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KRNY > SEC Filings for KRNY > Form 10-K on 13-Sep-2013All Recent SEC Filings

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

Form 10-K for KEARNY FINANCIAL CORP.


13-Sep-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 $208.4 million to $3.15 billion at June 30, 2013 from $2.94 billion at June 30, 2012. The increase was funded largely through growth in deposits which was augmented by net increases in borrowings. The net growth in deposits was reflected in both noninterest-bearing and interest-bearing deposits with the growth in the latter comprised of increases in interest-bearing checking and savings accounts that was partially offset by a decline in certificates of deposit. The growth in liabilities funded an increase in earning assets as well as an increase in bank-owned life insurance included in non-earning assets. The net growth in earning assets reflected growth in loans and non-mortgage-backed securities that was partially offset by declines in the balances of mortgage-backed securities and other interest-earning assets.

As noted in the applicable discussion presented under "Item 1. Business - General", the Company executed a series of balance sheet restructuring and wholesale growth transactions during fiscal 2013 that resulted in both growth and diversification within the securities portfolio. Notwithstanding the near term effects of these transactions on the composition and allocation of our earning assets, it remains the long term goal of our business plan to reallocate the Company's balance sheet to reflect a greater percentage of earning assets in the loan portfolio while, in turn, reducing the relative size of the securities portfolio. Toward that end, the Company's business plan continues to call for increased origination of commercial loans with an emphasis on commercial mortgages, including multi-family and nonresidential mortgage loans, as well as secured and unsecured commercial business loans.

The lending environment during fiscal 2013 continued to reflect the challenges presented by the adverse economic environment. Those challenges include diminished real estate values coupled with high unemployment which, together, have significantly reduced demand for new loan originations by qualified borrowers. Despite these challenges, net loans receivable increased by $75.9 million to $1.35 billion or 42.9% of total assets at June 30, 2013 from $1.27 billion or 43.4% of total assets at June 30, 2012. Within the loan portfolio, however, commercial loans, including commercial mortgages and commercial business loans, grew by $164.2 million to $737.5 million or 23.4% of total assets from $573.3 million or 19.5% of total assets. For those same comparative periods, one-to-four family mortgage loans, including first mortgages and home equity loans and lines of credit, declined by $80.1 million to $608.1 million or 19.3% of total assets from $688.2 million or 23.4% of total assets.

The balance of investment securities, including mortgage-backed and non-mortgage-backed securities, increased by $113.5 million to $1.39 billion or 44.3% of total assets from $1.28 billion or 43.5% of total assets at June 30, 2012. As noted earlier, the year over year net increase in the securities portfolio largely reflected the effects of the restructuring and wholesale growth transactions discussed earlier as well as the Company's decision to reinvest a portion of its excess liquidity into investment securities. Toward that end, the balance of cash and cash equivalents decreased by $28.6 million during fiscal 2013 which provided the funding for a portion of the net growth within the securities portfolio.


For the year ended June 30, 2013, our total deposits increased by $198.7 million to $2.37 billion from $2.17 billion at June 30, 2012. As noted above, the growth in deposits was partly reflected in the growth of non-interest-bearing deposits which increased by $25.8 million during fiscal 2013. The remaining deposit growth was reflected in interest-bearing deposits which increased by $172.9 million to $2.18 billion at June 30, 2013. Within interest-bearing deposits, however, the balance of non-maturity deposits increased by $296.3 million reflecting $263.2 million and $33.1 million of growth, respectively, in interest-bearing checking accounts and savings accounts. This growth was partially offset by a $123.5 million decline in the balance of certificates of deposit. The increase in the balance of interest-bearing checking accounts was largely attributable to the utilization of "non-retail" money market accounts as a funding source supporting the wholesale growth transactions discussed earlier. In contrast, the decline in the balance of certificates of deposits largely reflected the Bank's efforts to manage its cost of retail deposits which allowed for some controlled outflow of time deposits during the year.

The balance of borrowings increased by $37.9 million to $287.7 million at June 30, 2013 from $249.8 million at June 30, 2012. The net growth in borrowings largely reflected the effects of the balance sheet restructuring and wholesale growth transactions discussed earlier.

