10-K 1 d774576d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended June 30, 2014

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 0-51093

 

 

KEARNY FINANCIAL CORP.

(Exact name of Registrant as specified in its Charter)

 

 

 

United States   22-3803741

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

120 Passaic Avenue, Fairfield, New Jersey   07004
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code: (973) 244-4500

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $0.10 par value   The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities

Act.    ¨  YES     x  NO

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    ¨  YES    x  NO

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  YES    ¨  NO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  YES    ¨  NO

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    ¨  YES    x  NO

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant on December 31, 2013 (the last business day of the Registrant’s most recently completed second fiscal quarter) was $154.5 million. Solely for purposes of this calculation, shares held by directors, executive officers and greater than 10% stockholders are treated as shares held by affiliates.

As of August 29, 2014 there were outstanding 67,350,247 shares of the Registrant’s Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

 

1. Portions of the definitive Proxy Statement for the Registrant’s 2014 Annual Meeting of Stockholders. (Part III)

 

 

 


Table of Contents

KEARNY FINANCIAL CORP.

ANNUAL REPORT ON FORM 10-K

For the Fiscal Year Ended June 30, 2014

INDEX

 

PART I

       

Page

Item 1.

 

Business

  1

Item 1A.

 

Risk Factors

  65

Item 1B.

 

Unresolved Staff Comments

  73

Item 2.

 

Properties

  74

Item 3.

 

Legal Proceedings

  77

Item 4.

 

Mine Safety Disclosures

  77

PART II

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

  78

Item 6.

 

Selected Financial Data

  81

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  83

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

  112

Item 8.

 

Financial Statements and Supplementary Data

  120

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

  120

Item 9A.

 

Controls and Procedures

  120

Item 9B.

 

Other Information

  121

PART III

Item 10.

 

Directors, Executive Officers and Corporate Governance

  122

Item 11.

 

Executive Compensation

  122

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

  122

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

  123

Item 14.

 

Principal Accounting Fees and Services

  123

PART IV

Item 15.

 

Exhibits, Financial Statement Schedules

  124

SIGNATURES

   

 

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PART I

Item 1. Business

Forward-Looking Statements

This Annual Report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and words of similar meaning. These forward-looking statements include, but are not limited to:

 

    statements of our goals, intentions and expectations;

 

    statements regarding our business plans, prospects, growth and operating strategies;

 

    statements regarding the quality of our loan and investment portfolios; and

 

    estimates of our risks and future costs and benefits.

These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

 

    general economic conditions, either nationally or in our market areas, that are worse than expected;

 

    changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses;

 

    our ability to access cost-effective funding;

 

    fluctuations in real estate values and both residential and commercial real estate market conditions;

 

    demand for loans and deposits in our market area;

 

    our ability to implement and changes in our business strategies;

 

    competition among depository and other financial institutions;

 

    inflation and changes in the interest rate environment that reduce our margins and yields, or reduce the fair value of financial instruments or reduce the origination levels in our lending business, or increase the level of defaults, losses and prepayments on loans we have made and make whether held in portfolio or sold in the secondary markets;

 

    adverse changes in the securities markets;

 

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    changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;

 

    our ability to manage market risk, credit risk and operational risk in the current economic conditions;

 

    our ability to enter new markets successfully and capitalize on growth opportunities;

 

    our ability to successfully integrate any assets, liabilities, customers, systems and management personnel we have acquired or may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;

 

    changes in consumer spending, borrowing and savings habits;

 

    changes in accounting policies and practices, as may be adopted by bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission or the Public Company Accounting Oversight Board;

 

    our ability to retain key employees;

 

    technological changes;

 

    significant increases in our loan losses; and

 

    changes in the financial condition, results of operations or future prospects of issuers of securities that we own.

Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

General

Kearny Financial Corp. (the “Company,” “Kearny-Federal” or the “Registrant”) is a federally-chartered corporation that was organized on March 30, 2001 for the purpose of being a holding company for Kearny Federal Savings Bank (“Kearny Bank” or the “Bank”), a federally-chartered stock savings bank. On February 23, 2005, the Company completed a minority stock offering in which it sold 21,821,250 shares, representing 30% of its outstanding common stock upon completion of the offering. The remaining 70% of the outstanding common stock, totaling 50,916,250 shares, were retained by Kearny MHC (“Kearny MHC” or the “MHC”). The Company issued an additional 1,044,087 shares of its common stock to the MHC on June 30, 2014 in conjunction with the Bank’s acquisition of Atlas Bank. The MHC is a federally-chartered mutual holding company and so long as the MHC is in existence, it will at all times own a majority of the outstanding common stock of the Company. The stock repurchase programs conducted by the Company since the offering, net of treasury shares issued in fulfillment of stock option exercises, have reduced the total number of shares outstanding. The 51,960,337 shares held by the MHC represented 77.2% of the 67,267,865 total shares outstanding as of the Company’s June 30, 2014 fiscal year end. The MHC and the Company are now regulated as savings and loan holding companies by the Board of Governors of the Federal Reserve System (“FRB”), as successor to the Office of Thrift Supervision (“OTS”) under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).

