of adoption and the anticipated effect on our results of operations and financial condition. Executive Summary Company Overview. At December 31, 2020, Valley had consolidated total assets of $40.7 billion, total net loans of $31.9 billion, total deposits of $31.9 billion and total shareholders’ equity of $4.6 billion. Our commercial bank operations include branch office locations in northern and central New Jersey, the New York City boroughs of Manhattan, Brooklyn and Queens, Long Island, Florida and Alabama. Of our curr ent 226 branch network, 58 percent, 17 percent, 18 percent and 7 percent of th e branches are located 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) and its wholly-owned subsidiary, Oritani Bank on December 1, 2019. See Note 2 to the consolidated financial statements for more information regarding the Oritani acquisition. 2020 Form 10-K 36 Impact of COVID-19. The spread of 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 in the United States and globally, including the markets that we serve. While the overall level of economic activity has improved in the second half of 2020 following the steep economic downturn in second quarter 2020, certain industries and businesses continue to be adversely impacted with a significant loss of their normal revenue streams and continue to experience business interruptions. Our outlook, which remains unchanged from the end of the third quarter 2020 indicates continued macroeconomic deterioration with higher levels of credit stress related to borrowers impacted by COVID-19 and lower valuations of collateral securing our non-performing taxi medallion loan portfolio. Uncertainties and disruptions resulting from the COVID-19 pandemic slowed our traditional new commercial loan volumes and the loan balances for residential and many consumer loan products saw moderate declines in t he second half of 2020, primarily as a result of the higher level of residential mortgage loans originated for sale due to our current interest rate risk manag ement strategies. Any sustained economic downturn due to COVID-19 and other factors, or other long-term changes in consumer and business behaviors from COVID-19 may adversely impact the value of assets that serve as collateral for our loans. The 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 facilitated approximately 13,000 SBA-approved PPP loans with balances totaling $2.2 billion as of December 31, 2020. While difficult to accurately predict, we expect the majority of these loans to be forgiven in accordance with rules, application and documentation requirements for this program. The Consolidated Appropriations Act, 2021, which was signed into law on December 27, 2020 (Appropriations Act), provides approximately $900 billion in new COVID-19 stimulus relief partly comprised of additional funding under the PPP. The Appropriations Act also expanded borrower eligibility under the PPP to certain second draws under the program. During the first quarter 2021, Valley has approved PPP loan ap plications totaling approximately $534 million within its pipeline, and originated $499 million of such loans through February 19, 2021. Our future PPP loan originations may ultimately be less than the approved loan application pipeline due to normal underwriting contingencies. We have reopened all bank branches in our network that were either temporarily closed or had reduced lobby services due to COVID-19. However, we continue to act with an abundance of caution in order to safeguard the health and wellness of our customers and employees and may limit capacity in our branch locations and/or require scheduled appointments in the future. We continue to closely monitor local conditions in the areas we serve and will take actions as circumstances warrant, which may necessitate certain branch or other office closures and reduced lobby services. Our business continuity plan continues to remain in effect with many of our non-customer facing employees continuing to work remotely as we 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 and in accordance with provisions set forth by the CARES Act, 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. Any extensions beyond this period were made in accordance with applicable regulatory guidance. As of December 31, 2020, Valley had $361 million of outstanding loans remaining in their payment deferral period under short-term modifications. The $361 million of loans in deferral represented approximately 1.1 percent of our total loan portfolio at December 31, 2020, having decreased significantly from approximately $1.1 billion, or 3.3 percent of total loans, near the start of the third quarter 2020. Significant uncertainties persist as to the impact of future economic conditions and stress on our customers. The severe adverse economic pressures, coupled with the implementation of an expected loss methodology for determining our provision for credit losses as required by CECL, contributed to a sharply increased provision for credit losses for the year ended December 31, 2020, following our initial adoption of CECL on January 1, 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 first quarter 2021 and beyond is highly uncertain. See the "Operating Environment" section of MD&A for more details. Branch Transformation. As previously disclosed, Valley has embarked on a strategy to continuously overhaul its retail network. Approximately two years 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 37 2020 Form 10-K implemented tailored action plans focused on improving profitability and deposit levels, as well as upgrades in staffing and training, within a defined ti meline. During 2020, we permanently closed an additional 16 branches located in New Jersey, including the consolidation of 11 acquired Oritani bran ches into nearby legacy Valley branch es, and 2 Florida branches. We also permanently closed one New Jersey branch in the first quarter 2021. For the overall 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. Annual Results . Net income totaled $390.6 million, or $0.93 per diluted common share, for the year ended December 31, 2020 compared to $309.8 million in 2019, or $0.87 per diluted common share. The increase in net income compared to 2019 was largely due to: • a $220.9 million, or 24.6 percent, increase in our net interest income driven primarily by a $5.6 billion increase in average loan balances and a sharp reduction in interest rates of 85 basis points on the cost of total interest bearing liabilities resulting from the low interest environment, partially offset by loan yields that were 53 basis points lower and interest expense related to a $3.9 billion increase in average interest bearing liabilities; and • a $7.5 million decrease in income tax expense largely due to a $31.1 million addition to our reserves for uncertain tax positions in 2019, partially offset by increased income taxes mostly caused by higher 2020 pre-tax income; partially offset by • a $101.5 million increase in our provision for credit losses for loans due to the CECL adoption and the impact of the COVID-19 pandemic on the model results; • a $31.5 million decrease in non-interest income, due in large part to a $78.5 million gain on the sale (and leaseback) of certain Bank properties recognized in 2019, partially offset by a $23.3 million increase in the gain on sale of residential mortgage loans, as well as swap fee income which increased $25.6 million to $59.0 million for 2020; and • a $14.6 million increase in non-interest expense largely due to higher levels of expense related to our expanded franchise following the Oritani acquisition on December 1, 2019 and the COVID-19 pandemic, partially offset by a $20.0 million decrease in the loss on extinguishment of debt and a $7.1 million decrease in the amortization of tax credit investments. See the “Net Interest Income,” “Non-Interest Income,” “Non-Interest Expense,” and “Income Taxes” sections below for more details on the items above and other infrequent items, including merger expenses and the loss on extinguishment of debt, impacting our 2020 annual results. Operating Environment. During 2020, real gross domestic product declined 3.5 percent compared to an increase of 2.2 percent in 2019. The decline in growth was driven by decreases in household consumption, exports, restocking of inventories, business fixed investment and state and local government spending. These decreases were partially offset by increases in residential fixed investment and federal government spending, particularly from non-defense spending, which supported economic activity. To support economic activity, the Federal Reserve reduced the target range for the federal funds rate in the first half of 2020 and began purchasing Treasury securities and agency residential and commercial mortgage-backed securities. As of the dated of this report, the target range for the federal funds rate is between zero and 0.25 percent. The Federal Reserve indicated at its recent meeting that the current stance of monetary policy is appropriate to support a return to sustained expansion of economic activity. The 10-year U.S. Treasury note yield ended 2020 at 0.93 percent, or 99 basis points lower as compared to December 31, 2019. The spread between the 2- and 10-year U.S. Treasury note yields ended the year at 0.80 percent, or 46 basis points higher, compared to the end of 2019. For all commercial banks in the U.S., loans and leases grew approximately 3.5 percent from December 31, 2019 to December 31, 2020. For the industry, banks reported that demand for most commercial loan products had declined sharply compared to the end of 2019. The decline was broad-based across commercial real estate lending and loans to middle market firms. However, banks reported sharply higher demand for residential mortgage loans, particularly those related to jumbo products. Additionally, the industry reported that underwriting standards had generally tightened significantly for both commercial and residential loans. Valley’s commercial and industrial originations in 2020 were primarily driven by loans associated with PPP. In addition, Valley continued to see solid demand for residential mortgage loans across its geographies during most of 2020. However, the path of economic activity is highly contingent on the progress made in combating COVID-19. Should health conditions warrant more widespread restrictions to business activity, spending and investment would 2020 Form 10-K 38 be adversely impacted. Therefore, if conditions remain subdued it could weigh on the Bank’s future financial results, as highlighted below in the MD&A. Loans. Total loans increased by $2.5 billion to $32.2 billion at December 31, 2020 from December 31, 2019 largely due to $2.2 billion of SBA PPP loans classified as commercial and industrial loans, as well as growth in commercial mortgage loans (including construction loans) which increased $827.1 million, or 4.7 percent during the year ended December 31, 2020. The residential mortgage category and most consumer loan categories experienced moderate declines during the year ended December 31, 2020 due to the impact of COVID-19 pandemic and a higher level of residential mortgage loans originated for sale. During the year ended December 31, 2020, we originated $1.2 billion of residential mortgage loans for sale rather than held for investment. Loans held for sale totaled $301.4 million and $76.1 million at December 31, 2020 and 2019, respectively. Asset Quality. Prior to our adoption of the CECL standard on January 1, 2020, our past due loans and non-accrual loans which are discussed further below, excluded those loans which were classified as purchased credit impaired (PCI) loans. Under the new standard, Valley's former PCI loans are accounted for as purchased credit deteriorated (PCD) loans and, if applicable, are reported in our past due and non-accrual categories at December 31, 2020. Total non-performing assets (NPAs), consisting of non-accrual loans, other real estate owned (OREO), other repossessed assets and non-accrual debt security increased $90.1 million, or 86.3 percent to $194.6 million at December 31, 2020 as compared to December 31, 2019. This increase was largely due to non-accrual PCD loans totaling approximately $45 million reported at December 31, 2020 and higher non-accrual taxi medallion loans within the commercial and industrial category. Non-accrual loans totaled $185.3 million, or 0.58 percent of our entire loan portfolio of $32.2 billion, at December 31, 2020 as compared to $93.1 million, or 0.31 percent of total loans, at December 31, 2019. Total accruing past due loans (i.e., loans past due 30 days or more and still accruing interest) increased $30.8 million to $99.0 million, or 0.31 percent of total loans at December 31, 2020 as compared to $68.2 million, or 0.23 percent of total loans, at December 31, 2019. The increase was largely due to an increase in early stage delinquencies in commercial real estate category as well as approximately $11 million of accruing past due loans PCD loans reported at December 31, 2020. 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 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 December 31, 2020. See the “Non-performing Assets” section below for further analysis of our asset quality. Deposits and Other Borrowings . Our mix of total deposits at December 31, 2020 as compared to December 31, 2019 reflects the shift in customer preference for deposits without stated maturities resulting from the uncertainties stemming from the COVID-19 pandemic and the low interest rates offered on our time deposits. Additionally, PPP loan originations were deposited into customers' checking accounts which increased the proportion of non-interest bearing deposits in our overall deposit mix. Average non-interest bearing deposits represented approximately 27 percent of total average deposits for the year ended December 31, 2020, whereas savings, NOW and money market accounts were 47 percent and time deposits were 26 percent of total average deposits for the year ended December 31, 2020. Average non-interest bearing deposits, savings, NOW and money market accounts, and time deposits were 25 percent, 45 percent, and 30 percent, respectively, for the year ended December 31, 2019. Average total deposits for the year ended December 31, 2020 as compared to 2019 increased by $5.4 billion due, in large part, to the aforementioned PPP loan proceeds, as well as our continuous efforts to encourage new and existing loan borrowers to maintain deposit accounts at Valley, including government deposits. Ending balances of brokered deposits (consisting of both time and money market deposit accounts) were $3.1 billion and $4.1 billion at December 31, 2020 and 2019, respectively. 