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KRNY > SEC Filings for KRNY > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for KEARNY FINANCIAL CORP.

Form 10-Q for KEARNY FINANCIAL CORP.


12-Nov-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 and Wholesale Growth Transactions

The following discussion presents an overview of certain balance sheet restructuring and wholesale growth transactions executed by the Company during the prior fiscal year ended June 30, 2013 and will serve as a point of reference for subsequent discussions included in this report.

The Company completed a series of balance sheet restructuring and wholesale growth transactions during the latter half of fiscal 2013 that improved the financial position and operating results of the Company and the Bank. Through the 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. The 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 during the year. The Company also modified the terms of its remaining high-rate FHLB advances to a lower interest rate while extending the duration of that modified funding to better protect against potential increases in interest rates in the future.

The key features and characteristics of the restructuring transactions executed during the latter half of fiscal 2013 were as follows:

The Company sold available for sale agency MBS totaling approximately $330.0 million with a weighted average book yield of 1.78% resulting in a one-time gain on sale totaling approximately $9.1 million;

A portion of the proceeds from the noted MBS sales were used to prepay $60.0 million of fixed-rate FHLB advances at a weighted average rate of 3.99% resulting in a one-time expense of $8.7 million largely attributable to the prepayment penalties paid to the FHLB to extinguish the debt; and

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The Company reinvested the remaining proceeds from the noted MBS sales into a diversified mix of high-quality securities with an aggregate tax-effective yield modestly exceeding that of the MBS sold. Such securities primarily included:

o Fixed-rate, bank-qualified municipal obligations;

o Floating-rate corporate bonds issued by financial companies;

o Floating-rate, asset-backed securities comprising education loans with 97% U.S. government guarantees;

o Fixed-rate agency commercial MBS secured by multi-family mortgage loans; and

o Fixed-rate agency collateralized mortgage obligations ("CMO").

The Company modified the terms of its remaining $145.0 million of "putable" FHLB advances with a weighted average cost of 3.68% and weighted average remaining maturity of approximately 4.5 years. Such advances were subject to the FHLB's quarterly "put" option enabling it to demand repayment in full in the event of an increase in interest rates. The terms of the modified advances extended their "non-putable" period to five years with a final stated maturity of ten years while reducing their average interest rate by 0.64% to 3.04% at no immediate cost to the Company.

The Company augmented the restructuring transaction noted above by also executing a limited wholesale growth strategy during the latter half of fiscal 2013. The strategy has further enhanced the Company's net interest income and operating results without significantly impacting 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.

In conjunction with the wholesale growth strategy, the Company drew an additional $300.0 million of wholesale funding that was utilized to purchase a diverse set of high-quality investment securities of an equivalent amount. The key features and characteristics of the wholesale growth transactions were as follows:

Wholesale funding sources utilized in the strategy included 90-day FHLB borrowings and money-market deposits indexed to one-month LIBOR acquired through Promontory Interfinancial Network's ("Promontory") Insured Network Deposits ("IND") program.

The Company utilized interest rate derivatives in the form of "plain vanilla" swaps and caps with aggregate notional amounts totaling $300.0 million to serve as cash flow hedges to manage the interest rate risk exposure of the floating rate funding sources noted above.

The investment securities acquired with this funding primarily included:

o Floating-rate corporate bonds issued by financial companies;

o Floating-rate, asset-backed securities comprising education loans with 97% U.S. government guarantees;

o Floating rate collateralized loan obligations ("CLO")

o Fixed-rate agency residential and commercial MBS; and

o Fixed-rate agency collateralized mortgage obligations ("CMO").

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Comparison of Financial Condition at September 30, 2013 and June 30, 2013

General. Total assets increased by $92.4 million to $3.24 billion at September 30, 2013 from $3.15 billion at June 30, 2013. The increase in total assets was primarily attributable to increases in the balances of loans and FHLB stock that were partially offset by declines in the balances of cash and cash equivalents and mortgage-backed securities. The net increase in total assets was complemented by increases in the balance of borrowings and stockholders' equity that was partially offset by a decline in the balance of deposits.

