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| KRNY > SEC Filings for KRNY > Form 10-K on 15-Sep-2008 | All Recent SEC Filings |
15-Sep-2008
Annual Report
General
This discussion and analysis reflects Kearny Financial Corp.'s consolidated financial statements and other relevant statistical data. We include it to enhance your understanding of our financial condition and results of operations. You should read the information in this section in conjunction with Kearny Financial Corp.'s consolidated financial statements and notes thereto contained in this Annual Report on Form 10-K and the other statistical data provided herein.
Overview
Financial Condition. Total assets increased $165.8 million to $2.08 billion at June 30, 2008 from $1.92 billion at June 30, 2007. The increase was due primarily to increases in net loans receivable and mortgage-backed securities of $161.2 million and $82.2 million, respectively. Partially offsetting these increases were decreases in non-mortgage-backed securities and cash and cash equivalents of $50.7 million and $31.6 million, respectively.
During the year ended June 30, 2008, per the Company's business plan, management continued to focus on changing the Bank's asset mix, increasing the loan portfolio while reducing the relative size of the securities portfolio. Our loan portfolio now represents a greater percentage of our interest-earning assets than our securities portfolio. At June 30, 2008, net loans receivable comprised 49.0% of total assets compared to 44.9% a year earlier while securities comprised 36.7% of total assets compared to 38.2% a year earlier. Between June 30, 2007 and June 30, 2008, net loans receivable increased $161.2 million, or 18.7%, while securities increased $31.6 million. Generally, management utilized cash flows from principal and interest payments from mortgage-backed securities, calls, maturities and interest payments from non-mortgage-backed securities and proceeds from the sale of municipal bonds in the securities portfolio to fund loan originations during the year.
At June 30, 2008, our total deposits were $1.38 billion, compared to $1.41 billion at June 30, 2007. Year-over-year, certificates of deposit decreased $14.5 million and core deposits decreased $18.2 million, however, deposits increased $63.6 million in aggregate during the third and fourth fiscal quarters, reversing the trend of deposit outflows experienced by the Bank since the quarter ended December 31, 2006. Reductions in the federal funds rate amounting to a 325 basis point cut in aggregate between September 2007 and May 2008 have had a significant effect on interest rates, particularly lowering the rates paid on certificates of deposit, which has made the Bank's rate offerings more competitive in the marketplace while also helping to lower the cost of deposits.
Our FHLB of New York borrowings were $218.0 million at June 30, 2008 compared to $28.5 million a year earlier. During the first half of the 2008 fiscal year, the Bank borrowed $200.0 million from the FHLB to replenish liquidity previously depleted by loan originations and deposit outflows and to make cash available for potential implementation of growth and diversification strategies related to execution of the Company's business plan.
Stockholders' equity increased $8.8 million to $471.4 million at June 30, 2008, from $462.6 million at June 30, 2007. The increase was primarily the result of a $7.5 million decrease in accumulated other comprehensive loss, net of income taxes, due to mark-to-market adjustments to the available for sale non-mortgage-backed securities and mortgage-backed securities portfolios and benefit plans related amortization from accumulated other comprehensive income pursuant to SFAS No. 158.
Net income for the year ended June 30, 2008 was $5.9 million or $0.09 per diluted share, an increase of $4.0 million from $1.9 million or $0.03 per diluted share for the year ended June 30, 2007. The increase in net income year-over-year resulted primarily from a decrease in non-interest expense as well as an increase in net interest income, a decrease in the provision for loan losses and an increase in non-interest income, partially offset by an increase in income taxes and a loss on impairment of securities.
Our net interest income increased by $1.7 million to $46.8 million during the year ended June 30, 2008 from $45.1 million during the year ended June 30, 2007. The net interest rate spread increased to 1.81% for the year ended June 30, 2008 from 1.70% for 2007 as the yield on average interest-earning assets climbed to 5.27% from 5.15% while the cost of average interest-bearing liabilities only increased to 3.46% from 3.45%. Total interest income increased to $97.4 million during the year ended June 30, 2008 from $95.6 million during the year ended June 30, 2007 due to an increase in the yield on average interest-earning assets while average interest-earning assets remained virtually unchanged at $1.85 billion. Total interest expense remained virtually unchanged at $50.5 million, year-over-year, due to minimal change in the average cost and volume of interest-bearing liabilities.
Non-interest expense decreased $4.0 million to $40.9 million during the year ended June 30, 2008, from $44.9 million during the year ended June 30, 2007. The decrease in non-interest expense resulted primarily from a decrease in salaries and employee benefits expense. Also contributing were decreases in equipment expense, advertising expense and amortization of intangible assets expense, partially offset by an increase in net occupancy expense of premises.
