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KRNY > SEC Filings for KRNY > Form 10-Q on 10-May-2013All Recent SEC Filings

Show all filings for KEARNY FINANCIAL CORP. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for KEARNY FINANCIAL CORP.


10-May-2013

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This Form 10-Q may include certain forward-looking statements based on current management expectations. Such forward-looking statements may be identified by reference to a future period or periods or by the use of forward-looking terminology, such as "may", "will", "believe", "expect", "estimate", "anticipate", "continue", or similar terms or variations on those terms, or the negative of those terms. The actual results of the Company could differ materially from those management expectations. Factors that could cause future results to vary from current management expectations include, but are not limited to, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulations of federal, state and local tax authorities. Additional potential factors include changes in interest rates, deposit flows, cost of funds, demand for loan products and financial services, competition, changes in the quality or composition of loan and investment portfolios of the Company. Other factors that could cause future results to vary from current management expectations include changes in accounting principles, policies or guidelines, and other economic, competitive, governmental and technological factors affecting the Company's operations, markets, products, services and prices. Further description of the risks and uncertainties to the business are included in the Company's other filings with the Securities and Exchange Commission.

Restructuring Transaction

During the two month period ended April 30, 2013, the Company successfully completed a series of balance sheet restructuring transactions that are expected to result in improvements in the financial position and expected operating results of the Company and the Bank. The Company expects such improvements to be reflected in an expanded net interest margin resulting in an immediate improvement in net interest income and earnings.

Through these restructuring transactions, the Company reduced its concentration in agency mortgage-backed securities ("MBS") in favor of other investment sectors within the portfolio. As a result, the Company reduced its exposure to residential mortgage prepayment and extension risk while enhancing the overall yield of the investment portfolio and providing some additional protection to earnings against potential movements in market interest rates. Gains recognized through the sale of MBS enabled the Company to fully offset the costs of prepaying a portion of its high-rate Federal Home Loan Bank ("FHLB") advances. Additionally, the Company modified the terms of its remaining high-rate FHLB advances to a lower interest rate while extending the duration of the modified funding to better protect against potential increases in interest rates in the future.

The restructuring was initiated by the Company in March 2013 and completed during April 2013. Consequently, only a portion of the applicable transactions were completed by the close of the Company's third quarter ended March 31, 2013, with the remaining transactions being reflected in the Company's financial results for the quarter and fiscal-year ending June 30, 2013.

Given the effects of the restructuring, the Company continues to maintain high levels of on-balance sheet liquidity while the sensitivity of its Economic Value of Equity ("EVE") to movements in interest rates - a key measure of long-term exposure to interest rate risk - remains substantially unchanged. Moreover, the Company is evaluating additional opportunities to utilize capital through

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effective deployment of wholesale growth and diversification strategies designed to improve earnings further while prudently managing its exposure to interest rate, credit and liquidity risk.

Additional information regarding the noted restructuring transaction is presented in Note 5 to the consolidated financial statements.

Comparison of Financial Condition at March 31, 2013 and June 30, 2012

General. Total assets decreased by $70.5 million to $2.87 billion at March 31, 2013 from $2.94 billion at June 30, 2012. The decrease in total assets was primarily reflected in the decline in the balance of mortgage-backed securities that was partially offset by an increase in the balances of loans, debt securities, cash and cash equivalents and bank-owned life insurance. The net decrease in total assets was complemented by a decrease in the balances of deposits and borrowings as well as a decline in the balance of total stockholders' equity.

Cash and Cash Equivalents. Cash and cash equivalents, which consist primarily of interest-earning and non-interest-earning deposits in other banks, increased by $54.3 million to $209.9 million at March 31, 2013 from $155.6 million at June 30, 2012. The increase in the balance was largely attributable to cash inflows arising from the sale of investment securities in conjunction with the restructuring transaction noted earlier. As discussed below, a portion of the cash inflows from such sales were redeployed into the investment portfolio or used to prepay selected borrowings by March 31, 2013. However, a portion of such proceeds remained in cash and cash equivalents as of that date pending their redeployment into additional investment securities during the following quarter.