Finally, stockholders' equity decreased $23.9 million to $467.7 million at June 30, 2013 from $491.6 million at June 30, 2012. The decrease in stockholders' equity was largely attributable to a decline in accumulated other comprehensive income arising from a decrease in the fair value of the Company's available for sale securities whose unrealized losses are reflected therein on an after tax basis. The net decrease in stockholders' equity also reflected an increase in treasury stock resulting from the Company's share repurchase activity during fiscal 2013. These decreases were partially offset by the increase in retained earnings resulting from the Company's net income for fiscal 2013 as well as the reduction of unearned ESOP shares relating to the offsets of benefit plan expenses during the year.

Results of Operations. Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets and the interest we pay on our interest-bearing liabilities. It is a function of the average balances of loans and investments versus deposits and borrowed funds outstanding in any one period and the yields earned on those loans and investments and the cost of those deposits and borrowed funds. Our results of operations are also affected by our provision for loan losses, non-interest income and non-interest expense.

Net income for the fiscal year ended June 30, 2013 was $6.5 million or $0.10 per diluted share; an increase of $1.4 million from $5.1 million or $0.08 per diluted share for the fiscal year ended June 30, 2012. The increase in net income year-over-year resulted primarily from an increase in non-interest income coupled with a decline in the provisions for loan losses and income taxes that were partially offset by a decrease in net interest income coupled with an increase in noninterest expense.

Our net interest income decreased $3.9 million to $66.3 million for the year ended June 30, 2013 from $70.2 million for the year ended June 30, 2012. The decrease in net interest income reflected a $10.3 million decline in interest income to $88.3 million from $98.5 million. The decline in interest income primarily reflected a decrease in the average yield on earning assets. For the year ended June 30, 2013, the average yield on interest-earning assets decreased by 39 basis points to 3.33% from 3.72% for the year ended June 30, 2012. For those same comparative periods, the average balance of interest-earning assets remained stable at $2.65 billion.

The decline in interest income was partially offset by a $6.4 million decline in interest expense to $22.0 million from $28.4 million. The decline in interest expense reflected decreases in the average cost and average balance of interest-bearing liabilities. For the year ended June 30, 2013, the average cost of


interest-bearing liabilities decreased 27 basis points to 0.99% from 1.26% for the year ended June 30, 2012. For those same comparative periods, the average balance of interest-bearing liabilities decreased by $17.5 million to $2.23 billion from $2.25 billion.

In total, the net interest rate spread decreased 12 basis points to 2.34% for fiscal 2013 from 2.46% for fiscal 2012 while the net interest margin decreased 15 basis points to 2.50% from 2.65% for those same comparative periods.

The provision for loan losses decreased $1.3 million to $4.5 million for fiscal 2013 from $5.8 million for fiscal 2012. The net decrease in the provision reflected the effects of recognizing comparatively lower provisions on loans evaluated individually for impairment. These decreases were partially offset by increases in provisions attributable to loans evaluated collectively for impairment due primarily to the overall growth within the non-impaired portion of the portfolio coupled with increases in environmental and historical loss factors.

Non-interest income increased by $14.2 million to $16.4 million for fiscal 2013 from $2.1 million for fiscal 2012. The increase in non-interest income primarily reflected an increase in gains on securities sold in conjunction with the balance sheet restructuring transactions discussed earlier. The increase in non-interest income also reflected an increase in income attributable to the Company's investment in bank-owned life insurance that was augmented by a decline on losses relating to write downs and sales of real estate owned. Less noteworthy variances in non-interest income included increases in loan-related and deposit-related fees and charges, including electronic banking fees and charges, that were partially offset by declines in the gain on sale of loans originated through our SBA programs and other miscellaneous income.

Non-interest expense increased by $10.7 million to $69.4 million for the year ended June 30, 2013 from $58.7 million for the year ended June 30, 2012. The increase in non-interest expense primarily reflected debt extinguishment expenses recognized in conjunction with the balance sheet restructuring transactions discussed earlier. The increase in non-interest expense was also reflected across many other categories of non-interest expense including those relating to compensation, premises occupancy, equipment and systems, deposit insurance and director compensation expenses. These increases were partially offset by advertising and marketing expenses and other miscellaneous expense.