Non-interest income, excluding gain/loss on securities, increased $274,000 to $2.7 million during the year ended June 30, 2008 compared to $2.4 million during the year ended June 30, 2007 due to a $344,000 increase in fees and service charges, partially offset by a $70,000 decrease in miscellaneous income. Total non-interest income, including gain/loss on securities, decreased $440,000 to $2.0 million from $2.5 million, year-over-year.
The provision for loan losses was $94,000 for the year ended June 30, 2008 compared to $571,000 for the year ended June 30, 2007. The decrease in the provision was due primarily to the absence of any material change in asset quality.
Business Strategy. Our current business strategy is to seek to grow and improve our profitability by:
• increasing the volume of our loan originations and the size of our loan portfolio relative to our securities portfolio;
• increasing the origination of multi-family and commercial real estate loans, construction loans and commercial business loans;
• building our core banking business through internal growth and de novo branching, as well as actively considering expansion opportunities such as the acquisition of branches and other financial institutions;
• maintaining high asset quality.
Our deposits have traditionally exceeded our loan originations and we have invested these deposits primarily in mortgage-backed securities and non-mortgage-backed securities. Following our acquisition of South Bergen Savings Bank in 1999, we began to emphasize increasing the size of our loan portfolio. Prior to that time, we focused our efforts on obtaining deposits from the communities in which we operated our five branch offices in Bergen and Hudson counties and investing those funds in mortgage-backed and non-mortgaged-backed securities. The focal point of our current business strategy is to increase our volume of loan originations and the size of our loan portfolio, which we fund by gathering deposits through our 28 branches located in eight counties. Since June 1999, the Company has nearly doubled in terms of assets while the loan portfolio has grown by more than three and one-half times, from $283.0 million at June 30, 1999 to $1.02 billion at June 30, 2008. At June 30, 2008, mortgage-backed securities and non-mortgage-backed securities have fallen to 36.7% of assets, compared to 67.2% at June 30, 1999. Our residential loan originations have traditionally been largely advertising driven, but we also utilize regional loan advisors who specialize in residential mortgage loan originations and are available to meet with prospective loan customers wherever it is most convenient for them.
An important component of our business plan calls for expanding our presence in the commercial marketplace. We expect to increase the size of our commercial lending staff, particularly by adding experienced commercial lenders in order to increase the size of the commercial loan portfolio. Internet banking and cash management products are now available for commercial customers and we anticipate adding remote deposit capture to our commercial product line later this year.
Critical Accounting Policies
Our accounting policies are integral to understanding the results reported. We describe them in detail in Note 1 to consolidated financial statements beginning on Page F-9 of this document. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated statements of financial condition and revenues and expenses for the periods then ended. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes relate to the determination of the allowance for loan losses, the assessment of prepayment risks associated with mortgage-backed securities, the evaluation of securities impairment and the impairment testing of goodwill.
Allowance for Loan Losses. The allowance for loan losses represents our best estimate of losses known and inherent in our loan portfolio that are both probable and reasonable to estimate. In determining the amount of the allowance for loan losses, we consider the losses inherent in our loan portfolio and changes in the nature and volume of our loan activities, along with general economic and real estate market conditions. We use a two-tier approach: (1) identification of impaired loans and establishment of specific loss allowances on such loans; and (2) establishment of general valuation allowances on the remainder of our loan portfolio as required by generally accepted accounting principles ("GAAP") and regulatory guidelines. We maintain a loan review system, which allows for a periodic review of our loan portfolio and the early identification of potential impaired loans. Our system takes into consideration, among other things, delinquency status, size of loans and type of collateral and financial condition of the borrowers. We establish specific loan loss allowances for identified loans based on a review of such information and/or appraisals of the underlying collateral. We base general loan loss allowances upon a
Although we establish specific and general loan loss allowances in accordance with management's best estimate, actual losses are dependent upon future events and, as such, further provisions for loan losses may be necessary in order to increase the level of the allowance for loan losses. For example, our evaluation of the allowance includes consideration of current economic conditions and a change in economic conditions could reduce the ability of our borrowers to make timely repayments of their loans. This could result in increased delinquencies and increased non-performing loans and thus a need to make increased provisions to the allowance for loan losses, which would be a charge to income during the period the provision is made, resulting in a reduction to our earnings. A change in economic conditions could also adversely affect the value of the properties collateralizing our real estate loans, resulting in increased charge-offs against the allowance and reduced recoveries and thus a need to make increased provisions to the allowance for loan losses. Furthermore, a change in the composition of our loan portfolio or growth of our loan portfolio could result in the need for additional provisions.
Prepayment Risks Associated with Mortgage-Backed Securities. At June 30, 2008 and June 30, 2007, net premiums of approximately $2.0 million were included in the carrying amounts of our mortgage-backed securities. We amortize the premium included in the carrying amount over the average life of the security using the level-yield method. The mortgage-backed securities we hold in our portfolio are subject to prepayment risk because changes in interest rates can affect the expected life of these mortgage-backed securities. We must estimate the level of prepayments in order to estimate the average life of mortgage-backed securities.