In light of the historically low level of short term interest rates, the Company generally expects to continue maintaining the average balance of interest-earning cash and equivalents at comparatively lower levels than those reported at the close of the current quarter. Management will continue to monitor the level of short term, liquid assets in relation to the expected need for such liquidity to fund the Company's strategic initiatives - particularly those relating to the expansion of its commercial lending functions. The Company may alter its liquidity reinvestment strategies based upon the timing and relative success of those initiatives.

Debt Securities Available for Sale. Debt securities classified as available for sale increased by $125.2 million to $137.8 million at March 31, 2013 from $12.6 million at June 30, 2012. The net increase primarily reflected purchases of securities during the most recent quarter ended March 31, 2013. Non-mortgage-backed securities purchased during the current period were primarily acquired in conjunction with the restructuring transaction noted earlier. As previously discussed, such securities included corporate and municipal obligations as well as asset-backed securities collateralized by government guaranteed student loans. The Company expects that diversification of its investments into these sectors will enable it to enhance earnings and more effectively manage the business risks inherent in its investment portfolio and overall balance sheet.

The increase in the portfolio also reflected an overall decrease in the net unrealized loss within the portfolio that was partially offset by the repayment of amortizing securities during the first nine months of fiscal 2013. The net unrealized loss for this portfolio decreased by $211,000 to $1.8 million at March 31, 2013 from $2.0 million at June 30, 2012. The decrease in the net unrealized loss was primarily attributable to an increase in the fair value of the Company's investment in single issuer, trust preferred securities whose unrealized losses decreased by $623,000 to $1.5 million at March 31, 2013 from $2.2 million at June 30, 2012. The decline in the unrealized loss in these securities was partially offset by additional unrealized losses within other segments of the portfolio.

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Based on its evaluation, management has concluded that no other-than-temporary impairment is present within this segment of the investment portfolio at March 31, 2013.

Additional information regarding debt securities available for sale at March 31, 2013 is presented in Note 7 and Note 9 to consolidated financial statements.

Debt Securities Held to Maturity. Debt securities classified as held to maturity increased by $112.2 million to $146.9 million at March 31, 2013 from $34.7 million at June 30, 2012. The net increase in the balance of the portfolio primarily reflected the purchase of U.S. agency debentures, separate from the restructuring transaction noted earlier, that were partially offset by the repayment of such securities upon being called by the issuers prior to their maturities. At March 31, 2013, the held to maturity debt securities portfolio primarily included U.S. agency debentures maturing within one to five years. Debt securities held to maturity at March 31, 2013 also included a nominal balance of short term municipal obligations that generally mature within one year. As noted earlier, these securities represent short term, bond anticipation notes ("BANs") issued by New Jersey municipalities with whom the Bank also maintains deposit relationships.

Based on its evaluation, management has concluded that no other-than-temporary impairment is present within this segment of the investment portfolio at March 31, 2013.

Additional information regarding debt securities held to maturity at March 31, 2013 is presented in Note 8 and Note 9 to the consolidated financial statements.

Loans Receivable. Loans receivable, net of unamortized premiums, deferred costs and the allowance for loan losses, increased by $56.1 million to $1.33 billion at March 31, 2013 from $1.27 billion at June 30, 2012. The increase in net loans receivable was primarily attributable to new loan acquisitions outpacing loan repayments during the first nine months of fiscal 2013.

Residential mortgage loans, including home equity loans and lines of credit, decreased by $67.8 million to $620.4 million at March 31, 2013 from $688.2 million at June 30, 2012. The components of the aggregate decrease included a net reduction in the balance of one-to-four family first mortgage loans of $52.2 million to $510.6 million at March 31, 2013 from $562.8 million at June 30, 2012 as well as a net reduction in the balance of home equity loans of $13.5 million to $82.3 million from $95.8 million for those same comparative periods. Additionally, the balance of home equity lines of credit decreased by $2.1 million to $27.4 million at March 31, 2013 from $29.5 million at June 30, 2012.

The aggregate decline in the residential mortgage loan portfolio for the nine months ended March 31, 2013 continues to reflect a diminished level of "new purchase" loan demand resulting from a weak economy and lower real estate values. The decline in the outstanding balance of the portfolio was exacerbated by accelerating refinancing activity resulting primarily from longer-term mortgage rates falling to new historical lows during the quarter. Such declines in mortgage rates were largely attributable to the Federal Reserve's efforts to stimulate the economy by driving longer term interest rates lower through quantitative easing. Through this policy, the Federal Reserve has continued to aggressively purchase mortgage-backed securities in the open market thereby driving the yield on such securities, and their underlying mortgage loans, to historical lows.