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 December 31, 2020. Additionally, the vast majority of the PPP loan customers that are Valley depositors are expected to continue to use PPP funds for qualifying payroll and other costs over an 8 to 24 week total period to obtain loan forgiveness . The resulting outflow of funds for such expenditures may contribute to lower levels of deposit balances in 2021. Average short-term borrowings decreased $448.7 million to $1.6 billion for 2020 as compared to 2019 largely due to the success of our retail and government deposit gathering efforts and a moderate shift into long-term borrowings. Average long-term borrowings increased $899.0 million to approximately $2.9 billion for 2020 as compared to 2019 largely due to new FHLB borrowings and our $115.0 million, 5.25 percent fixed-to-floating subordinated notes issued in June 39 2020 Form 10-K 2020. For further discussion of our average interest bearing liabilities see the “Net Interest Income” section below, and for further discussion of our borrowed funds, see Note 10 to the consolidated financial statements. Selected Performance Indicators. The following table presents our annualized performance ratios for the three years ended December 31, 2020, 2019 and 2018: 2020 2019 2018 Return on average assets 0.96 % 0.93 % 0.86 % Return on average assets, as adjusted 0.99 0.98 0.93 Return on average shareholders’ equity 8.68 8.71 7.91 Return on average shareholders’ equity, as adjusted 8.93 9.19 8.55 Return on average tangible shareholders’ equity (ROATE) 12.82 13.05 12.21 ROATE, as adjusted 13.19 13.77 13.20 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 that these 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. Adjusted net income for the three years ended December 31, 2020, 2019 and 2018 was computed as follows: 2020 2019 2018 (in thousands) Net income, as reported $ 390,606 $ 309,793 $ 261,428 Add: Loss on extinguishment of debt (net of tax) 8,649 22,992 — Add: Net impairment losses on securities (net of tax) — 2,104 — Add: (Gains) losses on securities transactions (net of tax) (377) 108 1,677 Add: Severance expense (net of tax) (1) 1,489 3,477 1,907 Add: Tax credit investment impairment (net of tax) (2) — 1,746 — Add: Branch related asset impairment (net of tax) — — 1,304 Add: Legal expenses (litigation reserve impact only, net of tax) — — 8,726 Add: Merger related expenses (net of tax) (3) 1,371 11,929 12,494 Add: Income tax expense (benefit) (4) — 31,123 (274) Less: Gain on sale-leaseback transaction (net of tax) (5) — (56,414) — Less: Gain on sale of Visa Class B shares (net of tax) (6) — — (4,677) Net income, as adjusted $ 401,738 $ 326,858 $ 282,585 (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 in 2019, and a net income tax benefit related to the Tax Cuts and Jobs Act and the USAB acquisition in 2018. (5) The gain on sale leaseback transactions is included in net gains on the sales of assets within other non-interest income. (6) The gain from the sale of non-marketable securities is included in other non-interest. 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. 2020 Form 10-K 40 Adjusted annualized return on average assets for the three years ended December 31, 2020, 2019 and 2018 was computed by dividing adjusted net income by average assets, as follows: 2020 2019 2018 ($ in thousands) Net income, as adjusted $ 401,738 $ 326,858 $ 282,585 Average assets 40,557,326 33,442,738 30,229,276 Return on average assets, as adjusted 0.99 % 0.98 % 0.93 % Adjusted annualized return on average shareholders' equity for the three years ended December 31, 2020, 2019 and 2018 was computed by dividing adjusted net income by average shareholders' equity, as follows: 2020 2019 2018 ($ in thousands) Net income, as adjusted $ 401,738 $ 326,858 $ 282,585 Average shareholders' equity 4,500,067 3,555,483 3,304,531 Return on average shareholders' equity, as adjusted 8.93 % 9.19 % 8.55 % ROATE and adjusted ROATE for the three years ended December 31, 2020, 2019 and 2018 were computed by dividing net income and adjusted net income, respectively, by average shareholders’ equity less average goodwill and average other intangible assets, as follows: 2020 2019 2018 ($ in thousands) Net income $ 390,606 $ 309,793 $ 261,428 Net income, as adjusted $ 401,738 $ 326,858 $ 282,585 Average shareholders’ equity $ 4,500,067 $ 3,555,483 $ 3,304,531 Less: Average goodwill and other intangible assets 1,454,349 1,182,140 1,163,398 Average tangible shareholders’ equity $ 3,045,718 $ 2,373,343 $ 2,141,133 ROATE 12.82 % 13.05 % 12.21 % ROATE, as adjusted 13.19 % 13.77 % 13.20 % 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. The net interest margin on a fully tax equivalent basis is calculated by dividing tax equivalent net interest income by average interest earning assets and is a key measurement used in the banking industry to measure income from interest earning assets. Annual Period 2020. Net interest income on a tax equivalent basis increased by $220.2 million to $1.1 billion for 2020 as compared to 2019. The increase was mainly driven by interest income related to a $5.6 billion increase in average loan balances, including the impact of $3.4 billion of loans acquired from Oritani on December 1, 2019, and an 85 basis point reduction in the cost of our total interest bearing liabilities due to the lower interest rate environment in 2020. The changes in our average interest earning assets and interest bearing liabilities are discussed further below. The net interest margin on a tax equivalent basis was 3.03 percent for the year ended December 31, 2020 and increased 8 basis points as compared to 2019. However, the yield on average interest earning assets decreased 59 basis points mainly attributable to decreased yield on average loans and average taxable investments. The yield on average loans decreased 53 basis points to 4.04 percent for 2020 as compared to 4.57 percent in 2019 largely due to new and refinanced loan originations at lower market interest rates, loan prepayments, and interest rates resetting on adjustable rate loans throughout 2020. Our average taxable investment portfolio yield decreased 54 basis points during 2020 as compared to the prior year due to the combination of principal repayments on higher yielding residential mortgage-backed securities, a $10.2 million increase in net premium amortization and lower yielding new investments purchased in 2020. More than offsetting the decrease in the yield on average interest earning assets, the cost of average interest bearing liabilities decreased 85 basis points to 0.99 percent for 2020 as compared to the prior year. The decrease in the overall cost as compared to 2019 was mainly due to significantly lower rates paid on our deposits products and a customer shift from higher cost maturing time deposits to deposits without stated maturities, as well as lower rates on short-term borrowings following the onset of the COVID-19 pandemic. The cost of funds was largely influenced by decreases which occurred in March 2020 totaling 150 basis points in the daily effective federal funds rate to a 41 2020 Form 10-K target range of between zero and 0.25 percent for the remainder of 2020. The average daily effective federal funds rate was 2.16 percent in 2019. Average interest earning assets totaling $37.0 billion for the year ended December 31, 2020 increased $6.4 billion, or 21.0 percent, as compared to 2019. Average loan balances increased $5.6 billion to $31.8 billion in 2020 and was the major driver in the $62.1 million increase in interest income on a tax equivalent basis for loans as compared to 2019. The growth in average loans during 2020 was due, in large part, to the $3.4 billion in loans acquired from Oritani, SBA PPP loans with average balances of $1.5 billion during the year ended December 31, 2020 and strong loan demand for commercial loans. These items were partially offset by principal repayments that outpaced new loan originations held for investment in the residential mortgage and consumer loan categories. The new commercial loan production in 2020 came from a blend of new and existing customer relationships with significant geographic and product diversification across our primary markets. Average interest bearing liabilities increased $3.9 billion to $26.9 billion for the year ended December 31, 2020 from the same period in 2019 mainly due to $2.9 billion of deposits assumed in the Oritani acquisition and higher retail and government deposit balances within our branch network. The average non-interest bearing deposits and savings, NOW and money market account balances increased by $1.9 billion and $2.9 billion, respectively, largely due to deposits from PPP loan customers, higher savings rates amongst our customers and increased customer preference for deposits without stated maturities driven by the combination of the uncertainties of the pandemic and the low rates offered on our time deposit products. Average time deposits increased $604.5 million to $8.1 billion for 2020 as compared to 2019 mainly due to $1.2 billion of time deposits acquired from Oritani, partially offset by the normal run off of maturing retail CDs. Average balances for retail CDs increased by $424.6 million to $4.7 billion for the year ended December 31, 2020 as compared to the prior year. Average short-term and long-term borrowings decreased $448.7 million and increased $899.0 million in 2020, respectively, as compared to 2019 due, in part, to our ability to lock in lower rates on long-term FHLB advances to fund new loan activities. See the "Fourth Quarter 2020" section below for more information regarding changes in our interest bearing liabilities during 2020. Fourth Quarter 2020. Net interest income on a tax equivalent basis totaling $288.8 million for the fourth quarter 2020 increased $4.7 million and $49.2 million as compared to the third quarter 2020 and fourth quarter 2019, respectively. The increase compared to the third quarter 2020 was mainly due to lower rates on our deposit products combined with a shift in customer preference towards deposits without stated maturities, as well as a reduction in average short-term and long-term borrowings funded by excess liquidity. Interest expense of $46.1 million for the three months ended December 31, 2020 decreased $8.1 million as compared to the third quarter 2020. Overall, average interest-bearing liabilities decreased $354.6 million and average non-interest bearing deposits increased $323.1 million in the fourth quarter 2020 as compared to the third quarter 2020. Interest income on a tax equivalent basis decreased $3.4 million to $335.0 million for the fourth quarter 2020 as compared to the third quarter 2020 mainly due to a 3 basis point decrease in the yield on average loans, as well as a moderate decline in interest and dividends from investment securities. The decrease was mostly attributable to principal repayments on securities, and a decline in our reinvestment activity within the available for sale investment securities portfolio largely due to the low interest rate environment. The net interest margin on a tax equivalent basis of 3.06 percent for the fourth quarter 2020 increased 5 basis points as compared to 3.01 percent for the third quarter 2020, and increased 10 basis points from 2.96 percent for the fourth quarter 2019. The yield on average interest earning assets decreased by 4 basis points on a linked quarter basis mostly due to the impact of the lower interest rate environment. The yield on average loans decreased to 3.86 percent for the fourth quarter 2020 from 3.89 percent for the third quarter 2020 largely due to the continued repayment of higher yielding loans, partially offset by a $2.2 million increase in interest and fees from PPP loans. The increase in interest and fees on PPP loans was mostly caused by a moderate level of loan forgiveness activity and acceleration of net unamortized deferred loan fees during the fourth quarter 2020. The overall cost of average interest-bearing liabilities decreased by 11 basis points to 0.69 percent for the fourth quarter 2020 as compared to the linked third quarter 2020 due to the lower rates offered on deposit products and the shift to lower cost deposits as well as lower average short- and long-term borrowing balances with repayments funded by excess liquidity. This includes our prepayment of $534 million in higher cost long-term borrowings during December 2020 that is expected to positively impact our average cost of funds in the first quarter 2021. Our cost of total average deposits was 0.33 percent for the fourth quarter 2020 as compared to 0.41 percent for the third quarter 2020. Looking forward, we expect ongoing interest rate pressures on the level of our net interest margin for the first quarter 2021 and beyond due to lower market rate driven yields on our overall mix of new and refinanced loan originations. However, we are encouraged by the opportunity to reprice stated maturity deposits and borrowings maturing over the 12-month period. We have over $4 billion of retail CDs maturing at an average cost of approximately 80 basis points during the first nine months of 2021. 2020 Form 10-K 42 The following table reflects the components of net interest income for each of the three years ended December 31, 2020, 2019 and 2018: ANALYSIS OF AVERAGE ASSETS, LIABILITIES AND SHAREHOLDERS’ EQUITY AND NET INTEREST INCOME ON A TAX EQUIVALENT BASIS 2020 2019 2018 Average Balance Interest Average Rate Average Balance Interest Average Rate Average Balance Interest Average Rate ($ in thousands) Assets Interest earning assets: Loans (1)(2) $ 31,785,859 $ 1,284,807 4.04 % $ 26,235,253 $ 1,198,908 4.57 % $ 23,340,330 $ 1,033,996 4.43 % Taxable investments (3) 3,446,670 81,893 2.38 3,394,397 98,949 2.92 3,409,687 100,515 2.95 Tax-exempt investments (1)(3) 549,204 18,434 3.36 647,178 22,051 3.41 733,956 27,220 3.71 Interest bearing deposits with banks 1,229,200 2,556 0.21 298,702 5,723 1.92 218,938 3,236 1.48 Total interest earning assets 37,010,933 1,387,690 3.75 30,575,530 1,325,631 4.34 27,702,911 1,164,967 4.21 Allowance for loan losses (295,131) (157,562) (136,775) Cash and due from banks 309,539 275,619 278,181 Other assets 3,495,464 2,762,478 2,431,537 Unrealized losses on securities available for sale, net 36,521 (13,327) (46,578) Total assets $ 40,557,326 $ 33,442,738 $ 30,229,276 Liabilities and Shareholders’ Equity Interest bearing liabilities: Savings, NOW and money market deposits $ 14,280,137 $ 76,169 0.53 % $ 11,406,073 $ 145,177 1.27 % $ 11,093,136 $ 108,394 0.98 % Time deposits 8,125,869 106,067 1.31 7,521,338 166,693 2.22 5,131,167 81,959 1.60 Total interest bearing deposits 22,406,006 182,236 0.81 18,927,411 311,870 1.65 16,224,303 190,353 1.17 Short-term borrowings 1,621,581 11,372 0.70 2,070,258 47,862 2.31 2,187,998 45,930 2.10 Long-term borrowings (4) 2,850,213 71,207 2.50 1,951,203 63,220 3.24 2,116,619 65,762 3.11 Total interest bearing liabilities 26,877,800 264,815 0.99 22,948,872 422,952 1.84 20,528,920 302,045 1.47 Non-interest bearing deposits 8,284,376 6,364,986 6,193,839 Other liabilities 895,083 573,397 201,986 Shareholders’ equity 4,500,067 3,555,483 3,304,531 Total liabilities and shareholders’ equity $ 40,557,326 $ 33,442,738 $ 30,229,276 Net interest income/interest rate spread (5) 1,122,875 2.76 % 902,679 2.50 % 862,922 2.74 % Tax equivalent adjustment (3,971) (4,631) (5,719) Net interest income, as reported $ 1,118,904 $ 898,048 $ 857,203 Net interest margin (6) 3.02 % 2.94 % 3.09 % Tax equivalent effect 0.01 0.01 0.02 % Net interest margin on a fully tax equivalent basis (6) 3.03 % 2.95 % 3.11 % (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 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. 