COMMITMENTS AND CONTINGENCIES (Note 14)

Lease Commitments

Certain bank facilities are occupied under non-cancelable long-term operating leases, which expire at various dates through 2058. Certain lease agreements provide for renewal options and increases in rental payments based upon increases in the consumer price index or the lessors’ cost of operating the facility. Minimum aggregate lease payments for the remainder of the lease terms are as follows:


			Sublease
Year	Gross Rents		Rents		Net Rents
	(in thousands)
2013	$	22,151	$	1,850	$	20,301
2014		21,252		1,725		19,527
2015		20,957		1,657		19,300
2016		20,615		1,530		19,085
2017		20,115		1,519		18,596
Thereafter		277,363		4,506		272,857

Total lease commitments	$	382,453	$	12,787	$	369,666

Net occupancy expense for years ended December 31, 2012, 2011, and 2010 included net rental expense of approximately $23.8 million, $21.2 million, and $21.1 million, respectively, net of rental income of $2.5 million, $1.8 million, and $2.1 million, respectively, for leased bank facilities.

Financial Instruments With Off-balance Sheet Risk

In the ordinary course of business in meeting the financial needs of its customers, Valley, through its subsidiary Valley National Bank, is a party to various financial instruments, which are not reflected in the consolidated financial statements. These financial instruments include standby and commercial letters of credit, unused portions of lines of credit and commitments to extend various types of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated financial statements. The commitment or contract amount of these instruments is an indicator of the Bank’s level of involvement in each type of instrument as well as the exposure to credit loss in the event of non-performance by the other party to the financial instrument. The Bank seeks to limit any exposure of credit loss by applying the same credit policies in making commitments, as it does for on-balance sheet lending facilities.

The following table provides a summary of financial instruments with off-balance sheet risk at December 31, 2012 and 2011:


	2012		2011
	(in thousands)
Commitments under commercial loans and lines of credit	$	1,944,815	$	1,778,837
Home equity and other revolving lines of credit		620,397		570,247
Outstanding commercial mortgage loan commitments		253,235		237,921
Standby letters of credit		228,694		237,279
Outstanding residential mortgage loan commitments		247,275		275,116
Commitments under unused lines of credit—credit card		59,969		64,144
Commercial letters of credit		6,043		11,076
Commitments to sell loans		100,400		85,000

Obligations to advance funds under commitments to extend credit, including commitments under unused lines of credit, are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have specified expiration dates, which may be extended upon request, or other termination clauses and generally require payment of a fee. These commitments do not necessarily represent future cash requirements as it is anticipated that many of these commitments will expire without being fully drawn upon. The Bank’s lending activity for outstanding loan commitments is primarily to customers within the states of New Jersey, New York and Pennsylvania.

Standby letters of credit represent the guarantee by the Bank of the obligations or performance of the bank customer in the event of the default of payment of nonperformance to a third party beneficiary.

Loan sale commitments represent contracts for the sale of residential mortgage loans to third parties in the ordinary course of the Bank’s business. These commitments require the Bank to deliver loans within a specific period to the third party. The risk to the Bank is its non-delivery of loans required by the commitment, which could lead to financial penalties. The Bank has not defaulted on its loan sale commitments.

Derivative Instruments and Hedging Activities

Valley is exposed to certain risks arising from both its business operations and economic conditions. Valley principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. Valley manages economic risks, including interest rate and liquidity risks, primarily by managing the amount, sources, and duration of its assets and liabilities and, from time to time, the use of derivative financial instruments. Specifically, Valley enters into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Valley’s derivative financial instruments are used to manage differences in the amount, timing, and duration of Valley’s known or expected cash receipts and its known or expected cash payments related to assets and liabilities outlined below.

Cash Flow Hedges of Interest Rate Risk. Valley’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, Valley uses interest rate swaps and caps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the payment of either fixed or variable-rate amounts in exchange for the receipt of variable or fixed-rate amounts from a counterparty. Interest rate caps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.