We evaluate the estimated average life of mortgage-backed securities on a monthly basis and adjust the amortization speed to reflect any change in the average life. Amortizing the premium faster results in a reduction of the yield on the securities, whereas slowing the amortization increases the yield. A reduction in the yield decreases our interest income on mortgage-backed securities, while an increase in the yield increases our interest income on mortgage-backed securities.
The assessment of the prepayment risks related to mortgage-backed securities is highly dependent upon the prediction of trends in market interest rates. A reduction in interest rates generally results in increased prepayments of mortgage-backed securities, as borrowers refinance their debt in order to reduce their borrowing cost. Correspondingly, an increase in interest rates should result in decreased prepayments and fewer re-financings. Because changes in interest rates can affect the average life of mortgage-backed securities, this makes the estimation of the prepayment risk difficult. We address this difficulty by adjusting the amortization speed monthly to reflect the current average life.
Impairment Testing of Goodwill. We record goodwill, representing the excess of amounts paid over the fair value of net assets of the institutions acquired in purchase transactions, at its fair value at the date of acquisition. Through June 30, 2002, we amortized goodwill using the straight-line method over 15 years. Effective July 1, 2002, we adopted the FASB's SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." Goodwill is tested and deemed impaired when the carrying value of goodwill exceeds its implied fair value. Goodwill was most recently tested as of May 30, 2008, at which time no impairment was indicated. At June 30, 2008, we reported goodwill of $82.3 million. The value of the goodwill can change in the future. We expect the value of the goodwill to decrease if there is a significant decrease in the franchise value of Kearny Federal Savings Bank. If an impairment loss is determined in the future, we will reflect the loss as an expense for the period in which the impairment is determined, leading to a reduction of our net income for that period by the amount of the impairment loss.
As of June 30, 2008, with the exception of the Bank's AMF Ultra Short Mortgage Fund as described in the Securities Portfolio section of Part I. Item 1., we concluded that any unrealized losses in the securities available for sale and mortgage-backed securities available for sale portfolios were temporary in nature due to market interest rates and not the underlying credit quality of the issuers of the securities. Additionally, we have the intent and ability to hold these investments for the time necessary to recover the amortized cost. Future events that would materially change this conclusion and require a charge to operations for an impairment loss include a change in the credit quality of the issuers.
Effective June 30, 2004, we adopted Emerging Issues Task Force ("EITF") Issuance No. 03-1, "The Meaning of Other than Temporary Impairment and Its Application to Certain Investments," which requires quantitative and qualitative disclosures for securities that are impaired at the balance sheet date, but for which other-than-temporary impairment has not been recognized. Adoption of EITF 03-01 has not changed our policies for determining whether any securities are other-than-temporarily impaired.
Deferred Tax Assets. Federal and state income taxes have been provided on the basis of reported income or loss. The amounts reflected on the Bank's tax returns differ from these provisions due principally to temporary differences in the reporting of certain items for financial reporting and income tax reporting purposes. The tax effect of these temporary differences is accounted for as deferred taxes applicable to future periods. Deferred income tax expense or benefit is determined by recognizing deferred tax assets and liabilities for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date.
The determination of the amount of deferred tax assets more likely than not to be realized is dependent on projections of future earnings, which are subject to frequent change. The realization of deferred tax assets is assessed and a valuation allowance is needed if it is more likely than not that all or a portion of the deferred tax asset will not be realized. "More likely than not" is defined as greater than a 50% chance. All available evidence, both positive and negative is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. Information about our current financial position and results of operations for the current and preceding years is readily available. This historical information is supplemented by all currently available information about future years.
Comparison of Financial Condition at June 30, 2008 and June 30, 2007
Total assets increased $165.8 million or 8.6%, to $2.08 billion at June 30, 2008 from $1.92 billion at June 30, 2007. The increase was due primarily to increases in net loans receivable and mortgage-backed securities of $161.2 million and $82.2 million, respectively. Partially offsetting these increases were decreases in non-mortgage-backed securities and cash and cash equivalents of $50.7 million and $31.6 million, respectively.
Cash and cash equivalents, consisting primarily of interest-bearing deposits in other banks decreased $31.6 million or 19.4%, to $131.7 million at June 30, 2008 from $163.3 million at June 30, 2007. During the first six months of the fiscal year, the Bank borrowed $200.0 million from the FHLB to replenish liquidity previously depleted by loan originations and deposit outflows. During the quarters ended September 30 and December 31, 2007 and June 30, 2008, management redeployed cash and cash equivalents into primarily loan originations and loan purchases. However, during the quarter ended March 31, 2008, cash and cash equivalents were redeployed into primarily mortgage-backed securities due to a decrease in loan originations resulting from the sluggish real estate market as well as the need to counter the negative effect on interest income derived from cash and cash equivalents resulting from the 325 basis point reduction in the federal funds rate between September 2007 and May 2008. At June 30, 2008, the Company had $52.0 million on deposit with a money center bank.