The combined effects of these factors resulted in higher pre-tax net income during fiscal 2013 compared with fiscal 2012. Notwithstanding, the Company recognized comparatively lower income tax expense primarily reflecting the effects of higher levels of tax-favored income earned during fiscal 2013, including income from municipal obligations and bank-owned life insurance, compared to fiscal 2012.

Business Strategy

The general goals of the Company's current business plan are to profitably deploy capital and enhance earnings through a variety of balance sheet growth and diversification strategies through which the Company intends to evolve from a traditional thrift business model toward that of a full service, community bank. The key strategic initiatives of the Company's business plan are presented below accompanied by an overview of the Company's activities and achievements during fiscal 2013 in support of those initiatives:

Commercial Mortgage Lending: Increase the outstanding balances of multi-family and nonresidential mortgage loans by expanding loan acquisition volume through all available channels including retail/broker originations as well as individual and pooled loan purchases and participations. Continue expanding commercial lending


personnel while developing and deploying creative product and pricing strategies in support of initiative.

During fiscal 2013, the Company increased its overall commercial mortgage loan portfolio by $181.9 million from $484.9 million or 37.7% of total loans at June 30, 2012 to $666.8 million or 49.0% of total loans at June 30, 2013.

Loan growth within the segment was achieved despite the severe economic challenges currently facing our regional and national economy. Such challenges continued to present significant headwinds that adversely impacted the Company's ability to achieve this first strategic goal solely through traditional, "organic" loan growth. Notwithstanding, the Company expanded and diversified its loan acquisition resources during fiscal 2013 supported by new product and pricing strategies designed to counterbalance the adverse effects of current economic conditions and support the Company's longer-term strategic goals. The Company expects to continue expanding its commercial mortgage lending activities into fiscal 2014.

Commercial Business (C&I) Lending: Increase the outstanding balances of "non-real estate" secured and unsecured business (C&I) loans through expansion of internal SBA and non-SBA loan originations with focus on lending relationships linked to non-maturity/noninterest-bearing deposit accounts. Augment current SBA-lending resources with additional business lending personnel in support of those objectives.

The Company focused much of its loan-related strategic efforts on expanding its commercial real estate lending activities during fiscal 2013. Such focus contributed to the overall decrease in the aggregate outstanding balances of this loan segment during fiscal 2013 as loan repayments outpaced new originations.

The Company expects its commercial lending activities will be expanded during fiscal 2014 to include a greater emphasis on business (C&I) lending. The Company's upcoming business lending strategies are expected to focus on expanding its recently reconfigured SBA lending function as well as acquiring new resources and infrastructure to support the development and deployment of various "non-SBA" business lending strategies. Through these strategies, the Company expects to increase the level of non-interest income through greater gains on sale of SBA loan originations. Moreover, the expanded business lending strategies are expected to be undertaken within a larger set of strategic initiatives designed to promote other business banking services intended to increase commercial deposit balances and services.

Residential Mortgage Lending: Stabilize the outstanding balances of one-to-four family first mortgages, home equity loans and home equity lines of credit. Utilize effective pricing strategies and modestly expand residential mortgage loan origination personnel in support of initiative. Generally maintain outstanding balance of applicable loans while allowing segment to decline as a percentage of total loans and earning assets.

As noted above, the Company focused much of its loan-related strategic efforts on expanding its commercial real estate lending activities during fiscal 2013 resulting in diminished strategic emphasis on residential mortgage lending. The declining balances within this loan sector during fiscal 2013 also reflected the challenges of diminished real


estate values and high levels of unemployment that have characterized the regional and national economy since the financial crisis of 2008-2009. In light of these factors, the Company maintained its conservative underwriting standards coupled with a disciplined pricing policy throughout fiscal 2013 which may have caused some potential borrowers to seek financing with more aggressive lenders.

An expected increase in long term interest rates during fiscal 2014 will support the Company's efforts to stabilize the aggregate outstanding balance of loans within the segment as loan prepayments slow and interest rates earned on new originations increase.

Investment Securities and Cash: Diversify composition and allocation of investment portfolio into new asset sectors to enhance earnings and reduce exposure to long term interest rate risk. Reduce concentration in agency one-to-four family residential pass-through MBS. Reduce the balance of cash and cash equivalents in relation to historical levels to further enhance yield on earning assets.