43 2020 Form 10-K 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 Valley 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 2020 Compared to 2019 2019 Compared to 2018 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* $ 234,704 $ (148,805) $ 85,899 $ 131,473 $ 33,439 $ 164,912 Taxable investments 1,502 (18,558) (17,056) (449) (1,117) (1,566) Tax-exempt investments* (3,293) (324) (3,617) (3,063) (2,106) (5,169) Federal funds sold and other interest bearing deposits 5,471 (8,638) (3,167) 1,372 1,115 2,487 Total increase (decrease) in interest income 238,384 (176,325) 62,059 129,333 31,331 160,664 Interest expense: Savings, NOW and money market deposits 30,152 (99,160) (69,008) 3,137 33,646 36,783 Time deposits 12,497 (73,123) (60,626) 46,254 38,480 84,734 Short-term borrowings (8,658) (27,832) (36,490) (2,558) 4,490 1,932 Long-term borrowings and junior subordinated debentures 24,674 (16,687) 7,987 (5,282) 2,740 (2,542) Total increase (decrease) in interest expense 58,665 (216,802) (158,137) 41,551 79,356 120,907 Increase (decrease) in net interest income $ 179,719 $ 40,477 $ 220,196 $ 87,782 $ (48,025) $ 39,757 * Interest income is presented on a tax equivalent basis using a 21 percent federal tax rate. Non-Interest Income Non-interest income represented 11.7 percent and 14.0 percent of total interest income plus non-interest income for 2020 and 2019, respectively. For the year ended December 31, 2020, non-interest income decreased $31.5 million as compared to the year ended December 31, 2019 largely due to the gain on the sale of several Valley properties recognized in 2019. See further details below. 2020 Form 10-K 44 The following table presents the components of non-interest income for the years ended December 31, 2020, 2019, and 2018: 2020 2019 2018 (in thousands) Trust and investment services $ 12,415 $ 12,646 $ 12,633 Insurance commissions 7,398 10,409 15,213 Service charges on deposit accounts 18,257 23,636 26,817 Gains (losses) on securities transactions, net 524 (150) (2,342) Net impairment losses on securities recognized in earnings — (2,928) — Fees from loan servicing 10,352 9,794 9,319 Gains on sales of loans, net 42,251 18,914 20,515 (Losses) gains on sales of assets, net (1,891) 78,333 (2,401) Bank owned life insurance 10,083 8,232 8,691 Other 83,643 55,634 45,607 Total non-interest income $ 183,032 $ 214,520 $ 134,052 Insurance commissions decreased $3.0 million for the year ended December 31, 2020 from $10.4 million in 2019 mainly due to lower volumes of business generated by the Bank's insurance agency subsidiary. Service charges on deposit accounts decreased $5.4 million for the year ended December 31, 2020 as compared to 2019 mostly due to waived fees related to COVID-19 customer relief efforts in 2020. Net impairment losses on securities totaling $2.9 million for the year ended December 31, 2019 relate to one special revenue bond in default of its contractual payments. See the “Investment Securities Portfolio” section of this MD&A and Note 4 to the consolidated financial statements for further details on our investment securities impairment analysis. Fees from loan servicing increased $558 thousand for the year ended December 31, 2020 from $9.8 million in 2019 mainly due to additional fees from mortgage servicing rights of loans originated and sold by us during the year ended December 31, 2020. The aggregate principal balances of residential mortgage loans serviced by us for others increased approximately $123 million to $3.5 billion, at December 31, 2020 from $3.4 billion at December 31, 2019. Net gains on sales of loans increased $23.3 million for the year ended December 31, 2020 as compared to 2019 largely due to higher spreads (or margins) on individual loan sales despite a slightly higher volume of residential mortgage loans sold during 2020. During 2020, we sold $1.0 billion of residential mortgages as compared to $935 million of residential mortgage loans sold during 2019, including $30 million and $436 million of pre-existing loans sold from our residential mortgage loan portfolio, respectively. 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 held for sale carried at fair value at each period end. The net gains in the fair value of loans held for sale totaled $13.5 million and $1.0 million in 2020 and 2019, respectively. Residential mortgage loan originations (including both new and refinanced loans) increased 22.3 percent to $1.9 billion for the year ended December 31, 2020 as compared to $1.6 billion in 2019. See further discussions of our residential mortgage loan origination activity under “Loans” in the "Executive Summary" section of this MD&A above and Note 3 to the consolidated financial statements for details about the fair value methodology. Net gains on sales of assets decreased $80.2 million for the year ended December 31, 2020 as compared to 2019 primarily due to a $78.5 million gain on the sale (and leaseback) of 26 bank properties recognized during the first quarter 2019. Other non-interest income increased $28.0 million for the year ended December 31, 2020 as compared to 2019 mainly due to a $25.6 million increase in fee income related to derivative interest rate swaps executed with commercial lending customers. Swap fee income totaled $59.0 million and $33.4 million for the years ended December 31, 2020 and 2019, respectively. A decline in commercial loan activity in 2021, as well as several other factors, could have a significant negative impact on our ability to generate swap fee income at or near the fees realized in 2020. 45 2020 Form 10-K Non-Interest Expense Non-interest expense increased $14.6 million to $646.1 million for the year ended December 31, 2020 as compared to 2019. The following table presents the components of non-interest expense for the years ended December 31, 2020, 2019 and 2018: 2020 2019 2018 (in thousands) Salary and employee benefits expense $ 333,221 $ 327,431 $ 333,816 Net occupancy and equipment expense 129,002 118,191 108,763 FDIC insurance assessment 18,949 21,710 28,266 Amortization of other intangible assets 24,645 18,080 18,416 Professional and legal fees 32,348 20,810 34,141 Loss on extinguishment of debt 12,036 31,995 — Amortization of tax credit investments 13,335 20,392 24,200 Telecommunication expense 10,737 9,883 12,102 Other 71,875 63,063 69,357 Total non-interest expense $ 646,148 $ 631,555 $ 629,061 Salary and employee benefits expense increased $5.8 million for the year ended December 31, 2020 as compared to 2019. The increase was largely due to additional salaries related to Bank branch and other operational staff retained from the Oritani acquisition, higher cash incentive compensation (including $2.2 million of special bonuses paid to hourly and part-time employees to reward them for their efforts and contributions during the COVID-19 pandemic) and increased medical expenses. These additional expenses were partially offset by cost reductions from our ongoing branch transformation efforts and other operational improvements during the year ended December 31, 2020 and lower merger related charges. Change in control, severance and retention expenses related to bank acquisitions was $13.9 million for the year ended December 31, 2019. Severance costs related to operational restructuring efforts and our branch transformation strategy totaled $2.1 million and $4.8 million for the years ended December 31, 2020 and 2019, respectively. Net occupancy and equipment expenses increased $10.8 million for the year ended December 31, 2020 as compared to 2019 largely due to higher rental expenses resulting from a sale leaseback transaction completed near the end of the first quarter 2019 and higher depreciation expense related to computer equipment and new data centers placed into service in fourth quarter 2019. In addition, during 2020, we incurred higher equipment and certain other COVID-19 pandemic related expenses which included additional cleaning services for facilities to maintain employee and customer safety. During 2020, we also incurred additional costs associated with branches and other facilities acquired from Oritani, which were partially offset by costs savings from branch closures during 2020 as compared to 2019. The FDIC insurance assessment decreased in 2020 largely due to the Bank's improved capital position following the Oritani acquisition and retained earnings resulting from a stronger 2020 performance. Amortization of other intangibles increased $6.6 million to $24.6 million at December 31, 2020 as compared to 2019 largely due to higher amortization expense of loan servicing rights and core deposit intangible, as well as $818 thousand of net impairment charges of loan servicing rights for the year ended December 31, 2020 as compared to net recoveries of impairment charges totaling $36 thousand in 2019. The increase in amortization of core deposits intangibles was primarily due to intangibles generated in the Oritani acquisition. See Note 8 to the consolidated financial statements for additional information. Professional and legal fees increased $11.5 million for the year ended December 31, 2020 as compared to 2019. The increase was mainly due to higher costs from technology transformation consulting services, as well as remote work readiness costs largely incurred in the second quarter 2020. Loss on extinguishment of debt totaling $12.0 million for the year ended December 31, 2020 reflects prepayment penalties related to the prepayments of $584.3 million of long-term borrowings primarily consisting of FHLB advances prepaid in the fourth quarter. These debt prepayments were funded by excess cash liquidity. See Note 10 to the consolidated financial statements for additional information. Amortization of tax credit investments decreased $7.1 million for the year ended December 31, 2020 as compared to 2019 partly due to a decline in impairment. The year ended December 31, 2019 included a $2.4 million impairment charge related to investments in three federal renewable energy tax credit funds sponsored by DC Solar (See Note 14 to the consolidated financial statements for additional information). The remainder of the variance from 2019 was mainly due to 2020 Form 10-K 46 differences in the timing and 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, directly reduce our income tax expense and effective tax rate. Other non-interest expense increased $8.8 million for the year ended December 31, 2020 as compared to 2019. This increase was largely due to higher data processing costs, certain PPP loan and other COVID-19 related costs, as well as 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 2019. Net gains on the sale of OREO properties included in other non-interest expense decreas ed $674 thousand for the year ended December 31, 2020 as compared to 2019. The negative impact of these times was partially offset by moderate decreases in severa l other significant components of other expense, such as travel, entertainment and business meals expense during 2020 as compared to 2019. Efficiency Ratio. The efficiency ratio measures total non-interest expense as a percentage of net interest income plus total non-interest income. We believe this non-GAAP measure provides a meaningful comparison of our operational performance and facilitates investors’ assessments of business performance and trends in comparison to our peers in the banking industry. Our overall efficiency ratio, and its comparability to some of our peers, is negatively impacted primarily by the amortization of tax credit investments, as well as infrequent charges within non-interest income and expense, including, but not limited to the loss on extinguishment of debt, merger expenses and the net gain on sale-leaseback transactions. The following table presents our efficiency ratio and a reconciliation of the efficiency ratio adjusted for such items during the years ended December 31, 2020, 2019 and 2018: 2020 2019 2018 ($ in thousands) Total non-interest expense, as reported $ 646,148 $ 631,555 $ 629,061 Less: Loss on extinguishment of debt (pre-tax) 12,036 31,995 — Less: Amortization of tax credit investments (pre-tax) 13,335 20,392 24,200 Less: Merger related expenses (pre-tax) (1) 1,907 16,579 17,445 Less: Severance expense (mainly branch transformation, pre-tax) (2) 2,072 4,838 2,662 Less: Legal expenses (litigation reserve impact only, pre-tax) — — 12,184 Total non-interest expense, as adjusted 616,798 557,751 572,570 Net interest income 1,118,904 898,048 857,203 Total non-interest income, as reported 183,032 214,520 134,052 Add: Net impairment losses on securities (pre-tax) — 2,928 — Add: Branch related asset impairment (pre-tax) (3) — — 1,821 Add: Losses on securities transactions, net (pre-tax) (524) 150 2,342 Less: Gain on the sale of Visa Class B shares (pre-tax) (4) — — 6,530 Less: Gain on sale leaseback transaction (pre-tax) (5) — 78,505 — Total non-interest income, as adjusted $ 182,508 $ 139,093 $ 131,685 Gross operating income, as adjusted $ 1,301,412 $ 1,037,141 $ 988,888 Efficiency ratio 49.63 % 56.77 % 63.46 % Efficiency ratio, adjusted 47.39 % 53.78 % 57.90 % (1) Merger related expenses are primarily within salary and employee benefits expense, professional and legal fees, and other expense. (2) Severance expenses are included in salary and employee benefits. (3) Branch related asset impairment is included in net losses on sale of assets within non-interest income. (4) The gain from the sale of non-marketable securities is included in other non-interest income. (5) The gain on sale leaseback transactions is included in gains on the sales of assets within other non-interest income. Management continuously monitors its expenses in an effort to optimize Valley's performance. Based upon these efforts and our revenue goals, we achieved an adjusted efficiency ratio (as shown in the table above) of 47.39 percent for 2020 that exceeded our previously announced goal of 51 percent or lower for the year. We can provide no assurance that our adjusted efficiency ratio will remain at the level reported for 2020. 