 

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The Company is a unitary savings and loan holding company and conducts no significant business or operations of its own. References in this Annual Report on Form 10-K to the Company, Kearny-Federal or Registrant generally refer to the Company and the Bank, unless the context indicates otherwise. References to “we”, “us”, or “our” refer to the Bank or Company, or both, as the context indicates.

The Bank was originally founded in 1884 as a New Jersey mutual building and loan association. It obtained federal insurance of accounts in 1939 and received a federal charter in 1941. The Bank’s deposits are federally insured by the Deposit Insurance Fund as administered by the Federal Deposit Insurance Corporation (“FDIC”) and the Bank is regulated by the Office of the Comptroller of the Currency (“OCC”), as successor to the OTS under the Dodd-Frank Act, and the FDIC.

The Company’s primary business is the ownership and operation of the Bank. The Bank is principally engaged in the business of attracting deposits from the general public in New Jersey and New York and using these deposits, together with other funds, to originate or purchase loans for its portfolio and invest in securities. Our loan portfolio is primarily comprised of loans collateralized by residential and commercial real estate augmented by secured and unsecured loans to businesses and consumers. We also maintain a portfolio of investment securities, primarily comprised of U.S. agency mortgage-backed securities, U.S. government and agency debentures, bank-qualified municipal obligations, corporate bonds, asset-backed securities and collateralized loan obligations. The Bank maintains a small balance of single issuer trust preferred securities and non-agency mortgage-backed securities which were acquired through the Company’s purchase of other institutions and does not actively purchase such securities.

At June 30, 2014, net loans receivable comprised 49.3% of our total assets while investment securities, including mortgage-backed and non-mortgage-backed securities, comprised 38.7% of our total assets. By comparison, at June 30, 2013, net loans receivable comprised 42.9% of our total assets while securities comprised 44.3% of our total assets. During the latter half of fiscal 2013, we executed a series of balance sheet restructuring and wholesale growth transactions to enhance our earnings and reduce our exposure to long term interest rate risk, resulting 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 our balance sheet to reflect a greater percentage of interest-earning assets to loans while, in turn, reducing the relative size of the securities portfolio. The composition and volume of loan originations and purchases during fiscal 2014 reflected that strategic focus through which we have increased our commercial loan origination and support staff and expanded relationships with loan participants and other external loan origination resources.

We operate from our administrative headquarters in Fairfield, New Jersey and had 42 branch offices as of June 30, 2014. We also operate an Internet website at www.kearnyfederalsavings.com through which copies of our periodic reports are available free of charge as soon as reasonably practicable after they are filed with the Securities and Exchange Commission.

 

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Business Strategy

Our goal is to continue to evolve from a traditional thrift business model toward that of a full service, community bank, profitably deploying capital and enhancing earnings through a variety of balance sheet growth and diversification strategies. The key strategic initiatives of our business plan are presented below accompanied by an overview of our activities and achievements in support of those initiatives:

 

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

During fiscal 2014, we increased our commercial mortgage loan portfolio by $317.0 million to $983.8 million, or 56.4% of total loans from $666.8 million, or 49.0% of total loans at June 30, 2013. This increase reflected commercial mortgage loan originations and purchases totaling $334.4 million and $87.0 million, respectively. We plan to continue to increase our portfolio of commercial mortgage loans by expanding loan acquisition volume through all available channels, including retail and broker originations, as well as individual and pooled loan purchases and participations.

Additionally, we intend to continue to expand our commercial lending infrastructure and resources, which will be supported by new product and pricing strategies designed to increase origination volume in a very competitive marketplace.

 

    Continue to Increase Commercial Business Lending: Increase the outstanding balances of non-real estate secured and unsecured business loans through all available channels and expand those business relationships.

We plan to continue to focus our efforts on expanding our commercial non-real estate secured and unsecured business lending activities through all available channels. Although our commercial business loan originations increased during fiscal 2014, we had a modest $3.4 million decrease in the aggregate outstanding balance of this loan segment during fiscal 2014 as loan repayments outpaced new originations during the year. Despite this modest decline, we anticipate this loan segment to increase in the future. In addition, we will attempt to expand our relationships with these borrowers to include commercial deposits and other products, with the goal of increasing our non-interest income.