In conjunction with the balance sheet restructuring and wholesale growth transaction discussed earlier, the Company made significant progress in diversifying the composition and allocation of its securities portfolio. The Company added or expanded its investments in several asset classes including, but not limited to, asset-backed securities, corporate bonds, municipal obligations, collateralized loan obligations and commercial MBS while reducing its concentration in traditional residential MBS. Several of the added sectors include floating rate securities that reduce the level of interest rate risk ("IRR") embedded in the portfolio.

As a complement to the transactions noted above, the Company generally reduced the average balance of its interest-earning and non-interest earning cash balances during fiscal 2013 by maintaining lower average balances of short term, liquid assets in favor of redeploying such assets into the higher yielding security asset classes noted above.

The Company expects to continue investing in this diversified set of investment asset classes during fiscal 2014 with an emphasis on portfolio reallocation into floating rate assets maintaining comparatively lower levels of short term, liquid assets.

Asset Quality: Maintain high asset quality while continuing to reduce the current level of nonperforming assets.

The Company continues to maintain a strong level of asset quality to complement the execution of the loan-related strategies noted above. The balance of nonperforming assets decreased by $4.3 million to $33.0 million or 1.05% of total assets at June 30, 2013 from $37.3 million or 1.27% of total assets at June 30, 2012.

The balance of nonperforming assets at June 30, 2013 included $30.9 million of nonperforming loans and $2.1 million of real estate owned. A disproportionate balance of the Company's nonperforming loans represent residential mortgage loans that were originally purchased from Countrywide and are now serviced by Bank of America. At June 30, 2013, such loans total $9.2 million or 29.8% of nonperforming loans. By comparison, the entire remaining balance of the Bank of America loans, including nonperforming loans, totals approximately $41.8 million or 3.1% of total loans as of that same date.


Based upon information published by federal banking regulators in the Uniform Bank Performance Report ("UBPR") for the quarter ended June 30, 2013, the median nonperforming asset ratio for savings institutions with total assets greater than $1 billion was 2.71%. The comparable ratio for the Bank was 2.45% as of that same date indicating that the Bank's level of nonperforming assets, irrespective of origination source, remains less than that of its peer group, as defined by federal bank regulators. The noted ratio reported on the UBPR divides total nonperforming assets, as defined above, by the sum of total loans plus other real estate owned ("OREO").

Retail Deposits: Expand funding through retail deposit growth within existing branch network with greatest emphasis on growth in non-maturity/noninterest-bearing deposits. Support such growth with expanded business (C&I) lending initiatives. Selectively evaluate expansion of brick and mortar branch network opportunities as they arise.

The Bank's total deposits increased by $198.7 million for the year ended June 30, 2013. However, that growth included approximately $229.9 million of "non-retail" brokered money market deposits acquired in conjunction with the wholesale growth transactions presented earlier. Excluding those funds, the Bank's remaining retail deposits declined $31.2 million with such declines primarily attributable to a decrease in "non-core" time deposits.

Specifically, during fiscal 2013, non-interest-bearing checking accounts increased by $25.8 million while savings accounts and interest-bearing checking accounts, excluding "non-retail" balances, increased by $33.1 million and $33.3 million, respectively. Offsetting these increases in non-maturity "retail" deposits was a $123.5 million decrease in the balance of certificates of deposit during fiscal 2013.

The decline in the balance of certificates of deposit was partly attributable to the Company's active management of deposit pricing during fiscal 2013 to support net interest spread and margin which allowed for some degree of controlled outflow of maturing deposit types. A portion of the decline in time deposits reflected disintermediation into non-maturity deposits as consumers elected to maintain their funds in liquid accounts, given the comparatively low market rates on certificates of deposit. In addition to the effects of this disintermediation, the increase in non-maturity deposits also reflected the Company's efforts to attract additional transaction accounts through its various product and service strategies. In particular, the growth in non-interest-bearing checking accounts reflected the Company's ongoing efforts to expand its business banking relationships.

With the opening of the Bank's newest branch during fiscal 2012, the Bank now has a total of 41 branches; 27 branches operating under the name of Kearny Federal Savings Bank and 14 branches operating under the CJB Division brand. The Company will continue to carefully search out and evaluate additional de novo branch opportunities on a selective basis.