At December 31, 2012, Valley had the following cash flow hedge derivatives:

•

Four forward starting interest rate swaps with a total notional amount of $300 million to hedge the changes in cash flows associated with certain prime-rate-indexed deposits, consisting of consumer and commercial money market deposit accounts. Two of the four swaps, totaling $200 million, expire in October 2016 and require Valley to pay fixed-rate amounts at approximately 4.73 percent, in exchange for the receipt of variable-rate payments at the prime rate. Starting in July 2012, the other two swaps totaling $100 million require the payment by Valley of fixed-rate amounts at approximately 5.11 percent in exchange for the receipt of variable-rate payments at the prime rate and expire in July 2017.

•

Two interest rate caps with a total notional amount of $100 million, strike rates of 2.50 percent and 2.75 percent, and a maturity date of May 1, 2013 used to hedge the variability in cash flows associated with customer repurchase agreements and money market deposit accounts that have variable interest rates based on the federal funds rate.

•

Two interest rate caps with a total notional amount of $100 million, strike rates of 6.00 percent and 6.25 percent, and a maturity date of July 15, 2015 used to hedge the total change in cash flows associated with prime-rate-indexed deposits, consisting of consumer and commercial money market deposit accounts, which have variable interest rates indexed to the prime rate.

Fair Value Hedges of Fixed Rate Assets and Liabilities. Valley is exposed to changes in the fair value of certain of its fixed rate assets or liabilities due to changes in benchmark interest rates based on one month-LIBOR. From time to time, Valley uses interest rate swaps to manage its exposure to changes in fair value. Interest rate swaps designated as fair value hedges involve the receipt of variable rate payments from a counterparty in exchange for Valley making fixed rate payments over the life of the agreements without the exchange of the underlying notional amount.

At December 31, 2012, Valley had the following fair value hedge derivatives:

•

One interest rate swap with a notional amount of approximately $8.8 million used to hedge the change in the fair value of a commercial loan.

•

One interest rate swap with a notional amount of $51 million, maturing in March 2014, used to hedge the change in the fair value of certain fixed-rate brokered certificates of deposit entered into during 2011.

For derivatives that are designated and qualify as fair value hedges, the gain or loss on the derivative as well as the loss or gain on the hedged item attributable to the hedged risk are recognized in earnings. Valley includes the gain or loss on the hedged items in the same income statement line item as the loss or gain on the related derivatives.

Non-designated Hedges. Derivatives not designated as hedges may be used to manage Valley’s exposure to interest rate movements or to provide service to customers but do not meet the requirements for hedge accounting under U.S. GAAP. Derivatives not designated as hedges are not entered into for speculative purposes. Under a program, Valley executes interest rate swaps with commercial lending customers to facilitate their respective risk management strategies. These interest rate swaps with customers are simultaneously offset by interest rate swaps that Valley executes with a third party, such that Valley minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of December 31, 2012, Valley had a total of 37 interest rate swaps with an aggregate notional amount of $146.9 million, including 13 interest rate swaps totaling $16.4 million acquired from State Bancorp, related to this program.

Valley also enters into mortgage banking derivatives which are non-designated hedges. These derivatives include interest rate lock commitments provided to customers to fund certain residential mortgage loans to be sold into the secondary market and forward commitments for the future delivery of such loans. Valley enters 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 Valley’s commitments to fund the loans as well as on its portfolio of mortgage loans held for sale. As of December 31, 2012, Valley had mortgage banking derivatives with an aggregate notional amount of $194.3 million.

Amounts included in the consolidated statements of financial condition related to the fair value of Valley’s derivative financial instruments were as follows:


	Balance Sheet	Fair Value at December 31,
	Line Item	2012		2011
		(in thousands)
Asset Derivatives:
Derivatives designated as hedging instruments:
Cash flow hedge interest rate caps and swaps	Other Assets	$	23	$	294
Fair value hedge interest rate swaps	Other Assets		652		852

Total derivatives designated as hedging instruments		$	675	$	1,146

Derivatives not designated as hedging instruments:
Interest rate swaps	Other Assets	$	7,002	$	4,065
Mortgage banking derivatives	Other Assets		239		—

Total derivatives not designated as hedging instruments		$	7,241	$	4,065

Liability Derivatives:
Derivatives designated as hedging instruments:
Cash flow hedge interest rate caps and swaps	Other Liabilities	$	17,198	$	15,649
Fair value hedge interest rate swaps	Other Liabilities		2,197		2,140

Total derivatives designated as hedging instruments		$	19,395	$	17,789

Derivatives not designated as hedging instruments:
Interest rate swaps	Other Liabilities	$	6,999	$	4,065
Mortgage banking derivatives	Other Liabilities		200		—