During the quarter ended March 31, 2014, we hired an experienced senior business lending officer to oversee our C&I lending function and expect to augment our existing resources with additional lenders and administrative resources during fiscal 2015. We expect to hire a senior Small Business Administration (“SBA”) lending officer dedicated to that function during fiscal 2015 as well as the needed administrative resources to support an anticipated increase in SBA lending volume during that time.

Through these strategies, we anticipate an increase in the level of non-interest income through greater gains on sale of SBA loan originations and other business loan-related fee income. 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.

 

    Modestly Increase Residential Mortgage Lending: Modestly increase the outstanding balance of our one- to four-family first mortgage portfolio while stabilizing the balance of home equity loans and home equity lines of credit. Allow segment to continue to decline as a percentage of total loans and earning assets.

We plan to modestly increase our portfolio of one- to four-family first mortgages while stabilizing the balance of home equity loans and home equity lines of credit and maintaining our conservative underwriting standards. During the year ended June 30,

 

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2014, we originated $78.2 million of one- to four-family first mortgage loans compared to $65.1 million during the year ended June 30, 2013. We anticipate that this segment of our loan portfolio will continue to decline as a percentage of total loans and earning assets as other loan categories grow.

The overall stability in the outstanding balance of the residential mortgage loan portfolio and, more significantly, its decline as a percentage of total loans continues to reflect our decreased strategic focus on residential mortgage lending, coupled with the slowed pace of refinancing and diminished level of demand for “new purchase” mortgage loans.

 

    Continue to Diversify Investment Securities: Continue to 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 mortgage-backed securities.

In order to enhance earnings and reduce our exposure to long term interest rate risk in fiscal 2013, we initiated a plan to diversify the composition and allocation of our investment portfolio into new asset sectors, including asset-backed securities, corporate bonds, municipal obligations, collateralized loan obligations and commercial mortgage-backed securities (“MBS”) while reducing our 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 our securities portfolio. During fiscal 2014, we continued to expand our investments into these sectors and expect to continue to do so in the future.

 

    Maintain Strong Asset Quality: Maintain high asset quality and continue to reduce the current level of nonperforming assets.

We continue to emphasize and maintain strong asset quality. Nonperforming assets decreased by $6.1 million to $26.9 million, or 0.77% of total assets, at June 30, 2014 from $33.0 million, or 1.05% of total assets, at June 30, 2013. Through our conservative underwriting standards and our prompt attention to potential problem loans, we anticipate maintaining strong asset quality ratios as we continue to grow and diversify our loan portfolio.

 

    Expand Funding Through Retail Deposits: Expand our funding through retail deposit growth within existing branch network with greatest emphasis on growth in non-maturity/non-interest bearing deposits.

Our total deposits increased by $109.4 million for the year ended June 30, 2014 including $86.1 million of deposits assumed in conjunction with our Atlas Bank acquisition. Non-interest-bearing deposits increased $33.1 million during fiscal 2014 while interest-bearing deposits increased $76.3 million. Within interest-bearing deposits, the balance of savings accounts and certificates of deposit increased by $51.9 million and $55.7 million, respectively. This growth was partially offset by a $31.3 million decline in the balance of interest-bearing checking accounts.

With the acquisition of Atlas Bank, we now have a total of 42 branches. We plan to selectively evaluate branch network expansion opportunities, with a particular focus on limited branch expansion in Brooklyn and Staten Island, New York, as an outgrowth of our acquisition of Atlas Bank. We will also continue to carefully seek and evaluate

 

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additional de novo branch opportunities to contiguously expand our existing New Jersey branch network with an emphasis on “fill ins” between our northern and central New Jersey locations.

Notwithstanding the opportunities presented by de novo branching, we expect to place greater strategic emphasis on leveraging the opportunities to increase market share and expand the depth and breadth of customer relationships within the existing branch system. We continue to develop and deploy strategies to promote the “relationship banking” business model throughout our branch network with an emphasis on expanding business customer relationships linked to business lending initiatives.

 

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

As a complement to the “organic” growth strategies, we continue to actively seek out opportunities to deploy capital, diversify our balance sheet mix, enter new markets and enhance earnings through mergers and acquisitions with other financial institutions. We are an experienced acquiror, having acquired five banks in the last 15 years. As demonstrated through our acquisition of Atlas Bank during fiscal 2014, we expect to place the greatest emphasis on opportunities to expand within the existing markets we serve or to enter new markets that are generally contiguous to such markets.