As a portfolio lender cognizant of potential exposure to interest rate risk, the Bank has generally refrained from lowering its long term, fixed rate residential mortgage rates to the levels available in the marketplace. Consequently, a portion of the Company's residential mortgage borrowers may continue to seek long term, fixed rate refinancing opportunities from other market resources resulting in further declines in the outstanding balance of its residential mortgage loan portfolio.

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In total, residential mortgage loan origination and purchase volume for the nine months ended March 31, 2013 was $49.0 million and $9.7 million, respectively, while aggregate originations of home equity loans and home equity lines of credit totaled $19.0 million for that same period.

Commercial loans, in aggregate, increased by $130.2 million to $703.5 million at March 31, 2013 from $573.3 million at June 30, 2012. The components of the aggregate increase included an increase in commercial mortgage loans totaling $142.3 million that was partially offset by a decline in commercial business loans of $12.1 million. The ending balances of commercial mortgage loans and commercial business loans at March 31, 2013 were $627.2 million and $76.3 million, respectively. Commercial loan origination volume for the first nine months of fiscal 2013 totaled $220.8 million comprising $202.3 million and $18.5 million of commercial mortgage and commercial business loans originations, respectively. No commercial loans were acquired through purchase of participations during the nine months ended March 31, 2013.

The outstanding balance of construction loans, net of loans-in-process, decreased by $6.8 million to $13.5 million at March 31, 2013 from $20.3 million at June 30, 2012. Construction loan disbursements for the first nine months of fiscal 2013 totaled $2.1 million.

Finally, other loans, primarily comprising account loans, deposit account overdraft lines of credit and other consumer loans, increased $438,000 to $4.5 million at March 31, 2013 from $4.0 million at June 30, 2012. Other loan originations for the first nine months of fiscal 2013 totaled approximately $1.5 million.

Nonperforming Loans. At March 31, 2013, nonperforming loans decreased by $5.2 million to $28.3 million or 2.11% of total loans from $33.5 million or 2.61% of total loans as of June 30, 2012. The balance of nonperforming loans at March 31, 2013 included $27.9 million of "nonaccrual" loans and $445,000 of loans reported as "over 90 days past due and accruing". By comparison, nonperforming loans at June 30, 2012 included $32.8 million and $691,000 of "nonaccrual" loans and loans reported as "over 90 days past due and accruing", respectively.

The composition of nonperforming loans at March 31, 2013 continued to include a disproportionate balance of residential mortgage loans originally acquired from Countrywide Home Loans, Inc. ("Countrywide") which continue to be serviced by their acquirer, Bank of America through its subsidiary, BAC Home Loans Servicing, LP ("BOA"). In total, nonperforming Countrywide loans included 37 loans totaling $10.3 million or 36.3% of total nonperforming loans at March 31, 2013. As of that same date, the Company owned a total of 96 residential mortgage loans with an aggregate outstanding balance of $42.7 million that were originally acquired from Countrywide. Of these loans, an additional seven loans totaling $2.6 million are 30-89 days past due and are in various stages of collection.

Including the Countrywide loans noted above, nonperforming residential first mortgage loans at March 31, 2013 included a total of 48 nonaccrual mortgage loans with aggregate outstanding balances of $12.4 million.

As of that same date, nonperforming loans also included a total of nine nonaccrual home equity loans totaling $412,000 and one home equity line of credit totaling $470,000 reported as nonperforming as of that date.

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A total of five nonaccrual construction loans with an aggregate outstanding balance of $1.8 million were reported as nonperforming at March 31, 2013 while one additional construction loan with an outstanding balance of $445,000 was reported as over 90 days past due and accruing.

Nonperforming commercial mortgage loans at March 31, 2013 included 19 nonaccrual loans with aggregate outstanding balances totaling $8.5 million.

Commercial business loans reported as nonperforming at March 31, 2013 included 31 nonaccrual loans totaling $4.4 million.

Finally, nonperforming loans at March 31, 2013 included two nonaccrual consumer loans totaling $26,000.