Total derivatives not designated as hedging instruments		$	7,199	$	4,065

Gains (losses) included in the consolidated statements of income and in other comprehensive income (loss), on a pre-tax basis, related to interest rate derivatives designated as hedges of cash flows were as follows:


	2012			2011			2010
	(in thousands)
Interest rate caps on short-term borrowings and deposit accounts:
Amount of loss reclassified from accumulated other comprehensive income or loss to interest on short-term borrowings	$	(6,478	)	$	(3,067	)	$	(1,967	)
Amount of (loss) gain recognized in other comprehensive income (loss)		(5,774	)		(24,393	)		1,494

Valley recognized net gains of $73 thousand and net losses of $23 thousand and $205 thousand in other expense for hedge ineffectiveness on the cash flow hedge interest rate caps for the years ended December 31, 2012, 2011 and 2010, respectively. The accumulated net after-tax losses related to effective cash flow hedges included in accumulated other comprehensive loss was $12.7 million and $13.1 million at December 31, 2012 and 2011, respectively.

Amounts reported in accumulated other comprehensive loss related to cash flow interest rate derivatives are reclassified to interest expense as interest payments are made on the hedged variable interest rate liabilities. Valley estimates that $8.6 million will be reclassified as an increase to interest expense in 2013.

Gains (losses) included in the consolidated statements of income related to interest rate derivatives designated as hedges of fair value were as follows:


	2012			2011			2010
	(in thousands)
Derivative—interest rate swaps:
Interest income—interest and fees on loans	$	(57	)	$	(761	)	$	(361	)
Interest expense—interest on time deposits		(200	)		852			—
Hedged item—loans and deposits:
Interest income—interest and fees on loans	$	57		$	761		$	361
Interest expense—interest on time deposits		220			(884	)		—

Valley recognized net gains of $20 thousand and net losses of $32 thousand in non-interest expense for the years ended December 31, 2012 and 2011, respectively, related to hedge ineffectiveness on the fair value hedge interest rate swaps. There were no net gains or net losses for the year ended December 31, 2010. Valley also recognized a net reduction to interest expense of $561 thousand and $472 thousand for the years ended December 31, 2012 and 2011, respectively, related to Valley’s fair value hedges on brokered time deposits, which includes net settlements on the derivatives.

Net gains included in the consolidated statements of income related to derivative instruments not designated as hedging instruments for the years ended December 31, 2012, 2011, and 2010 were as follows:


	2012		2011		2010
	(in thousands)
Non-designated hedge interest rate derivatives
Trading gains, net	$	—	$	—	$	1,984
Other non-interest income		253		—		369

Credit Risk Related Contingent Features. By using derivatives, Valley is exposed to credit risk if counterparties to the derivative contracts do not perform as expected. Management attempts to minimize counterparty credit risk through credit approvals, limits, monitoring procedures and obtaining collateral where appropriate. Credit risk exposure associated with derivative contracts is managed at Valley in conjunction with Valley’s consolidated counterparty risk management process. Valley’s counterparties and the risk limits monitored by management are periodically reviewed and approved by the Board of Directors.

Valley has agreements with its derivative counterparties providing that if Valley defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then Valley could also be declared in default on its derivative counterparty agreements. Additionally, Valley has an agreement with several of its derivative counterparties that contains provisions that require Valley’s debt to maintain an investment grade credit rating from each of the major credit rating agencies, from which it receives a credit rating. If Valley’s credit rating is reduced below investment grade or such rating is withdrawn or suspended, then the counterparty could terminate the derivative positions, and Valley would be required to settle its obligations under the agreements. As of December 31, 2012, Valley was in compliance with the provisions of its derivative counterparty agreements.

As of December 31, 2012, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $26.2 million. Valley has derivative counterparty agreements that require minimum collateral posting thresholds for certain counterparties. No collateral has been assigned or posted by Valley’s counterparties under the agreements at December 31, 2012. At December 31, 2012, Valley had $25.9 million in collateral posted with its counterparties.

Litigation

In the normal course of business, Valley may be a party to various outstanding legal proceedings and claims. In the opinion of management, the financial condition, results of operations, and liquidity of Valley should not be materially affected by the outcome of such legal proceedings and claims.