In addition to searching for acquisitions of financial institutions or their branches, we are currently exploring opportunities for acquisitions or strategic partnerships to broaden our product and service offerings to include insurance agency and/or insurance related brokerage services. While we continue to evaluate potential acquisition opportunities, there are no current agreements or arrangements for any such acquisitions.

 

    Information Technology: Procure and implement various information technologies designed to support our strategic initiatives while improving operating efficiency and reducing cost.

In conjunction with our strategic efforts to improve operating efficiency and control operating expenses, while expanding and enhancing product and service offerings, we completed the conversion of our primary core processing and related customer-facing systems to Fiserv, Inc. platforms during fiscal 2014. Additional Fiserv, Inc. technologies are expected to be deployed during fiscal 2015. We anticipate that such measures will significantly reduce our recurring technology service provider expenses and enhance our commercial business lending platform.

We consider the noted enhancements to our information technology infrastructure to be the first of several strategies to be deployed to control growth in non-interest expenses and improve our overall operating efficiency. Upon completion of this initiative, we expect to perform further evaluation and analysis of other significant categories of non-interest expense with the goal of optimizing the cost level, resource allocation and utilization of our growing infrastructure to support our strategic goals and objectives.

Acquisition Activity. Since 1999, we have acquired five banking institutions including: 1st Bergen Bancorp (March 31, 1999), Pulaski Bancorp, Inc. (October 18, 2002), West Essex Bancorp (July 1, 2003), Central Jersey Bancorp (November 30, 2010) and, most recently, Atlas Bank (June 30, 2014). Atlas Bank, a federal mutual savings bank, had total assets with a fair value of $120.9 million at June 30, 2014

 

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and two branch offices in Brooklyn and Staten Island, New York as of that date. As of June 30, 2014, Atlas Bank operated its main retail banking office in Brooklyn and a retail branch in Staten Island, New York, and had assets with a fair value of $120.9 million and deposit balances with fair values totaling $86.1 million. Atlas Bank had no public stockholders, and therefore no merger consideration was paid to third parties. We issued 1,044,087 shares of Kearny-Federal common stock to Kearny MHC as consideration for the transaction. As the merger was completed on June 30, 2014, the transaction is reflected in the consolidated statements of conditions and consolidated statements of operations at and for the relevant period presented in this Annual Report.

Upon completion of the transaction, Atlas Bank merged with and into Kearny Bank, and Atlas Bank’s existing branch offices began operating under the name “Atlas Bank, a division of Kearny Federal Savings Bank,” for at least a year following the merger.

Market Area. At June 30, 2014, our primary market area consists of the New Jersey counties in which we currently operate branches including Bergen, Essex, Hudson, Middlesex, Monmouth, Morris, Ocean, Passaic and Union counties. Our market area was expanded to include Kings and Richmond counties in New York resulting from our acquisition of Atlas Bank on June 30, 2014. Our lending is concentrated in these markets and our predominant sources of deposits are the communities in which our offices are located as well as the neighboring communities.

Our primary market area is largely urban and suburban with a broad economic base as is typical within the New York metropolitan area. Service jobs represent the largest employment sector followed by wholesale/retail trade. Our business of attracting deposits and making loans is generally conducted within our primary market area. A downturn in the local economy could reduce the amount of funds available for deposit and the ability of borrowers to repay their loans which would adversely affect our profitability.

According to SNL Financial, the population in our primary market area has increased from 2010 to 2014, with weighted population growth rates of 2.06% and 3.29% for the nine New Jersey counties and the two New York counties that we operate in, respectively. The weighted average median household income for 2014 for the nine New Jersey counties that we operate in was $72,840, while the weighted average median income for 2014 for the two New York counties that we operate in was $49,792. By contrast, the national level of median household income for 2014 was $51,579. By 2019, the projected increases in median household income are expected to be 4.12% for the nine New Jersey counties that we operate in and 6.36% for the two New York counties that we operate in. By 2019, the projected national level of increase in median household income is expected to be 4.58%.

Competition. We operate in a market area with a high concentration of banking and financial institutions and we face substantial competition in attracting deposits and in originating loans. A number of our competitors are significantly larger institutions with greater financial and managerial resources and lending limits. Our ability to compete successfully is a significant factor affecting our growth potential and profitability.

Our competition for deposits and loans historically has come from other insured financial institutions such as local and regional commercial banks, savings institutions and credit unions located in our primary market area. We also compete with mortgage banking and finance companies for real estate loans and with commercial banks and savings institutions for consumer loans. We also face competition for attracting funds from providers of alternative investment products such as equity and fixed income investments such as corporate, agency and government securities as well as the mutual funds that invest in these instruments.