47 2020 Form 10-K Income Taxes Income tax expense was $139.5 million for the year ended December 31, 2020, reflecting an effective tax rate of 26.3 percent, as compared to $147.0 million for the year ended 2019, reflecting an effective tax rate of 32.2 percent. The decline in the effective tax rate in 2020 as compared to 2019 was mainly due to a $31.1 million increase in the provision for income taxes related to uncertain tax liability positions during 2019. However, income tax expense declined by only $7.5 million as compared to 2019 largely due to an increase in taxable income for the year ended December 31, 2020. At December 31, 2020 and 2019, our uncertain tax liability positions relate to renewable energy tax credits and other tax benefits previously recognized from our investments in mobile generators sold and leased back by DC Solar and its affiliates. The CARES Act did not have a material impact on our reported income tax expense for the year ended December 31, 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. See additional information regarding our income taxes under our “Critical Accounting Policies and Estimates” section above, as well as Note 13 to the consolidated financial statements. 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 the 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. Consumer lending. The consumer lending segment represented 21.4 percent of the total loan portfolio at December 31, 2020, and was 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 portfolio (which represented 13.0 percent of our total loan portfolio at December 31, 2020) is subject to movements in the market level of interest rates and forecasted prepayment speeds. The weighted average life of the automobile loans portfolio (representing 4.2 percent of total loans at December 31, 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 $269.3 million to $7.2 billion for the year ended December 31, 2020 as compared to 2019. The increase was largely due to $255 million of loans acquired from Oritani on December 1, 2019, loan growth from residential mortgage loan originations for investment during the first quarter 2020 (prior to the economic slowdown caused by the COVID-19 pandemic). Income before income taxes generated by the consumer lending segment increased $46.6 million to $124.1 million for the year ended December 31, 2020 as compared to $77.5 million for the year ended December 31, 2019 largely due to increases of $28.5 million and $23.5 million in net interest income and non-interest income, respectively. The increase in net interest income was mostly driven by the lower cost of funding and increase in average loans, partially offset by lower yields on loans in the consumer segment. The increase in non-interest income was primarily attributable to higher net gains on sales of residential mortgage loans for the year ended December 31, 2020 as compared to 2019. The positive impact of the aforementioned items 2020 Form 10-K 48 was partially offset by increases of $4.8 million and $1.5 million in the provision for loan losses and non-interest expense, respectively. The increase in the provision for loan losses for the year ended December 31, 2020 as compared to 2019 was mainly due to the adverse economic forecast caused by COVID-19 pandemic included in our estimate of lifetime expected credit losses for this segment, as well as additional qualitative management adjustments to reflect the potential for higher levels of credit stress related to borrowers impacted by COVID-19 pandemic. See further details in the "Allowance for Credit Losses" section of this MD&A. The net interest margin on the consumer lending portfolio increased 29 basis points to 2.92 percent for the year ended 2020 as compared to 2019 due to a 66 basis point decrease in the costs associated with our funding sources, partially offset by a 37 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 37 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 loans, deposits and other borrowings. The return on average interest earning assets before income taxes for the consumer lending segment was 1.73 percent for 2020 compared to 1.12 percent for 2019. Commercial lending. The commercial lending segment is mainly 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 December 31, 2020. Commercial real estate loans and construction loans totaled $18.5 billion and represented 57.3 percent of the total loan portfolio at December 31, 2020. Average interest earning assets in this segment increased $5.3 billion to $24.6 billion for the year ended December 31, 2020 as compared to 2019. The increase was primarily due to organic loan growth from $2.2 billion of PPP loans originated in 2020, as well as $3.1 billion of commercial loans acquired from Oritani on December 1, 2019. For the year ended December 31, 2020, income before income taxes for the commercial lending segment increased $79.4 million to $448.6 million as compared to 2019. Net interest income increased $195.1 million to $863.7 million for the year ended December 31, 2020 as compared to 2019 mainly due to the combined effect of a $101.5 million increase in interest income driven by higher average loans balances and a $93.6 million decrease in interest expense caused by the reduction in our cost of funds. Non-interest income increased $23.6 million for the year ended December 31, 2020 as compared to 2019 primarily due to fee income related to derivative interest rate swaps executed with commercial loan customers which totaled $59.0 million for the year ended December 31, 2020 as compared to $33.4 million in 2019. The positive impact of the aforementioned items was partially offset by a $96.1 million increase in the provision for credit losses to $113.6 million for the year ended December 31, 2020 as compared to 2019. The increase in the provision for loan losses for the year ended December 31, 2020 as compared to 2019 was mainly due to the adverse economic forecast lifetime expected credit losses during 2020, higher specific reserves for tax medallion loans and qualitative adjustments for potential credit stress related to borrowers impacted by the COVID-19 pandemic. See the "Allowance for Credit Losses" section below for further details. Internal transfer expense increased $46.5 million to $267.6 million for the year ended December 31, 2020 as compared to 2019. The net interest margin for this segment increased 4 basis points to 3.5 percent during 2020 as compared to 2019 due to a 66 basis point decrease in the cost of our funding sources, mostly offset by a 62 basis point decrease in the yield on average loans. The return on average interest earning assets before income taxes for this segment was 1.82 percent for 2020 compared to 1.91 percent for the prior year period. Investment 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 increased $884.8 million to $5.2 billion for the year ended December 31, 2020 as compared to 2019 primarily due to a $930.5 million increase in average interest bearing deposits with banks, partially offset by a $45.7 million decline in average investment securities. The increase in average overnight interest bearing deposits with banks 49 2020 Form 10-K was mainly due to our higher levels of excess liquidity levels that were maintained in the 2020 period in response to the uncertainties created by the COVID-19 pandemic. The decrease in average investment securities was mainly driven by principal repayments on securities with slower reinvestment activity caused by the low interest rate environment. For the year ended December 31, 2020, income before income taxes for the investment management segment decreased $7.4 million to $19.6 million as compared to 2019 mainly due to increases in internal transfer expense and provision for credit losses for debt securities held to maturity totaling $7.1 million and $635 thousand, respectively. The net interest margin for this segment decreased 29 basis points to 1.30 percent during the year ended December 31, 2020 as compared to 2019 due to a 95 basis point decrease in the yield on average investments, partially offset by a 66 basis point decrease in costs associated with our funding sources. The decrease in the yield on average investments during 2020 as compared to one year ago was largely driven by repayment and prepayment of higher yield residential mortgage-backed securities, as well as calls and maturities of state and municipal bonds. Additionally, we have recorded a higher premium amortization expense related to the increased prepayment of mortgage-backed securities and purchased lower yielding investment securities during 2020. The increase in average overnight investments with banks at low yields also contributed to the decline in the net interest margin for the investment management segment. The return on average interest earning assets before income taxes for this segment was 0.37 percent for 2020 compared to 0.62 percent for 2019. 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 the loss on extinguishment of debt and merger expenses. The pre-tax net loss for the corporate segment totaled $62.2 million for the year ended December 31, 2020 as compared to $17.0 million in 2019. The negative change of $45.2 million was mainly due to a decrease in non-interest income coupled with an increase in non-interest expense, partially offset by higher internal transfer income. Non-interest income decreased $79.9 million to $26.7 million for the year ended December 31, 2020 from 2019 primarily due to a $78.5 million net gain on the sale (and leaseback) of several bank locations recognized during 2019. Non-interest expense increased $16.2 million to $468.7 million for the year ended December 31, 2020 as compared to 2019 lar gely due to increases in net occupancy and equipment expense, salaries and employee benefits expenses, loss on extinguishment of debt, and professional and legal fees. See further details in the "Non-Interest Expense" section in this MD&A. Internal transfer income increased $52.7 million to $402.2 million for the year ended December 31, 2020 as compared to the prior year largely due to general increases related to our growth. 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 attempts to achieve consistent accounting and economic benefits for financial assets and their related funding sources. We have predominately 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 December 31, 2020. The model assumes changes in interest rates without any proactive change in the composition or size of the balance sheet by management. In the model, the forecasted shape of the yield 2020 Form 10-K 50 curve remains static as of December 31, 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 December 31, 2020. Although the size of Valley’s balance sheet is forecasted to remain static as of December 31, 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 2020. The model utilizes an immediate parallel shift in the market interest rates at December 31, 2020. The assumptions used in the net interest income simulation are inherently uncertain. Actual results may differ significantly from those presented in the table above, 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 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 considering 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 $ 39,132 3.47 % +100 21,769 1.93 - 100 (36,059) (3.19) - 200 (39,083) (3.46) 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-month period by 1.93 percent as compared to December 31, 2019 (which projected an increase of 0.81 percent in net interest income over a 12-month period). Management believes the interest rate sensitivity remains within an acceptable tolerance range at December 31, 2020 . How ever, the level of net interest income sensitivity may increase or decrease in the future as a result of several factors, including, but not limited to potential changes in secondary mortgage loan sales, deposit and borrowings strategies, the slope of the yield curve and projected cash flows. 51 2020 Form 10-K The following table sets forth the amounts of interest earning assets and interest bearing liabilities that were outstanding at December 31, 2020 and their associated fair values. The expected cash flows are categorized based on each financial instrument’s anticipated maturity or interest rate reset date in each of the future periods presented. INTEREST RATE SENSITIVITY ANALYSIS Rate 2021 2022 2023 2024 2025 Thereafter Total Balance Fair Value ($ in thousands) Interest sensitive assets: Interest bearing deposits with banks 0.10 % $ 1,071,360 $ — $ — $ — $ — $ — $ 1,071,360 $ 1,071,360 Equity securities 2.79 29,378 — — — — — 29,378 29,378 Investment securities available for sale 2.26 427,937 301,174 146,051 93,599 93,774 276,938 1,339,473 1,339,473 Investment securities held to maturity 2.25 411,734 417,771 309,740 164,189 145,511 724,066 2,173,011 2,227,612 Loans held for sale, at fair value 3.07 301,427 — — — — — 301,427 301,427 Loans 3.81 8,778,292 5,403,499 3,303,992 2,296,397 1,676,110 10,758,822 32,217,112 31,635,060 Total interest sensitive assets 3.55 % $ 11,020,128 $ 6,122,444 $ 3,759,783 $ 2,554,185 $ 1,915,395 $ 11,759,826 $ 37,131,761 $ 36,604,310 Interest sensitive liabilities: Deposits: Savings, NOW and money market 0.15 % $ 16,015,658 $ — $ — $ — $ — $ — $ 16,015,658 $ 16,015,658 Time 0.75 5,877,581 502,743 167,077 59,719 38,229 69,329 6,714,678 6,639,022 Short-term borrowings 0.39 1,147,958 — — — — — 1,147,958 1,151,478 Long-term borrowings 2.75 860,124 29,377 553,164 300,000 378,000 175,000 2,295,665 2,405,345 Junior subordinated debentures 2.68 — — — — — 56,065 56,065 57,779 Total interest sensitive liabilities 0.55 % $ 23,901,321 $ 532,120 $ 720,241 $ 359,719 $ 416,229 $ 300,394 $ 26,230,024 $ 26,269,282 Interest sensitivity gap $ (12,881,193) $ 5,590,324 $ 3,039,542 $ 2,194,466 $ 1,499,166 $ 11,459,432 $ 10,901,737 $ 10,335,028 Ratio of interest sensitive assets to interest sensitive liabilities 0.46:1 11.51:1 5.22:1 7.10:2 4.60:1 39.15:1 1.42:1 1.39:1 The above table provides an approximation of the projected re-pricing of assets and liabilities at December 31, 2020 based on the contractual maturities, adjusted for anticipated prepayments of principal (including anticipated call dates on long-term borrowings and junior subordinated debentures), and scheduled rate adjustments. The prepayment experience reflected herein is based on historical experience combined with market consensus expectations derived from independent external sources. The actual repayments of these instruments could vary substantially if future prepayments differ from historical experience or current market expectations. While all non-maturity deposit liabilities are reflected in the 2021 column in the table above, management controls the re-pricing of the vast majority of the interest-bearing instruments within these liabilities. Our cash flow derivatives are designed to protect us from upward movement in interest rates on certain deposits and other borrowings. The interest rate sensitivity table reflects the sensitivity at current interest rates. As a result, the notional amount of our derivatives is not included in the table. We use various assumptions to estimate fair values. See Note 3 to the consolidated financial statements for further discussion of fair value measurements. The total gap re-pricing within one year as of December 31, 2020 was a negative $12.9 billion, representing a ratio of interest sensitive assets to interest sensitive liabilities of 0.46:1. The total gap re-pricing position, as reported in the table above, reflects the projected interest rate sensitivity of our principal cash flows based on market conditions as of December 31, 2020. As the market level of interest rates and associated prepayment speeds move, the total gap re-pricing position will change accordingly, but not likely in a linear relationship. Management does not view our one-year gap position as of December 31, 2020 as presenting an unusually high risk potential, although no assurances can be given that we are not at risk from interest rate increases or decreases. 