Cash and Cash Equivalents. Cash and cash equivalents, which consist primarily of interest-earning and non-interest-earning deposits in other banks, decreased by $8.8 million to $118.2 million at September 30, 2013 from $127.0 million at June 30, 2013. The decline in cash and cash equivalents generally reflects the Company's efforts to reduce the balance of short term, liquid assets maintained in favor of redeploying such assets into higher yielding securities.

In light of the historically low level of short term interest rates, the Company expects to continue maintaining the average balance of interest-earning and non-interest-earning cash and equivalents at comparatively lower levels than those maintained during prior years. 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 $422,000 to $300.5 million at September 30, 2013 from $300.1 million at June 30, 2013. The net increase primarily reflected the purchase of a collateralized loan obligation totaling $1.9 million during the three months ended September 30, 2013. This increase was partially offset by an overall increase in the net unrealized loss within the portfolio coupled with repayments of principal attributable to amortization during the first quarter of fiscal 2014.

The net unrealized loss for this portfolio increased by $1.5 million to $6.7 million at September 30, 2013 from $5.2 million at June 30, 2013. The increase in the net unrealized loss was primarily attributable to declines in the fair value of most sectors within the portfolio that resulted from recent increases in market interest rates. Partially offsetting these declines was an increase in the fair value of the Company's investment in single-issuer, trust preferred securities whose unrealized losses decreased by $117,000 to $1.4 million at September 30, 2013 from $1.6 million at June 30, 2013.

At September 30, 2013, the available for sale debt securities portfolio included U.S. agency debentures, single-issuer trust preferred securities, corporate bonds, asset-backed securities, collateralized loan obligations and municipal obligations. Based on its evaluation, management has concluded that no other-than-temporary impairment is present within this segment of the investment portfolio as of that date.

Additional information regarding debt securities available for sale at September 30, 2013 is presented in Note 7 and Note 9 to the unaudited consolidated financial statements.

Debt Securities Held to Maturity. Debt securities classified as held to maturity increased by $928,000 to $210.9 million at September 30, 2013 from $210.0 million at June 30, 2013. The net increase primarily reflected purchases of municipal obligations totaling $1.2 million during the three months ended September 30, 2013 that were partially offset by the repayment of such securities during the three months ended September 30, 2013.

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At September 30, 2013, the held to maturity debt securities portfolio included U.S. agency debentures as well as municipal obligations, a small portion of which represent non-rated, short term, bond anticipation notes ("BANs") issued by New Jersey municipalities with whom the Bank maintains or seeks to maintain deposit relationships. Based on its evaluation, management has concluded that no other-than-temporary impairment is present within this segment of the investment portfolio as of that date.

Additional information regarding debt securities held to maturity at September 30, 2013 is presented in Note 8 and Note 9 to the unaudited consolidated financial statements.

Loans Receivable. Loans receivable, net of unamortized premiums, deferred costs and the allowance for loan losses, increased by $124.3 million to $1.47 billion at September 30, 2013 from $1.35 billion at June 30, 2013. The increase in net loans receivable was primarily attributable to new loan origination and purchase volume outpacing loan repayments during the three months ended September 30, 2013.

Residential mortgage loans, including home equity loans and lines of credit, increased by $8.8 million to $616.9 million at September 30, 2013 from $608.1 million at June 30, 2013. The components of the net increase included an increase in the balance of one-to-four family first mortgage loans of $10.2 million to $510.8 million at September 30, 2013 from $500.6 million at June 30, 2013. Partially offsetting this increase was a net reduction in the balance of home equity loans of $990,000 to $79.8 million at September 30, 2013 from $80.8 million for those same comparative periods. Additionally, the balance of home equity lines of credit decreased by $318,000 to $26.3 million at September 30, 2013 from $26.6 million at June 30, 2013.

Residential mortgage loan activity for the quarter ended September 30, 2013 continues to reflect the Company's diminished strategic focus on such loans coupled with the reduced level of "new purchase" loan demand resulting from a weak economy and lower real estate values. The modest increase in the outstanding balance of the portfolio was supported by slowing refinancing activity resulting primarily from longer-term mortgage rates increasing during the current quarter from their historical lows. Such increases in mortgage rates were largely attributable to market expectations for a reduction or "tapering" in the Federal Reserve's efforts to stimulate the economy by maintaining longer-term interest rates at historically low levels through quantitative easing. Through this policy, the Federal Reserve has aggressively purchased mortgage-backed securities in the open market thereby driving the yield on such securities, and their underlying mortgage loans, to historical lows. Slowing the rate of such purchases by the Federal Reserve is expected to result in an increase in longer-term interest rates.