Allowance for Loan Losses. During the nine months ended March 31, 2013, the balance of the allowance for loan losses increased by approximately $641,000 to $10.8 million or 0.80% of total loans at March 31, 2013 from $10.1 million or 0.79% of total loans at June 30, 2012. The increase resulted from provisions of $3,139,000 during the nine months ended March 31, 2013 that were partially offset by charge offs, net of recoveries, totaling approximately $2,498,000.

With regard to loans individually evaluated for impairment, the balance of the Company's allowance for loan losses attributable to such loans decreased by $396,000 to $2.4 million at March 31, 2013 from $2.8 million at June 30, 2012. The balance at March 31, 2013 reflected the allowance for impairment identified on $7.3 million of impaired loans while an additional $30.1 million of impaired loans had no allowance for impairment as of that date. By comparison, the balance of the allowance at June 30, 2012 reflected the impairment identified on $10.1 million of impaired loans while an additional $31.9 million of impaired loans had no impairment as of that date. The outstanding balances of impaired loans reflect the cumulative effects of various adjustments including, but not limited to, purchase accounting valuations and prior charge offs, where applicable, which are considered in the evaluation of impairment.

With regard to loans evaluated collectively for impairment, the balance of the Company's allowance for loan losses attributable to such loans increased by $1,037,000 to $8.3 million at March 31, 2013 from $7.3 million at June 30, 2012. The increase in the balance of this portion of the allowance partly reflected the additional allowance attributable to an overall increase of $60.6 million in the non-impaired portion of the loan portfolio. This increase in the allowance also reflected changes in the Company's historical and environmental loss factors made in accordance with its allowance for loan loss calculation methodology as discussed earlier.

Specifically, the Company's loan portfolio experienced a net annualized average charge-off rate of 26 basis points during the nine months ended March 31, 2013 representing a decrease of 33 basis points from the 59 basis points of charge offs reported for fiscal 2012. The historical loss factors used in the Company's allowance for loan loss calculation methodology were updated to reflect the effect of these charge offs on the average annualized historical charge off rates by loan segment over the two year look-back period used by that methodology. Such updates, in conjunction with the change in the balance of the unimpaired portion of the loan portfolio, resulted in a net decrease of $114,000 in the applicable portion of the allowance to $2,174,000 as of March 31, 2013 compared to $2,288,000 at June 30, 2012.

Regarding environmental loss factors, changes to such factors during the nine months ended March 31, 2013 primarily reflected increases to those factors applicable to the Company's acquired loans. All such loans were initially recorded at fair value at acquisition reflecting any impairment identified on such loans at that time. In general, the aggregate level of realized losses on the acquired impaired loans

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has not exceeded the level of impairment originally ascribed to the loans at the time of acquisition. However, the Company has identified and recognized some degree of "post-acquisition" impairment and charge offs attributable to acquired loans that were performing at the time of acquisition. While the level of this "post-acquisition" impairment has generally been limited, the Company considers such losses in developing the environmental loss factors used to calculate the required allowance applicable to the non-impaired portion of its acquired loan portfolio. In recognition of these considerations, the Company has modified the following environmental loss factors applicable to the acquired loans during the nine months ended March 31, 2013 from those levels that were in effect at June 30, 2012:

Level of and trends in nonperforming loans: Increased (+6) from "3" to "9" reflecting continuing increases in the level of nonperforming loans and associated losses within the portfolio segment coupled with the potentially adverse effects of Hurricane Sandy on borrower repayment ability.

National and local economic trends and conditions: Increased (+3) from "3" to "6" reflecting the continuing effects of adverse national and regional economic conditions affecting the loans within the portfolio segment.

Changes in the value of underlying collateral: Increased (+3) from "3" to "6" reflecting the continuing weakness in real estate values applicable to the loans within the portfolio segment coupled with the potentially adverse effects of Hurricane Sandy on the values of the collateral securing such loans.

Given their prior acquisition at fair value, the environmental loss factors established for the loans acquired though business combinations generally reflect a comparatively lower level of risk than those applicable to the remaining portfolio. In accordance with the methodology described earlier, the Company has assigned the risk values to the three environmental loss factors noted above resulting in a reported number of basis points of allowance being allocated to the applicable loans at March 31, 2013. The level of environmental loss factors attributable to these loans will continue to be monitored and adjusted to reflect the Company's best judgment as to the level of incurred losses on the acquired loans that are collectively evaluated for impairment.