2020 Form 10-K 52 Liquidity and Cash Requirements 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 reported by our Treasury Department to two Board committees. 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 requires 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 December 31, 2020. At December 31, 2020, the Bank had various contractual obligations totaling $7.9 billion and $10.1 billion of maturing liabilities due in 12 months or less and greater than 1 year, respectively. The following table summarized maturities of contractual obligations of the Bank at December 31, 2020: One Year or Less One to Three Years Three to Five Years Over Five Years Total (in thousands) Time deposits $ 5,877,581 $ 669,820 $ 97,948 $ 69,329 $ 6,714,678 Short-term borrowings 1,147,958 — — — 1,147,958 Long-term borrowings 852,519 457,540 579,635 — 1,889,694 Lease obligations 35,944 62,856 55,027 122,848 276,675 Capital expenditures 22,744 — — — 22,744 Other purchase obligations 39,793 1,657 712 — 42,162 Total $ 7,976,539 $ 1,191,873 $ 733,322 $ 192,177 $ 10,093,911 In the ordinary course of operations, the Bank enters into various financial obligations, including contractual obligations that may require future cash payments. As a financial services provider, we routinely enter into commitments to extend credit, including loan commitments, standby and commercial letters of credit. Such commitments are subject to the same credit policies and approval process accorded to loans made by the Bank. We enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on Bank's commitments to fund the loans, as well as on its portfolio of mortgage loans held for sale. Commitments to extend credit and standby letters of credit are subject to change since many of these commitments are expected to expire unused or only partially used based upon our historical experience, the total amounts of these commitments do not necessarily reflect future cash requirements. At December 31, 2020 our off-balance sheet commitments totaled $7.8 billion, inclusive of commitments of $2.9 billion due in 12 months or less. See Note 16 to the consolidated financial statements for further details. Management believes the Bank has the ability to generate and obtain adequate amounts of cash to meet its short-term and long-term obligations as they come due by utilizing various cash resources described below. 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. Liquid assets totaled approximately $3.1 billion, representing 8.3 percent of earning assets, at December 31, 2020 and $2.2 billion, representing 6.4 percent of earning assets, at December 31, 2019. Of the $3.1 billion of liquid assets at December 31, 2020, approximately $789.0 million of various investment securities were pledged to counterparties to support our earning asset funding strategies. We anticipate the receipt of approximately $926.0 million in principal from securities in the total investment portfolio over the next 12-month period due to normally scheduled principal repayments and expected prepayments of certain securities, primarily residential mortgage-backed securities. 53 2020 Form 10-K 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 December 31, 2020) are projected to be approximately $8.9 billion over the next 12-month period. As a contingency plan for significant funding needs, liquidity could also be derived from the sale of conforming residential mortgages from our loan portfolio, or 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 $25.8 billion and $20.4 billion for the years ended December 31, 2020 and 2019, respectively, representing 69.8 percent and 66.8 percent of average earning assets at December 31, 2020 and 2019, respectively. 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. The following table lists, by maturity, all certificates of deposit of $250 thousand and over at December 31, 2020: 2020 (in thousands) Less than three months $ 602,581 Three to six months 382,060 Six to twelve months 272,531 More than twelve months 138,114 Total $ 1,395,286 Additional funding may be provided through deposit gathering networks and in the form of federal funds purchased obtained through our well established relationships with several correspondent banks. While these lending lines are uncommitted, management believes that we could borrow approximately $1.5 billion for a short time from these banks on a collective basis. The Bank is also a member of the Federal Home Loan Bank of New York 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. Additionally, Valley's collateral pledged to the FHLB may be used to obtain Municipal Letters of Credit (MULOC) to collateralize certain municipal deposits held by Valley. At December 31, 2020, Valley had $700 million of MULOCs outstanding for this purpose. Furthermore, we are able to obtain overnight borrowings from the Federal Reserve Bank of New York via the discount window as a contingency for additional liquidity. At December 31, 2020, our borrowing capacity (excluding added capacity available to us by pledging PPP loans), under the Federal Reserve Bank's discount window was approximately $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 $55.0 million to $1.1 billion at December 31, 2020 from December 31, 2019 largely due to an increase of $60 million in FHLB advances. Average short-term FHLB advances exceeded 30 percent of total shareholders' equity at December 31, 2019. The following table sets forth information regarding Valley’s short-term FHLB advances at the date and for the year ended December 31, 2019: 2019 ($ in thousands) FHLB advances: Average balance outstanding $ 1,681,844 Maximum outstanding at any month-end during the period 2,510,000 Balance outstanding at end of period 940,000 Weighted average interest rate during the period 1.88 % Weighted average interest rate at the end of the period 1.85 2020 Form 10-K 54 Corporation Liquidity. Valley's long-term cash requirements included obligations under subordinated debt and junior subordinated debentures issued to capital trust totaling $400 million and $60.8 million at December 31, 2020, respectively. 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 subsidiary. 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. Investment Securities Portfolio The primary purpose of the investment portfolio is to provide a source of earnings, be a source of liquidity, and serve as a tool for managing interest rate risk. The decision to purchase or sell securities is based upon the current assessment of long and short-term economic and financial conditions, including the interest rate environment and other statement of financial condition components. See additional information under "Interest Rate Sensitivity", "Liquidity" and "Capital Adequacy" sections elsewhere in this MD&A. As of December 31, 2020, our investment portfolio was comprised of equity securities (mainly consisting of a money market mutual fund and investments in public and private Community Reinvestment Act funds), U.S. Treasury securities, U.S. government agency securities, taxable and tax-exempt issues of states and political subdivisions, residential mortgage-backed securities, single-issuer trust preferred securities principally issued by bank holding companies and high quality corporate bonds. Among other securities, our available for sale debt securities such as bank issued and other corporate bonds, as well as municipal special revenue bonds, that may pose a higher risk of future impairment charges to us as a result of the uncertain economic environment and its potential negative effect on the future performance of the security issuers. 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. Certain securities with limited marketability and/or restrictions, such as Federal Home Loan Bank and Federal Reserve Bank stocks, are carried at cost and are included in other assets. 55 2020 Form 10-K Investment securities at December 31, 2020, 2019 and 2018 were as follows: 2020 2019 2018 (in thousands) Equity securities $ 29,378 $ 41,410 $ — Available for sale debt securities U.S. Treasury securities 51,393 50,943 49,306 U.S. government agency securities 26,157 29,243 36,277 Obligations of states and political subdivisions: Obligations of states and state agencies 41,799 78,573 97,113 Municipal bonds 38,151 91,478 99,979 Total obligations of states and political subdivisions 79,950 170,051 197,092 Residential mortgage-backed securities 1,090,022 1,254,786 1,429,782 Corporate and other debt securities 91,951 61,778 37,087 Total available for sale debt securities 1,339,473 1,566,801 1,749,544 Total investment securities (fair value) $ 1,368,851 $ 1,608,211 $ 1,749,544 Held to maturity debt securities U.S. Treasury securities $ 68,126 $ 138,352 $ 138,517 U.S. government agency securities 6,222 7,345 8,721 Obligations of states and political subdivisions: Obligations of states and state agencies 262,762 297,454 341,702 Municipal bonds 207,497 203,251 243,954 Total obligations of states and political subdivisions 470,259 500,705 585,656 Residential mortgage-backed securities 1,550,306 1,620,119 1,266,770 Trust preferred securities 37,348 37,324 37,332 Corporate and other debt securities 40,750 32,250 31,250 Total investment securities held to maturity (amortized cost) $ 2,173,011 $ 2,336,095 $ 2,068,246 Total investment securities $ 3,541,862 $ 3,944,306 $ 3,817,790 As of December 31, 2020, total investments decreased $402.4 million or 10.2 percent as compared to 2019 largely due to (i) a combined net decrease of $234.6 million in residential mortgage-backed securities within both the held to maturity and available for sale categories mainly driven by a higher level of prepayments during 2020, (ii) a combined $120.5 million decrease in obligations of states and state agencies within both the held to maturity and available for sale categories mainly due to normal maturities, sales, calls, and paydowns, and (iii) a $70.2 million decrease in held to maturity U.S. Treasury securities. At December 31, 2020, we had $1.6 billion and $1.1 billion of residential mortgage-backed securities classified as held to maturity and available for sale, respectively. Approximately 66 percent and 56 percent of these residential mortgage-backed securities, respectively, were issued and guaranteed by Ginnie Mae. The remainder of our outstanding residential mortgage-backed security balances at December 31, 2020 were issued by either Fannie Mae or Freddie Mac. 2020 Form 10-K 56 The following table presents the remaining contractual maturities (unadjusted for any expected prepayments) with the corresponding weighted-average yields of held to maturity and available for sale debt securities at December 31, 2020: 0-1 year 1-5 years 5-10 years Over 10 years Total Amount (1) Yield (2) Amount (1) Yield (2) Amount (1) Yield (2) Amount (1) Yield (2) Amount (1) Yield (2) ($ in thousands) Available for sale debt securities U.S. Treasury securities $ — — % $ 51,393 2.01 % $ — — % $ — — % $ 51,393 2.01 % U.S. government agency securities 28 3.08 2,030 2.79 — 24,099 2.72 26,157 2.73 Obligations of states and political subdivisions: (3) Obligations of states and state agencies 1,245 2.46 4,606 4.44 12,716 6.97 23,232 4.12 41,799 4.97 Municipal bonds 13,282 0.99 7,379 3.17 9,732 5.21 7,758 4.59 38,151 3.22 Total obligations of states and political subdivisions 14,527 1.12 11,985 3.66 22,448 6.21 30,990 4.23 79,950 4.14 Residential mortgage-backed securities (4) 1,335 0.18 17,236 2.00 90,303 2.50 981,148 1.94 1,090,022 1.99 Corporate and other debt securities — — 19,771 3.41 72,180 4.66 — 91,951 4.39 Total $ 15,890 1.04 % $ 102,415 2.49 % $ 184,931 3.79 % $ 1,036,237 2.03 % $ 1,339,473 2.29 % Held to maturity debt securities U.S. Treasury securities $ — — % $ 68,126 3.74 % $ — — % $ — — % $ 68,126 3.74 % U.S. government agency securities — — — 6,222 2.54 6,222 2.54 Obligations of states and political subdivisions: (3) Obligations of states and state agencies 3,035 3.37 43,449 4.49 105,985 5.19 110,293 3.65 262,762 4.41 Municipal bonds 23,140 3.34 97,067 3.53 30,521 3.97 56,769 4.24 207,497 3.77 Total obligations of states and political subdivisions 26,175 3.34 140,516 3.83 136,506 4.92 167,062 3.85 470,259 4.13 Residential mortgage-backed securities (4) — 13,477 3.04 5,796 2.82 1,531,033 1.69 1,550,306 1.71 Trust preferred securities — — 1,353 8.23 35,995 2.30 37,348 2.51 Corporate and other debt securities 2,000 3.06 25,750 3.64 13,000 4.49 — 40,750 3.88 Total $ 28,175 3.32 % $ 247,869 3.74 % $ 156,655 4.83 % $ 1,740,312 1.91 % $ 2,173,011 2.35 % (1) Held to maturity debt securities amounts are presented at amortized costs, stated at cost less principal reductions, if any, and adjusted for accretion of discounts and amortization of premiums. Available for sale amounts are presented at fair value. (2) Average yields are calculated on a yield-to-maturity basis. (3) Average yields on obligations of states and political subdivisions are generally tax-exempt and calculated on a tax-equivalent basis using a statutory federal income tax rate of 21 percent. (4) Residential mortgage-backed securities are shown using stated final maturity. The residential mortgage-backed securities portfolio is a significant source of our liquidity through the monthly cash flow of principal and interest. Mortgage-backed securities, like all securities, are sensitive to change in the interest rate environment, increasing and decreasing in value as interest rates fall and rise. As interest rates fall, the potential increase in prepayments can reduce the yield on the mortgage-backed securities portfolio, and reinvestment of the proceeds will be at lower yields. Conversely, rising interest rates may reduce cash flows from prepayments and extend anticipated duration of these assets. We monitor the changes in interest rates, cash flows and duration, in accordance with our investment policies. Management seeks out investment securities with an attractive spread over our cost of funds. 