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.

In total, residential mortgage loan origination and purchase volume for the three months ended September 30, 2013 was $26.6 million and $10.3 million, respectively, while aggregate originations of home equity loans and home equity lines of credit totaled $9.7 million for that same period.

Commercial loans, in aggregate, increased by $118.4 million to $855.9 million at September 30, 2013 from $737.5 million at June 30, 2013. The components of the aggregate increase included an increase in commercial mortgage loans totaling $118.6 million that was partially offset by a decline in

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commercial business loans of $226,000. The ending balances of commercial mortgage loans and commercial business loans at September 30, 2013 were $785.5 million and $70.5 million, respectively. Commercial loan origination volume for the three months ended September 30, 2013 totaled $98.2 million comprising $93.2 million and $5.0 million of commercial mortgage and commercial business loans originations, respectively. Commercial loan originations were augmented with the purchase of commercial loans totaling $46.0 million during the three months ended September 30, 2013.

The outstanding balance of construction loans, net of loans-in-process, decreased by $1.6 million to $10.3 million at September 30, 2013 from $11.9 million at June 30, 2013. Construction loan disbursements for the three months ended September 30, 2013 totaled $1.2 million.

Finally, other loans, primarily comprising account loans, deposit account overdraft lines of credit and other consumer loans, increased $234,000 to $4.5 million at September 30, 2013 from $4.3 million at June 30, 2013. Other loan originations for the three months ended September 30, 2013 totaled approximately $575,000.

Additional information regarding loans receivable at September 30, 2013 is presented in Note 10 to the unaudited consolidated financial statements.

Nonperforming Loans. At September 30, 2013, nonperforming loans decreased by $985,000 to $29.9 million or 2.01% of total loans from $30.9 million or 2.27% of total loans as of June 30, 2013. The balance of nonperforming loans at September 30, 2013 included $29.7 million and $226,000 of "nonaccrual" loans and loans reported as "over 90 days past due and accruing", respectively. By comparison, the balance of nonperforming loans at June 30, 2013 was comprised entirely of "nonaccrual" loans.

The composition of nonperforming loans at September 30, 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 totaled $10.1 million or 33.6% of total nonperforming loans at September 30, 2013. As of that same date, the Company owned a total of 90 residential mortgage loans with an aggregate outstanding balance of $41.0 million that were originally acquired from Countrywide. Of these loans, an additional four loans totaling $1.4 million are 30-89 days past due and are in various stages of collection.

Additional information about the Company's nonperforming loans at September 30, 2013 is presented in Note 10 to the unaudited consolidated financial statements.

Allowance for Loan Losses. During the three months ended September 30, 2013, the balance of the allowance for loan losses increased by approximately $510,000 to $11.4 million or 0.77% of total loans at September 30, 2013 from $10.9 million or 0.80% of total loans at June 30, 2013. The increase resulted from provisions of $1.2 million during the three months ended September 30, 2013 that were partially offset by charge offs, net of recoveries, totaling approximately $658,000.

With regard to loans individually evaluated for impairment, the balance of the Company's allowance for loan losses attributable to such loans decreased by $310,000 to $1.8 million at September 30, 2013 from $2.1 million at June 30, 2013. The balance at September 30, 2013 reflected the allowance for impairment identified on $4.3 million of impaired loans while an additional $38.2 million of impaired loans had no allowance for impairment as of that date. By comparison, the balance of the allowance at June 30, 2013 reflected the impairment identified on $4.7 million of impaired loans while an additional $34.8 million of impaired loans had no impairment as of that date. The outstanding balances of impaired

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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 $820,000 to $9.6 million at September 30, 2013 from $8.8 million at June 30, 2013. The increase in the balance of this portion of the allowance largely reflected the additional allowance attributable to an overall increase of $123.0 million in the non-impaired portion of the loan portfolio between comparative periods. The increase in the allowance also reflected changes in the Company's historical 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 18 basis points during the three months ended September 30, 2013 representing a decrease of 10 basis points from the 28 basis points of charge offs reported for fiscal 2013. 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. Together, these factors resulted in a net decrease of $64,000 in the applicable portion of the allowance to $2,375,000 at September 30, 2013 from $2,439,000 as of June 30, 2013.