Notwithstanding the opportunities presented by de novo branching as discussed above, the Company expects to place greater strategic emphasis on leveraging the opportunities to grow market share and expand the depth and breadth of customer relationships within the existing branch system. The Company continues to develop and deploy strategies to


promote the "relationship banking" business model throughout its branch network with an emphasis on expanding business customer relationships linked to the business (C&I) lending initiatives discussed above.

Wholesale Funding and Derivatives: Restructure borrowings to reduce net interest costs while extending duration to reduce exposure to long-term IRR. Utilize additional borrowings in conjunction with leverage growth transaction designed to enhance earnings while being long-term IRR "neutral".

In conjunction with the balance sheet restructuring transactions and wholesale growth discussed earlier, the Company restructured its portfolio of FHLB advances during fiscal 2013 resulting in the prepayment of its highest cost borrowings coupled with a modification of the terms of its remaining advances. Through these transactions, the Company reduced the ongoing interest cost of its wholesale funding while extending its duration to better protect against IRR. The Company also utilized additional wholesale funding in the form of short-term FHLB advances and "non-retail" money market deposits in conjunction with the wholesale growth transactions executed during the latter half of fiscal 2013. Through these transactions, augmented with the use of interest rate derivatives such as swaps and caps, the Company enhanced prospective earnings by increasing net interest income while generally maintaining its exposure to IRR at current levels.

The Company will continue to explore further utilization of wholesale funding and interest rate derivatives during fiscal 2014 to enhance net interest income and manage the Company's overall exposure to IRR.

Mergers and Acquisitions: Actively seeking out franchise expansion opportunities such as the acquisition of other financial institutions or branches.

As a complement to the growth strategies noted above, the Company actively seeks out opportunities to deploy capital, diversify its balance sheet mix and enhance earnings through mergers and acquisitions with other institutions. The Company continues to selectively seek out and evaluate opportunities to achieve its strategic goals through the acquisition of other financial institutions or branches. The Company expects to place the greatest emphasis on opportunities to expand within existing markets served or to enter new markets that are generally contiguous to those already served.

In addition to acquisitions of financial institutions or their branches, the Company is currently exploring opportunities for acquisitions or strategic partnerships to broaden its product and service offerings to include insurance agency and/or brokerage services.

Information Technology and Operating Efficiency: Procure and implement various information technologies designed to support the Company's strategic initiatives while improving operating efficiency and reducing cost.

In conjunction with the its strategic efforts to improve operating efficiency and reduce operating expenses while expanding and enhancing product and service offerings, the Company completed a comprehensive evaluation of its current information technology ("IT") infrastructure, service providers and delivery channels during fiscal 2013. Through this evaluation, management identified or validated certain limitations and shortcomings of its current IT infrastructure, including both internal and customer-facing


systems, in relation to the goals and objectives of the Company's strategic business plan. In response to these findings, management thoroughly evaluated a number of alternative solutions available through select service providers focused on delivering IT-based solutions to financial institutions.

Based on this evaluation, the Company has selected and engaged Fiserv Inc. ("Fiserv") to be its primary source of internal and customer-facing technology solutions including, but not limited to, core and item processing, Internet banking and electronic bill payment, and ATM/debit card management and processing. Fiserv will also provide the Company with technology solutions supporting data communications, electronic document management, data warehouse and reporting, financial accounting and analysis as well as certain forms of loan and credit-related analyses. Through the relationship with Fiserv, the Company also intends to enhance and expand its technology-based services offerings to include mobile banking, person-to-person payments and online account opening.

The Company currently expects to convert its primary core processing and related customer-facing systems to the applicable Fiserv platforms during the third and fourth quarters of fiscal 2014. Upon completing all applicable system conversions and integrations with Fiserv, the Company anticipates that its recurring technology service provider expenses will be reduced by approximately $1.0 million per year. Such anticipated cost savings are based upon the current composition and transactional characteristics of the Company's customer account base and may vary over time based upon changes to those factors.

The Company considers the forthcoming enhancements to the Company's IT infrastructure to be the first of several strategies to be deployed to reduce the Company's level of non-interest expenses and improve operating efficiency. Upon completion of this critical technology initiative, the Company expects to perform further evaluation and analysis of other significant . . .

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