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 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 57 2020 Form 10-K 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 December 31, 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 year ended December 31, 2020 and, as a result, there was no allowance for credit losses for available for sale debt securities at December 31, 2020. During 2019, Valley recognized a $2.9 million impairment charge under the other-than-temporary impairment model on one special revenue bond classified as available for sale included in obligations of states and state agencies category. At December 31, 2020, the impaired security had an adjusted amortized cost and fair value of $680 thousand and $815 thousand, respectively . There was no impairment recognized in earnings during the year ended December 31, 2018. Held to maturity debt securities. As discussed further in Note 4 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 December 31, 2020, held to maturity debt securities were carried net of allowance for credit losses totaling $1.4 million. The provision totaled $635 thousand for the year ended December 31, 2020 driven mainly by our negative economic forecast incorporated within the allowance model since the onset of the COVID-19 pandemic. There were no net charge-offs of debt securities during 2020. Investment grades . 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. 2020 Form 10-K 58 The following table presents the held to maturity and available for sale debt investment securities portfolios by investment grades at December 31, 2020. December 31, 2020 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (in thousands) Available for sale investment grades:* AAA Rated $ 1,152,291 $ 43,476 $ (786) $ 1,194,981 AA Rated 26,640 672 (32) 27,280 A Rated 7,558 206 — 7,764 BBB Rated 31,047 840 (18) 31,869 Non-investment grade 11,839 19 (69) 11,789 Not rated 64,131 1,673 (14) 65,790 Total debt securities available for sale $ 1,293,506 $ 46,886 $ (919) $ 1,339,473 Held to maturity investment grades:* AAA Rated $ 1,821,431 $ 54,035 $ (254) $ 1,875,212 AA Rated 183,391 6,537 — 189,928 A Rated 14,527 429 — 14,956 BBB Rated 5,000 512 — 5,512 Non-investment grade 5,650 — (105) 5,545 Not rated 143,012 813 (7,366) 136,459 Total debt securities held to maturity $ 2,173,011 $ 62,326 $ (7,725) $ 2,227,612 * Rated using external rating agencies. Ratings categories include 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 debt securities held to maturity portfolio included $143.0 million in investments not rated by the rating agencies with aggregate unrealized losses of $7.4 million at December 31, 2020 related to four single-issuer bank trust preferred issuances with a combined amortized cost of $36.0 million. See Note 4 to the consolidated financial statements for additional information regarding our investment securities portfolio. 59 2020 Form 10-K Loan Portfolio The following table reflects the composition of the loan portfolio for the years indicated. At December 31, 2020 2019 2018 2017 2016 ($ in thousands) Commercial and industrial $ 4,709,569 $ 4,825,997 $ 4,331,032 $ 2,741,425 $ 2,638,195 Commercial and industrial PPP loans 2,152,139 — — — — Total Commercial and industrial 6,861,708 4,825,997 4,331,032 2,741,425 2,638,195 Commercial real estate: Commercial real estate 16,724,998 15,996,741 12,407,275 9,496,777 8,719,667 Construction 1,745,825 1,647,018 1,488,132 851,105 824,946 Total commercial real estate 18,470,823 17,643,759 13,895,407 10,347,882 9,544,613 Residential mortgage 4,183,743 4,377,111 4,111,400 2,859,035 2,867,918 Consumer: Home equity 431,553 487,272 517,089 446,280 469,009 Automobile 1,355,955 1,451,623 1,319,571 1,208,902 1,139,227 Other consumer 913,330 913,446 860,970 728,056 577,141 Total consumer loans 2,700,838 2,852,341 2,697,630 2,383,238 2,185,377 Total loans * $ 32,217,112 $ 29,699,208 $ 25,035,469 $ 18,331,580 $ 17,236,103 As a percent of total loans: Commercial and industrial 21.3 % 16.2 % 17.3 % 15.0 % 15.3 % Commercial real estate 57.3 59.5 55.5 56.4 55.4 Residential mortgage 13.0 14.7 16.4 15.6 16.6 Consumer loans 8.4 9.6 10.8 13.0 12.7 Total 100 % 100 % 100 % 100 % 100 % * Includes net unearned discount and deferred loan fees of $95.8 million at December 31, 2020, and net unearned premiums and deferred loan fees of $12.6 million, $21.5 million, $22.2 million, and $15.3 million at December 31, 2019, 2018, 2017, and 2016, respectively. Net unearned discounts and deferred loans fees at December 31, 2020 include the non-credit discount on purchased credit deteriorated (PCD) loans and $43.2 million of net unearned fees related to PPP loans. Total loans increased by $2.5 billion, or 8.5 percent to $32.2 billion at December 31, 2020 from December 31, 2019 mainly due to approximately $2.2 billion of SBA PPP loans within commercial and industrial loans, as well as continued annual growth in our commercial real estate loan portfolio. Upon our adoption of the CECL standard on January 1, 2020, we recorded a $61.6 million gross-up for PCD loans (mainly commercial and industrial and commercial real estate loans) that increased the amortized cost basis of loans with a corresponding increase to the allowance for credit losses. During 2020, Valley also originated $1.2 billion of residential mortgage loans for sale rather than investment. Loans held for sale totaled $301.4 million and $76.1 million at December 31, 2020 and 2019, respectively. See additional information regarding our residential mortgage loan activities below. Commercial and industrial loans totaled $6.9 billion at December 31, 2020 and increased $2.0 billion from December 31, 2019 mainly due to PPP loan originations. Excluding the PPP loans, commercial and industrial loans decreas ed $116.4 million largely due to our selective underwriting and tempered loan demand caused by the COVID-19 pandemic, particularly in the New Jersey and New York markets during the fourth quarter 2020, and our existing sm all to middle market lending relationships becoming more strategic with new capital expenditures due to the economic uncertainty. Commercial and industrial loans included PPP loans of approximately $2.2 billion, net of unearned net deferred fees to taling $43.2 million at December 31, 2020. Valley expects the majority of these borrowers to qualify for loan forgiveness under the guidelines of the SBA program. During 2021, PPP loan forgiveness and the unknown full impact of the COVID-19 pandemic could likely weigh on Valley's ability to grow the commercial and industrial loan portfolio. Commercial real estate loans (excluding construction loans) increased $728.3 million to $16.7 billion at December 31, 2020 from December 31, 2019. The increase was mainly due to strong loan volumes within our loan commitment pipeline, including many pre-existing, longstanding borrowers, an active refinance market driven by low interest rates as well as some slower repayment activity caused by the COVID-19 pandemic. Construction loans totaled $1.7 billion at December 31, 2020 and increased $98.8 million from December 31, 2019, mainly driven by loan advances on new and existing construction 2020 Form 10-K 60 projects, partially offset by the run-off of completed existing projects, and, to a lesser extent, migration of such completed projects to permanent financing during 2020. Construction demand in our Florida markets, which have mostly reopened during the current COVID-19 pandemic, remains robust as compared to the Northeast and we intend to be strategically competitive for the strongest borrowers and projects in that market. Residential mortgage loans totaled $4.2 billion at December 31, 2020 and decreased by $193.4 million from December 31, 2019 largely due to loan principal repayment and refinance activity and higher levels of residential mortgage loans originated for sale due to current interest rate risk management strategies. Our new and refinanced residential mortgage loan originations increased 22.3 percent to $1.9 billion for the year ended December 31, 2020 as compared to $1.6 billion in 2019. Of the $1.9 billion in total originations, $367 million represented Florida residential mortgage loans. During 2020, we sold $1.0 billion of residential mortgages as compared to $934.5 million of residential mortgage loans sold during 2019, including $30 million and $436 million of pre-existing loans sold from our residential mortgage loan portfolio, respectively. We retain mortgage originations based on credit criteria and loan to value levels, the composition of our interest earning assets and interest bearing liabilities and our ability to manage the interest rate risk associated with certain levels of these instruments. From time to time, we purchase residential mortgage loans originated by, and sometimes serviced by, other financial institutions based on several factors, including current loan origination volumes, market interest rates, excess liquidity, CRA and other asset/liability management strategies. Purchased residential mortgage loans are generally selected using Valley’s normal underwriting criteria at the time of purchase and are sometimes partially or fully guaranteed by third parties or insured by government agencies such as the Federal Housing Administration. Valley purchased approximately $24.3 million and $35 million of 1-4 family loans, qualifying for CRA purposes during 2020 and 2019, respectively. We may continue to sell a large portion of our new fixed rate residential mortgage loan originations during 2021 based upon normal management of the interest rate risk and mix of the interest earning assets on our balance sheet. Consumer loans totaled $2.7 billion at December 31, 2020 and decreased $151.5 million from December 31, 2019 mainly due to decreases in automobile and home equity loan portfolios. Automobile loans decreased $95.7 million or 6.6 percent to $1.4 billion at December 31, 2020 from December 31, 2019 as our new indirect auto loan volumes did not keep pace with the normal portfolio repayment and refinance activity during 2020. New loan originations have declined since the beginning of the second quarter 2020 mostly due to a combination of tightening our underwriting policies and impact of the COVID-19 pandemic. During 2020, our Florida dealership network con tributed $84.6 million in auto loan originations, representing approximately 17 percent of Valley's total new auto loan production for 2020 as compared to $169 million, or 23 percent, of total originations in 2019. Home equity loans decreased $55.7 million in 2020 from $487.3 million at December 31, 2019. New home equity loan volumes and customer usage of existing home equity lines of credit continue to be modest and outpaced by repayment activity, despite the favorable low interest rate environment. Other consumer loans totaled $913.3 million at December 31, 2020 and remained relatively unchanged as compared to 2019 mainly due to both tempered usage and demand within our collateralized personal lines of credit portfolio . Most of our lending is in northern and central New Jersey, New York City, Long Island, and Florida, with the exception of smaller auto and residential mortgage loan portfolios derived primarily 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. For 2021, we remain cautiously optimistic about overall loan growth, exclusive of PPP loans. In the early stages of the first quarter 2021, our loan origination pipelines remain robust and organic growth opportunities, especially in Florida, appear to have returned to closer to pre-pandemic levels. However, there can be no assurance that those positive trends will continue, or balances will not decline from December 31, 2020 given the potential for unforeseen changes in consumer confidence, the economy, and other market conditions. In addition, while difficult to accurately predict, we believe that many of our SBA PPP loans will become eligible for forgiveness in 2021 in accordance with the rules of this program and is highly likely to result in a large reduction in these loan balances. 61 2020 Form 10-K The following table reflects the contractual maturity distribution of the commercial and industrial and construction loans within our loan portfolio as of December 31, 2020: One Year or Less One to Five Years Over Five Years Total (in thousands) Commercial and industrial—fixed-rate $ 1,884,762 $ 629,218 $ 1,030,907 $ 3,544,887 Commercial and industrial—adjustable-rate 626,965 1,591,237 1,098,619 3,316,821 Construction—fixed-rate 217,919 147,489 86,750 452,158 Construction—adjustable-rate 839,709 348,675 105,283 1,293,667 $ 3,569,355 $ 2,716,619 $ 2,321,559 $ 8,607,533 We may renew loans at maturity when requested by a customer. In such instances, we generally conduct a review which includes an analysis of the borrower’s financial condition and, if applicable, a review of the adequacy of collateral via a new appraisal from an independent, bank approved, certified or licensed property appraiser or readily available market resources. A rollover of the loan at maturity may require a principal reduction or other modified terms. 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 were 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 PCD loans on a loan level basis and, if applicable, are reported in our past due and non-accrual loans at December 31, 2020. Non-performing assets (NPAs) include non-accrual loans, other real estate owned (OREO), other repossessed assets (which consist of automobiles and taxi medallions) and non-accrual debt securities at December 31, 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 cost to sell. Non-performing assets totaling $194.6 million at December 31, 2020 increased $90.1 million, or 86.3 percent, from December 31, 2019 (as shown in the table below) mainly due to higher non-accrual loans in most loan categories, including approximately $45 million of non-accrual PCD loans (largely in the commercial loan categories) reported at December 31, 2020. The increase in non-accruals within non-PCD loans was mainly due to the negative impact of the COVID-19 pandemic. NPAs as a percentage of total loans and NPAs totaled 0.60 percent and 0.35 percent at December 31, 2020 and 2019, respectively. We believe our total NPAs has remained relatively low as a percentage of the total loan portfolio over the past five years, despite the uptick in 2020 related to non-accrual PCD loans (not required to be reported as non-performing in prior periods) and borrowers impacted by COVID-19. The level of NPAs is reflective of our consistent approach to the loan underwriting criteria for both Valley originated loans and loans purchased from third parties. For additional details, see the "Credit quality indicators" section in Note 5 to the consolidated financial statements. Our lending strategy is based on underwriting standards designed to maintain high credit quality and we remain optimistic regarding the overall future performance of our loan portfolio. However, due to the potential for future credit deterioration caused by the uncertain economic recovery from the COVID -19 pandemic recession, lack of, or inadequate additional federal stimulus and a number of our borrowers that are performing under short-term forbearance agreements, management cannot provide assurance that our non-performing assets will not increase substantially from the levels reported at December 31, 2020. 