Non-mortgage-backed securities available for sale decreased $50.7 million or 57.0%, to $38.2 million from $88.9 million between June 30, 2007 and June 30, 2008 due primarily to sales of securities, calls, principal repayments, an other-than-temporary impairment charge and an increase in unrealized losses. During the year ended June 30, 2008, management sold securities from the municipal bond portfolio with an amortized cost of $48.5 million, with realized gains and losses netting to zero. During the year ended June 30, 2007, the decision to sell municipal bonds was initially prompted by a below market yield on such bonds as well as the overall decline in the Company's pre-tax income, which reduced the advantage of holding tax-exempt instruments. As pre-tax income increased during the year ended June 30, 2008, management continued to sell municipal bonds due primarily to a preference for securities that provide a steady cash flow. As described in the Securities Portfolio section of Part I. Item 1., the Company recognized a pre-tax non-cash charge to earnings of $659,000 as a result of other-than-temporary impairment in the value of the Bank's investment in the AMF Ultra Short Mortgage Fund, during the quarter ended June 30, 2008.
Loans receivable, net of deferred fees and costs and the allowance for loan losses, increased $161.2 million or 18.7%, to $1.02 billion at June 30, 2008, compared to $860.5 million at June 30, 2007. Total loans increased during the quarters ended September 30 and December 31, 2007, by $70.3 million and $31.2 million, respectively. Total loans decreased $14.2 million during the quarter ended March 31, 2008. The decrease was attributable to a decrease in loan originations due to a decline in borrower demand resulting from a slowing economy, as well as the repayment of approximately $9.0 million in loans from one borrower. The quarter ended June 30, 2008 featured a significant increase in loan originations and loans purchased, with total loans increasing by $74.2 million. During the entire fiscal year, the Bank originated $204.0 million in new loans, which exceeded principal repayments by $58.0 million, and supplemented in-house originations with purchases of $102.2 million in one-to-four family residential mortgages.
During the year ended June 30, 2008, loan growth was concentrated in one-to-four family residential first mortgage loans, which increased by $128.4 million to $687.7 million at June 30, 2008. Nonresidential mortgages increased by $15.9 million to $157.4 million at June 30, 2008. Multi-family mortgages increased by $3.5 million to $21.2 million at June 30, 2008. Home equity loans increased by $10.4 million to $124.0 million at June 30, 2008. Commercial business loans increased by $4.5 million and totaled $8.7 million at June 30, 2008. The disbursed portion of home equity lines of credit decreased $1.3 million to $11.5 million while the undisbursed balance increased $565,000 to $24.6 million at June 30, 2008. Construction loans outstanding and gross construction loans increased $702,000 to $12.1 million and $4.7 million to $21.1 million, respectively, at June 30, 2008. With respect to gross construction loans, $18.5 million is committed for one-to-four family structures and $2.6 million for nonresidential structures. Other loan categories decreased $647,000 to $4.0 million at June 30, 2008.
FHLB of New York capital stock increased $8.9 million or 211.9%, to $13.1 million at June 30, 2008, compared to $4.2 million at June 30, 2007 due to a required purchase of stock related to the $200.0 million increase in advances from FHLB. The FHLB paid annualized cash dividends for the quarters ended September 30 and December 31, 2007, and March 31 and June 30, 2008, of 8.05%, 8.40%, 7.80% and 6.50%, respectively.
Premises and equipment was virtually unchanged at $34.9 million at June 30, 2008 compared to $35.4 million at June 30, 2007, as depreciation of $1.9 million nominally exceeded the cost of additions to fixed assets of $1.4 million. The most significant additions to premises and equipment during the fiscal year was leasehold improvements of $280,000 at the Bank's new retail branches in Brick Township (Tom's River) and Lakewood, New Jersey and renovations totaling $223,000 in the Fairfield administrative building, which included expanding the computer room.
Bank owned life insurance increased $555,000, to $15.7 million at June 30, 2008 compared to $15.2 million at June 30, 2007, due to an increase in the cash surrender value of the underlying insurance policies.
Deposits decreased $32.7 million or 2.3%, to $1.38 billion at June 30, 2008, compared to $1.41 billion at June 30, 2007. However, the trend of deposit outflows which the Bank had experienced since the quarter ended December 31, 2006 was reversed as deposits increased $35.3 million during the quarter ended March 31, 2008 and $28.3 million during the quarter ended June 30, 2008, compared to decreases during the quarters ended September 30 and December 31, 2007 of $73.4 million and $22.9 million, respectively. Year-over-year, savings . . .
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