In conjunction with the net changes to the outstanding balance of the applicable loans, the increase in the environmental loss factors during the nine months ended March 31, 2013 resulted in a net increase of $1,150,000 in the applicable valuation allowances to $6,169,000 at March 31, 2013 from $5,019,000 at June 30, 2012.

The tables on the following pages present the historical and environmental loss factors, reported as a percentage of outstanding loan principal, that were the basis for computing the portion of the allowance for loan losses attributable to loans collectively evaluated for impairment at March 31, 2013, and June 30, 2012.

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Allowance for Loan Losses Allocation of Loss Factors on Loans Collectively Evaluated for Impairment

                               at March 31, 2013
                                                         Environmental
       Loan Category          Historical Loss Factors   Loss Factors (2)   Total

Residential mortgage loans
Originated                             0.08%                 0.30%         0.38%
Purchased                              2.63%                 0.75%         3.38%
Acquired in merger                     0.15%                 0.21%         0.36%

Home equity loans
Originated                             0.15%                 0.36%         0.51%
Acquired in merger                     0.30%                 0.21%         0.51%

Home equity lines of credit
Originated                             0.00%                 0.36%         0.36%
Acquired in merger                     0.00%                 0.21%         0.21%

Construction loans
1-4 family
  Originated                           0.57%                 0.72%         1.29%
  Acquired in merger                   0.00%                 0.21%         0.21%
Multi-family
  Originated                           0.00%                 0.72%         0.72%
  Acquired in merger                   0.00%                 0.21%         0.21%
Nonresidential
  Originated                           0.00%                 0.72%         0.72%
  Acquired in merger                   0.00%                 0.21%         0.21%

Commercial mortgage loans
Multi-family
  Originated                           0.00%                 0.72%         0.72%
  Acquired in merger                   0.00%                 0.21%         0.21%
Nonresidential
  Originated                           0.05%                 0.72%         0.77%
  Acquired in merger                   0.09%                 0.21%         0.30%

Commercial business loans
Secured (1-4 family)
  Originated                           0.00%                 0.72%         0.72%
  Acquired in merger                   0.00%                 0.21%         0.21%
Secured (Other)
  Originated                           0.01%                 0.72%         0.73%
  Acquired in merger                   0.15%                 0.21%         0.36%
Unsecured
  Originated                           0.00%                 0.57%         0.57%
  Acquired in merger                   0.00%                 0.15%         0.15%

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                       Allowance for Loan Losses
    Allocation of Loss Factors on Loans Collectively Evaluated for
                              Impairment
                     at March 31, 2013 (continued)
                                            Environmental
                         Historical         Loss Factors
   Loan Category        Loss Factors             (2)             Total
SBA 7A
  Originated               0.00%                0.72%            0.72%
  Acquired in merger       1.41%                0.21%            1.62%
SBA Express
  Originated               0.00%                0.72%            0.72%
  Acquired in merger       1.52%                0.21%            1.73%
  SBA Line of Credit
  Originated               0.00%                0.72%            0.72%
  Acquired in merger       0.00%                0.21%            0.21%
SBA Other
  Originated               0.00%                0.72%            0.72%
  Acquired in merger       0.00%                0.21%            0.21%

Other consumer loans
(1)                          -                    -                -
________________________________________________


(1) The Company generally maintains an environmental loss factor of 0.27% on other consumer loans while historical loss factors range from 0.00% to 100.00% based on loan type. Resulting balances in the allowance for loan losses are immaterial and therefore excluded from the presentation.

(2) "Base" environmental factors reported excluding the effect of "weights" attributable to internal credit-rating classification as follows: "Pass-1": 70%, "Pass-2": 80%, "Pass-3": 90%, "Pass-4": 100%, "Watch": 200%, "Special Mention": 400%, "Substandard": 600%, "Doubtful": 800%. (e.g. Environmental loss factor applicable to originated residential mortgage loan rated as "Substandard": 0.30% X 600% = 1.8%)

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Allowance for Loan Losses Allocation of Loss Factors on Loans Collectively Evaluated for Impairment

                                at June 30, 2012
                                                         Environmental
       Loan Category          Historical Loss Factors   Loss Factors (2)   Total

Residential mortgage loans
Originated                             0.07%                 0.30%         0.37%
Purchased                              2.25%                 0.75%         3.00%
Acquired in merger                     0.00%                 0.09%         0.09%

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