2020 Form 10-K 62 The following table sets forth by loan category, accruing past due and non-performing assets on the dates indicated in conjunction with our asset quality ratios: At December 31, 2020 2019 2018 2017 2016 ($ in thousands) Accruing past due loans * 30 to 59 days past due Commercial and industrial $ 6,393 $ 11,700 $ 13,085 $ 3,650 $ 6,705 Commercial real estate 35,030 2,560 9,521 11,223 5,894 Construction 315 1,486 2,829 12,949 6,077 Residential mortgage 17,717 17,143 16,576 12,669 12,005 Total Consumer 10,257 13,704 9,740 8,409 4,197 Total 30 to 59 days past due 69,712 46,593 51,751 48,900 34,878 60 to 89 days past due Commercial and industrial 2,252 2,227 3,768 544 5,010 Commercial real estate 1,326 4,026 530 — 8,642 Construction — 1,343 — 18,845 — Residential mortgage 10,351 4,192 2,458 7,903 3,564 Total Consumer 1,823 2,527 1,386 1,199 1,147 Total 60 to 89 days past due 15,752 14,315 8,142 28,491 18,363 90 or more days past due Commercial and industrial 9,107 3,986 6,156 — 142 Commercial real estate 993 579 27 27 474 Construction — — — — 1,106 Residential mortgage 3,170 2,042 1,288 2,779 1,541 Total Consumer 271 711 341 284 209 Total 90 or more days past due 13,541 7,318 7,812 3,090 3,472 Total accruing past due loans $ 99,005 $ 68,226 $ 67,705 $ 80,481 $ 56,713 Non-accrual loans * Commercial and industrial $ 106,693 $ 68,636 $ 70,096 $ 20,890 $ 8,465 Commercial real estate 46,879 9,004 2,372 11,328 15,079 Construction 84 356 356 732 715 Residential mortgage 25,817 12,858 12,917 12,405 12,075 Total Consumer 5,809 2,204 2,655 1,870 1,174 Total non-accrual loans 185,282 93,058 88,396 47,225 37,508 Other real estate owned (OREO) 5,118 9,414 9,491 9,795 9,612 Other repossessed assets 3,342 1,276 744 441 384 Non-accrual debt securities 815 680 — — 1,935 Total non-performing assets (NPAs) $ 194,557 $ 104,428 $ 98,631 $ 57,461 $ 49,439 Performing troubled debt restructured loans $ 57,367 $ 73,012 $ 77,216 $ 117,176 $ 85,166 Total non-accrual loans as a % of loans 0.58 % 0.31 % 0.35 % 0.26 % 0.22 % Total NPAs as a % of loans and NPAs 0.60 0.35 0.39 0.31 0.29 Total accruing past due and non-accrual loans as a % of loans 0.88 0.54 0.62 0.70 0.55 Allowance for loan losses as a % of non-accrual loans 183.64 173.83 171.79 255.92 305.05 * Past due loans and non-accrual loans presented at December 31, 2019, 2018, 2017, and 2016, respectively, exclude PCI loans. Prior to January 1, 2020, PCI loans were accounted for on a pool basis under U.S. GAAP and were not subject to delinquency classification. 63 2020 Form 10-K Loans past due 30 to 59 days increased $23.1 million to $69.7 million at December 31, 2020 as compared to $46.6 million at December 31, 2019 partially due to a $12.3 million matured commercial real estate loan and two commercial real estate loan relationships with a combined total of $16.8 million reported in this delinquency category at December 31, 2020. While one of these loans is internally classified as substandard, management believes it is well secured and in the process of collection. Loans past due 60 to 89 days increased $1.4 million to $15.8 million at December 31, 2020 as compared to December 31, 2019 mostly due to higher residential mortgage loan delinquencies caused by a few larger borrowers. Loans 90 days or more past due and still accruing increased $6.2 million to $13.5 million at December 31, 2020 as compared to December 31, 2019 mainly due to higher commercial and industrial loan delinquencies. Residential mortgage loan delinquencies increased $1.1 million as compared to 2019 primarily due to one large loan included in this category at December 31, 2020. All 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 $92.2 million to $185.3 million at December 31, 2020 as compared to December 31, 2019. Commercial and industrial non-accrual loans increased $38.1 million mainly due to the reclassification of $34.2 million of previously accruing taxi medallion loans to non-accrual status during the first quarter of 2020 and $12.7 million of non-accrual PCD loans included at December 31, 2020. See further discussion of our taxi medallion loan portfolio below. The $37.9 million increase in non-accrual commercial real estate loans was largely due to six loan relationships totaling $20.8 million and $22.1 of non-accrual PCD included at December 31, 2020. Although the timing of collection is uncertain, management believes that most of the non-accrual loans at December 31, 2020, are well secured and largely collectible based on, in part, our quarterly review of collateral dependent loans and the valuation of the underlying collateral, if applicable. If interest on non-accrual loans had been accrued in accordance with the original contractual terms, such interest income would have amounted to approximately $6.2 million, $2.5 million and $3.6 million for the years ended December 31, 2020, 2019 and 2018, respectively; none of these amounts were included in interest income during these periods. During 2020, we continued to closely monitor the performance of our New York City and Chicago taxi medallion loans totaling $90.6 million and $6.9 million, respectively, within the commercial and industrial loan portfolio at December 31, 2020. Due to continued negative trends in estimated fair valuations of the underlying taxi medallion collateral, a weak operating environment for ride services 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 December 31, 2020, non-accrual taxi medallion loans totaling $97.5 million had related reserves of $66.4 million, or 68.1 percent of such loans, within the allowance for loan losses as compared to $63.3 million with related reserve s of $25.0 million December 31, 2019. Valley's historical taxi medallion lending criteria was conservative in regard to capping the loan amounts in relation to the prevailing 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 over the last several years has adversely affected the estimated fair valuation of these loans and, as a result, increased the level of our allowance for loan losses at December 31, 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 the COVID-19 pandemic could also negatively impact the future performance of this portfolio. For example, a 25 percent further decline in our current estimated market value of the taxi medallions would require additional allocated reserves of $5.5 million within the allowance for loan losses based upon taxi medallion loan balances at December 31, 2020. OREO (which consisted of 25 commercial and residential properties) decreased to $5.1 million at December 31, 2020 as compared to $9.4 million at December 31, 2019. During 2020, we transferred 14 properties totaling $4.0 million and sold 19 properties for total proceeds of $9.0 million. The sales of OREO properties resulted in net gains of $674 thousand for the year ended December 31, 2020 as compared to net gains of $1.3 million for the year ended December 31, 2019 . See Notes 1 and 3 to the consolidated financial statements for additional information regarding OREO and other repossessed assets, including our foreclosed asset activity. 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) decreased $15.6 million to $57.4 million at December 31, 2020 as compared to $73.0 million at December 31, 2019 mainly due to paydowns of several commercial and industrial loans during 2020. Performing TDRs consisted of 87 loans and 119 loans (primarily in the commercial and industrial loan and commercial real estate portfolios) at December 31, 2020 and 2019, respectively. On an aggregate basis, the $57.4 million in performing TDRs at December 31, 2020 had a modified weighted 2020 Form 10-K 64 average interest rate of approximately 4.68 percent as compared to a pre-modification weighted average interest rate of 4.94 percent . See Note 5 to the consolidated financial statements for additional disclosures regarding our TDRs. Loan Forbearance. In response to the COVID-19 pandemic and its economic impact to certain customers, Valley implemented short-term loan modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant, when requested by customers. Generally, the modification terms allow for a deferral of payments for up to 90 days, which Valley may extend for an additional 90 days. Any extensions beyond this period were done in accordance with applicable regulatory guidance. The following table presents the outstanding loan b alances and number of loans in an active payment deferral period under short-term modifications as of December 31, 2020: December 31, 2020 Amount Number of loans ($ in thousands) Commercial and industrial $ 12,835 53 Commercial real estate 299,874 55 Residential mortgage 38,615 95 Consumer 9,937 407 Total $ 361,261 610 During the fourth quarter 2020, active loan forbearances decreased from approximately 1,400 loans with total outstanding balances of $1.1 billion remaining as of September 30, 2020. Higher Risk COVID-19 Credit Exposures. Valley has identified certain borrower industries as being potentially exposed to the effects of economic shutdowns related to the COVID-19 pandemic. The following table presents non-PPP loans and active deferrals in the COVID-19 e xposure industries at December 31, 2020: December 31, 2020 Non-PPP loan balance % of non-PPP loans Active deferrals % of total industry loans ($ in thousands) Doctors and surgery $ 510,772 1.7 % $ 4,609 0.9 % Retail trade 596,015 2.0 15,974 2.7 Hotels and hospitality 504,571 1.7 — — Restaurants and food service 328,838 1.1 25,973 7.9 Entertainment and recreation 215,695 0.7 3,564 1.7 Total $ 2,155,891 7.2 % $ 50,120 2.3 % As of December 31, 2020, Valley had approx imately $2.2 billion, or 7.2 percent of total loans (excluding PPP loans), that were made to borrowers in these industries. Active deferrals in this category totaled approximately $50 million, or 2.3 percent of total loans in COVID-19 exposed industries at December 31, 2020, as compared to $158 million, or 7.1 percent of total loans at September 30, 2020. Approximately 90 percent of total loan balances within the higher risk industries were pass-rated under Valley’s internal risk rating system as of December 31, 2020. Potential Problem Loans Although we believe that substantially all risk elements at December 31, 2020 have been disclosed in the categories presented above, it is possible that for a variety of reasons, including economic conditions, certain borrowers may be unable to comply with the contractual repayment terms on certain real estate and commercial loans. As part of the analysis of the loan portfolio, management determined that there were approximately $258.8 million and $91.7 million in potential problem loans at December 31, 2020 and 2019, respectively. The increase from 2019 was mainly due to many of the risk rating downgrades resulting from the adverse impacts of the COVID-19 pandemic had on borrowers, as well as inclusion of PCD loans, which were previously excluded and were accounted for under ASC Subtopic 310-30. Potential problem loans were not classified as non-accrual loans in the non-performing asset table above. Potential problem loans are defined as performing loans for which management has concerns about the ability of such borrowers to comply with the loan repayment terms and which may result in a non-performing loan. Our decision to include performing loans in potential problem loans does not necessarily mean that management expects losses to occur, but rather that management recognizes potential problem loans carry a higher probability of default. At December 31, 2020, the potential problem loans consisted of various types of performing commercial loan 65 2020 Form 10-K credits, including industries highlighted in the "Higher Risk COVID-19 Credit Exposures" table above, that are internally risk rated substandard because the loans exhibited well-defined weaknesses and required additional attention by management. See further discussion regarding our internal loan classification system at Note 5 to the consolidated financial statements. There can be no assurance that Valley has identified all of its potential problem loans at December 31, 2020. Asset Quality and Risk Elements Lending is one of the most important functions performed by Valley and, by its very nature, lending is also the most complicated, risky and profitable part of our business. For our commercial loan portfolio, comprised of commercial and industrial loans, commercial real estate loans, and construction loans, a separate credit department is responsible for risk assessment and periodically evaluating overall creditworthiness of a borrower. Additionally, efforts are made to limit concentrations of credit to minimize the impact of a downturn in any one economic sector. We believe our loan portfolio is diversified as to type of borrower and loan. However, loans collateralized by real estate represent approximately 72 percent of total loans at December 31, 2020. Most of the loans collateralized by real estate are in northern and central New Jersey, New York City and Florida presenting a geographical credit risk if there was a further significant broad-based deterioration in economic conditions within these regions impacted by COVID-19 pandemic. See Item 1A. Risk Factors -" Risks Related to the COVID-19 Pandemic". Consumer loans are comprised of residential mortgage loans, home equity loans, automobile loans and other consumer loans. Residential mortgage loans are secured by 1-4 family properties mostly located in New Jersey, New York and Florida. We do provide mortgage loans secured by homes beyond this primary geographic area; however, lending outside this primary area has generally consisted of loans made in support of existing customer relationships, as well as targeted purchases of certain loans guaranteed by third parties. Our mortgage loan originations are comprised of both jumbo (i.e., loans with balances above conventional conforming loan limits) and conventional loans based on underwriting standards that generally comply with Fannie Mae and/or Freddie Mac requirements. The weighted average loan-to-value ratio of all residential mortgage originations in 2020 wa s 68 percent while FICO ® (independent objective criteria measuring the creditworthiness of a borrower) scores averaged 757. Home equity and automobile loans are secured loans and are made based on an evaluation of the collateral and the borrower’s cr editworthiness. In addition to our primary markets, automobile loans are mostly originated in several other contiguous states. Due to the level of our underwriting standards applied to all loans, management believes the out of market loans generally present no more risk than those made within the market. However, each loan or group of loans made outside of our primary markets poses different geographic risks based upon the economy of that particular region. Management realizes that some degree of risk must be expected in the normal course of lending activities. Allowances are maintained to absorb such lifetime expected credit losses inherent in the portfolio. Allowance for Credit Losses The allowance for credit losses (ACL) includes the allowance for loan losses and the reserve for unfunded commercial letters of credit. Effective January 1, 2020, we adopted the new CECL standard, which is based on lifetime expected credit losses rather than incurred losses. Periods prior to 2020 have been reported in accordance with previously applicable GAAP, which followed the incurred credit losses methodology. See the table below and Notes 1 and 5 to the consolidated financial statements for further details on the impact of the Day 1 CECL adoption and the incurred credit losses methodology. Under CECL, our methodology to establish the allowance for loan losses has two basic components: (1) a collective reserve component for estimated expected credit losses for pools of loans that share common 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. Valley estimated the collective ACL using a current expected credit losses methodology which is based on relevant information about historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the loan balances. 