The environmental loss factors utilized in the Company's ALLL calculation methodology remained substantially unchanged at September 30, 2013 from June 30, 2013. However, those stable loss factors applied to the growth in the non-impaired portion of the loan portfolio noted earlier resulted in a net increase of $884,000 in the applicable valuation allowances to $7,263,000 at September 30, 2013 from $6,379,000 at June 30, 2013.

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The following tables 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 September 30, 2013 and June 30, 2013.

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

                                 at September 30, 2013
                                           Historical        Environmental
                                              Loss               Loss
              Loan Category                  Factors          Factors (2)      Total

    Residential mortgage loans
    Originated                                0.07%              0.30%         0.37%
    Purchased                                 2.65%              0.75%         3.40%
    Acquired in merger                        1.62%              0.24%         1.86%

    Home equity loans
    Originated                                0.15%              0.36%         0.51%
    Acquired in merger                        0.37%              0.24%         0.61%

    Home equity lines of credit
    Originated                                0.00%              0.36%         0.36%
    Acquired in merger                        0.00%              0.24%         0.24%

    Construction loans
    1-4 family
      Originated                              0.00%              0.72%         0.72%
      Acquired in merger                      0.00%              0.24%         0.24%
    Multi-family
      Originated                              0.00%              0.72%         0.72%
      Acquired in merger                      0.00%              0.24%         0.24%
    Nonresidential
      Originated                              0.00%              0.72%         0.72%
      Acquired in merger                      0.00%              0.24%         0.24%

    Commercial mortgage loans
    Multi-family
      Originated                              0.00%              0.72%         0.72%
      Acquired in merger                      0.00%              0.24%         0.24%
    Nonresidential
      Originated                              0.14%              0.72%         0.86%
      Acquired in merger                      0.09%              0.24%         0.33%

    Commercial business loans
    Secured (1-4 family)
      Originated                              0.00%              0.72%         0.72%
      Acquired in merger                      0.00%              0.24%         0.24%
    Secured (Other)
      Originated                              0.08%              0.72%         0.80%
      Acquired in merger                      0.06%              0.24%         0.30%
    Unsecured
      Originated                              0.00%              0.57%         0.57%
      Acquired in merger                      0.00%              0.18%         0.18%

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                               Allowance for Loan Losses
            Allocation of Loss Factors on Loans Collectively Evaluated for
                                      Impairment
                           at September 30, 2013 (continued)
                                  Historical    Environmental
                                     Loss           Loss
              Loan Category        Factors       Factors (2)         Total
            SBA 7A
              Originated            0.00%           0.72%            0.72%
              Acquired in
            merger                  8.04%           0.24%            8.28%
            SBA Express
              Originated            0.00%           0.72%            0.72%
              Acquired in
            merger                  0.00%           0.24%            0.24%
              SBA Line of
            Credit
              Originated            0.00%           0.72%            0.72%
              Acquired in
            merger                  0.52%           0.24%            0.76%
            SBA Other
              Originated            0.00%           0.72%            0.72%
              Acquired in
            merger                  0.00%           0.24%            0.24%

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

    Residential mortgage loans
    Originated                                0.09%              0.30%         0.39%
    Purchased                                 2.78%              0.75%         3.53%
    Acquired in merger                        1.62%              0.24%         1.86%

    Home equity loans
    Originated                                0.15%              0.36%         0.51%
    Acquired in merger                        0.30%              0.24%         0.54%

    Home equity lines of credit
    Originated                                0.00%              0.36%         0.36%
    Acquired in merger                        0.00%              0.24%         0.24%

    Construction loans
    1-4 family
      Originated                              0.00%              0.72%         0.72%
      Acquired in merger                      0.00%              0.24%         0.24%
    Multi-family
      Originated                              0.00%              0.72%         0.72%
      Acquired in merger                      0.00%              0.24%         0.24%
. . .
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