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. 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) the impact of the reasonable and supportable economic forecast, relative probability weightings and reversion period, (ii) other asset specific risks to the extent they do not exist in the historical loss information, and (iii) net expected recoveries of charged off loan balances. These adjustments are based on qualitative factors not reflected in the quantitative model but are likely to impact the measurement of estimated credit 2020 Form 10-K 66 losses. The expected lifetime loss rate is the life of loan loss percentage from the transition matrix model plus the impact of the adjustments for qualitative factors. The expected credit losses are the product of multiplying the model’s expected lifetime loss rate by the exposure at default at period end on an undiscounted basis. 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 on a straight-line basis. 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. During the fourth quarter 2020, we continued to incorporate a probability weighted three-scenario economic forecast, including Moody's Baseline, S-3 and S-4 scenarios. At December 31, 2020, Valley maintained a higher combined weighting on the S-3 and S-4 alternative downside scenarios as compared to the Moody's Baseline scenario to reflect downside risk factors, including, but not limited to the unknown effect of the latest federal economic stimulus to promote a strong economic recovery, loan customers with payment deferrals, increasing COVID-19 infection rates in many locales and the efficacy of COVID-19 vaccines and the timing of the vaccine distribution across the U.S. Each of these risk factors may affect the performance of Valley’s loan portfolio over time. The S-4 forecast is the most severe economic scenario and included the following assumptions at December 31, 2020 : • The COVID-19 pandemic will persist and meaningfully impact the economy; • The national unemployment rate will remain elevated throughout 2021 and 2022, with a peak at 11.5 percent in the third quarter 2022; • An overall decline in spending on a wide range of products and services; • A prolonged economic downturn will persist until the fourth quarter 2021 with real GDP growth resuming by mid-year 2022; and • The target federal funds interest rate will remain at or near zero for the foreseeable future. The allowance for credit losses for loans methodology and accounting policy are fully described in Note 1 to the consolidated financial statements. 67 2020 Form 10-K The following table summarizes the relationship among loans, loans charged-off, loan recoveries, the provision for credit losses and the allowance for credit losses for the years indicated: Years Ended December 31, 2020 2019 2018 2017 2016 ($ in thousands) Average loans outstanding $ 31,785,859 $ 26,235,253 $ 23,340,330 $ 17,819,003 $ 16,400,745 Beginning balance—Allowance for credit losses for loans $ 164,604 $ 156,295 $ 124,452 $ 116,604 $ 108,367 Impact of ASU No. 2016-13 adoption on January 1, 2020 (1) 37,989 — — — — Allowance for purchased credit deteriorated (PCD) loans (1) 61,643 — — — — Beginning balance, adjusted 264,236 156,295 124,452 116,604 108,367 Loans charged-off: (2) Commercial and industrial (34,630) (13,260) (2,515) (5,421) (5,990) Commercial real estate (767) (158) (348) (559) (650) Residential mortgage (598) (126) (223) (530) (866) Total Consumer (9,294) (8,671) (4,977) (4,564) (3,463) Total charge-offs (45,289) (22,215) (8,063) (11,074) (10,969) Charged-off loans recovered: Commercial and industrial 1,956 2,397 4,623 4,736 2,852 Commercial real estate 1,054 1,237 417 552 2,047 Construction 452 — — 873 10 Residential mortgage 670 66 272 1,016 774 Total Consumer 3,188 2,606 2,093 1,803 1,654 Total recoveries 7,320 6,306 7,405 8,980 7,337 Net charge-offs (37,969) (15,909) (658) (2,094) (3,632) Provision charged for credit losses 125,087 24,218 32,501 9,942 11,869 Ending balance—Allowance for credit losses for loans $ 351,354 $ 164,604 $ 156,295 $ 124,452 $ 116,604 Components of allowance for credit losses for loans: Allowance for loan losses $ 340,243 $ 161,759 $ 151,859 $ 120,856 $ 114,419 Allowance for unfunded credit commitments 11,111 2,845 4,436 3,596 2,185 Allowance for credit losses for loans $ 351,354 $ 164,604 $ 156,295 $ 124,452 $ 116,604 Components of provision for credit losses for loans: Provision for credit losses for loans $ 123,922 $ 25,809 $ 31,661 $ 8,531 $ 11,873 Provision for unfunded credit commitments (3) 1,165 (1,591) 840 1,411 (4) Provision for credit losses for loans $ 125,087 $ 24,218 $ 32,501 $ 9,942 $ 11,869 Annualized ratio of net charge-offs during the period to average loans outstanding 0.12 % 0.06 % 0.00 % 0.01 % 0.02 % (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 January 1, 2020 exclude loans formerly accounting for as PCI loans. (3) Periods prior to January 1, 2020 represent the allowance and provision for unfunded letters of credit only . Our net loan charge-offs increased $22.1 million to $38.0 million in 2020 as compared to $15.9 million in 2019 mainly due to higher gross charge-offs in the commercial and industrial loan category. The higher level of commercial and industrial loan charge-offs in 2020 was largely driven by taxi medallion partial loan charge-offs totaling $12.5 million for the year ended 2020 Form 10-K 68 December 31, 2020 (as compared to $6.5 million for 2019) and the partial and full charge-offs of two loans totaling $7.8 million and $6.0 million, respectively. While net charge-offs increased largely due to borrowers impacted by the COVID-19 pandemic during 2020, they have remained within management's expectations for the credit quality of Valley's loan portfolio and its underwriting standards. During the five-year period ended December 31, 2020, our net charge-offs were at a high of 0.12 percent of average loans during 2020 and near zero during 2018. While we have a positive outlook for the future performance of the loan portfolio, there can be no assurance that our levels of net charge-offs will not deteriorate in 2021, especially given the uncertain course of the economic recovery, labor markets and the number of our COVID-19 impacted borrowers that remained in active deferral of contractual payments at December 31, 2020. The following table summarizes the allocation of the allowance for credit losses to specific loan portfolio categories for the past five years ended December 31,: 2020 2019 2018 2017 2016 Allowance Allocation* Percent of Loan Category to total loans Allowance Allocation* Percent of Loan Category to total loans Allowance Allocation* Percent of Loan Category to total loans Allowance Allocation* Percent of Loan Category to total loans Allowance Allocation* Percent of Loan Category to total loans ($ in thousands) Loan Category: Commercial and industrial $ 131,070 21.3 % $ 104,059 16.2 % $ 90,956 17.3 % $ 57,232 15.0 % $ 50,820 15.3 % Commercial real estate: Commercial real estate 146,009 51.9 20,019 53.9 26,482 49.6 36,293 51.8 36,405 50.6 Construction 18,104 5.4 25,654 5.6 23,168 5.9 18,661 4.6 19,446 4.8 Total commercial real estate 164,113 57.3 45,673 59.5 49,650 55.5 54,954 56.4 55,851 55.4 Residential mortgage 28,873 13.0 5,060 14.7 5,041 16.4 3,605 15.6 3,702 16.6 Total Consumer 16,187 8.4 6,967 9.6 6,212 10.8 5,065 13.0 4,046 12.7 Total allowance for loan losses 340,243 100.0 % 161,759 100.0 % 151,859 100.0 % 120,856 100.0 % 114,419 100.0 % Allowance for unfunded credit commitments 11,111 2,845 4,436 3,596 2,185 Total allowance for credit losses for loans $ 351,354 $ 164,604 $ 156,295 $ 124,452 $ 116,604 * 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 (including letters of credit), as a percentage of total loans was 1.09 percent at December 31, 2020 and 0.55 percent at December 31, 2019. The allowance for credit losses for loans increased $186.8 million at December 31, 2020 as compared to December 31, 2019 largely due to Valley's Day 1 CECL adoption adjustment of $99.6 million recorded on January 1, 2020 and the reserve build under CECL during 2020. The reserve build in 2020 reflected several factors, including deterioration in Valley's macroeconomic outlook since the onset of the COVID-19 pandemic, additional qualitative management adjustments to reflect the potential for higher levels of credit stress related to borrowers negatively impacted by the pandemic, the impact of lower valuations of collateral securing our non-performing taxi medallion loan portfolio and additional quantitative reserves, based upon expected and actual transitions in the credit quality of our loan portfolio. As a result, the provision for credit losses increased $100.9 million to $125.1 million in 2020 as compared to 2019. Loan Repurchase Contingencies We engage in the origination of residential mortgages for sale into the secondary market. Our loan sales totaled approximately $1.0 billion, $935 million and $676 million for 2020, 2019 and 2018, respectively. During 2020 and 2019, loan sales increased significantly from 2018 as new loan originations and refinance activity strengthened due to a favorably low interest rate environment complemented, from time to time, by sales from the held for investment portfolio. In connection with loan sales, we make representations and warranties, which, if breached, may require us to repurchase such loans, substitute other loans or indemnify the purchasers of such loans for actual losses incurred due to such loans. However, the performance of our loans sold has been historically strong due to our strict underwriting standards and procedures. Over the past several years, we have experienced a nominal amount of repurchase requests, only a few of which have actually resulted in repurchases by Valley (only two loan repurcha ses in 2020 and four loan repurchases in 2019). None of the loan repurchases resulted in material loss. Accordingly, no reserves pertaining to loans sold were established on our consolidated financial statements at December 31, 2020 and 2019. See Item 1A. Risk Factors - "We may incur future losses in 69 2020 Form 10-K connection with repurchases and indemnification payments related to mortgages that we have sold into the secondary market” of this report for additional information. Capital Adequacy A significant measure of the strength of a financial institution is its shareholders’ equity. At December 31, 2020 and 2019, shareholders’ equity totaled approximately $4.6 billion and $4.4 billion, or 11.3 percent and 11.7 percent of total assets, respectively. During 2020, total shareholders’ equity increased by $207.9 million primarily due to (i) net income of $390.6 million, (ii) an increase in other comprehensive income of $24.5 million, and (iii) a $13.0 million increase attributable to the effect of share issuances under our stock incentive plan. These positive changes were partially offset by (i) cash dividends declared on common and preferred stock totaling a combined $192.0 million and (ii) a $28.2 million ne t 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 Federal Reserve Bank 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 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 December 31, 2020 and 2019, Valley and Valley National Bank exceeded all capital adequacy requirements. See Note 17 to the consolidated financial statements for Valley’s and Valley National Bank’s regulatory capital positions and capital ratios at December 31, 2020 and 2019. 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 for 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) for the year ended December 31, 2020 will be phased in over the same time frame. 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 shareholders) per common share. Our retention ratio was 52.7 percent and 49.4 percent for the years ended December 31, 2020 and 2019, respectively. Cash dividends declared amounted to $0.44 per common share for both years ended December 31, 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 Item 1A. Risk Factors of this report for additional information. Valley maintains an effective shelf registration statement with the SEC that allows us to periodically offer and sell in one or more offerings, individually or in any combination, our common stock, preferred stock and other non-equity securities. The shelf registration statement provides Valley with capital raising flexibility and enables Valley to promptly access the capital markets in order to pursue growth opportunities that may become available in the future and permits Valley to comply with any changes in the regulatory environment that call for increased capital requirements. Valley’s ability, and any decision to issue and sell securities pursuant to the shelf registration statement, is subject to market conditions and Valley’s capital needs at such time. Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common stock, or both. Such offerings may be necessary in the future due to several reasons beyond management’s control, including numerous external factors that could negatively impact the strength of the U.S. economy or our ability to maintain or increase the level of our net income. See Note 18 to the consolidated financial statements for additional information on Valley’s preferred stock issuances. 2020 Form 10-K 70 Item 7A. Quantitative and Qualitative Disclosures About Market Risk Information regarding Quantitative and Qualitative Disclosures About Market Risk is discussed in the "Interest Rate Sensitivity" section contained in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and it is incorporated herein by reference. 71 2020 Form 10-K