 

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There are large retail banking competitors operating throughout our primary market area, including Bank of America, Citibank, JP Morgan Chase Bank, PNC Bank, TD Bank, and Wells Fargo Bank and we also face strong competition from other community-based financial institutions.

Restructuring and Wholesale Growth Transactions. The following discussion presents an overview of certain balance sheet restructuring and wholesale growth transactions we executed during the prior fiscal year ended June 30, 2013 and will generally 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 fiscal 2013 that were intended to improve 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;

 

    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:

 

    fixed-rate, bank-qualified municipal obligations;

 

    floating-rate corporate bonds issued by financial companies;

 

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

 

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

 

    fixed-rate agency collateralized mortgage obligations (“CMO”); and

 

    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.

 

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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 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:

 

    floating-rate corporate bonds issued by financial companies;

 

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

 

    floating rate collateralized loan obligations (“CLO”)

 

    fixed-rate agency residential and commercial MBS; and

 

    fixed-rate agency collateralized mortgage obligations (“CMO”).

 

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Lending Activities

General. In conjunction with our strategic efforts to evolve from a traditional thrift to a full-service community bank, our lending strategies have placed increasing emphasis on the origination of commercial loans while diminishing the emphasis on one- to four-family mortgage lending. The year-to-year trends in the composition and allocation of our loan portfolio, as reported in the table below, highlight those changes in business strategy. In particular, the outstanding balance of our commercial mortgages, including loans secured by multi-family, mixed-use and nonresidential properties, have significantly increased from both a dollar amount and percentage of portfolio basis over the past several years. Conversely, absent the effect of acquisitions, the outstanding balance of residential mortgage loans has declined during recent years, reflecting loan repayments that have outpaced originations.

Our commercial loan offerings also include secured business loans, most of which are secured by real estate, and unsecured business loans. Commercial loan offerings include programs offered through the SBA in which Kearny Bank participates as a Preferred Lender. Our consumer loan offerings primarily include home equity loans and home equity lines of credit as well as account loans, overdraft lines of credit, vehicle loans and personal loans. We also offer construction loans to builders/developers as well as individual homeowners. Substantially all of our borrowers are residents of our primary market area and would be expected to be similarly affected by economic and other conditions in that area. We have purchased out-of-state one- to four-family first mortgage loans to supplement our in-house originations. Please see “Lending Activities—Loan Originations, Purchases, Sales, Solicitation and Processing.”

 

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Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio in dollar amounts and as a percentage of the total portfolio at the dates indicated.

 

    At June 30,  
    2014     2013     2012     2011     2010  
    Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent  
    (Dollars in Thousands)  

Real estate mortgage:

                   

One- to four-family

  $ 580,612        33.31   $ 500,647        36.77   $ 562,846        43.77   $ 610,901        48.12   $ 663,850        65.52

Commercial

    983,755        56.44        666,828        48.97        484,934        37.71        383,690        30.23        203,013        20.04   

Commercial business

    67,261        3.86        70,688        5.19        88,414        6.88        105,001        8.28        14,352        1.42   

Consumer:

                   

Home equity loans

    75,611        4.34        80,813        5.93        95,832        7.45        111,478        8.78        101,659        10.03   

Home equity lines of credit

    24,010        1.38        26,613        1.95        29,530        2.30        32,925        2.59        11,320        1.12   

Passbook or certificate

    3,965        0.23        3,887        0.29        3,638        0.28        2,753        0.22        2,703        0.27   

Other

    373        0.02        391        0.03        404        0.03        1,026        0.08        1,545        0.15   

Construction

    7,281        0.42        11,851        0.87        20,292        1.58        21,598        1.70        14,707        1.45   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

    1,742,868        100.00     1,361,718        100.00     1,285,890        100.00     1,269,372        100.00     1,013,149        100.00
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Less:

                   

Allowance for loan losses

    12,387          10,896          10,117          11,767          8,561     

Unamortized yield adjustments including net premiums on purchased loans and net deferred loans costs and fees

    1,397          847          1,654          1,021          (564  
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   
    13,784          11,743          11,771          12,788          7,997     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total loans, net

  $ 1,729,084        $ 1,349,975        $ 1,274,119        $ 1,256,584        $ 1,005,152     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

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Loan Maturity Schedule. The following table sets forth the maturities of our loan portfolio at June 30, 2014. Demand loans, loans having no stated maturity and overdrafts are shown as due in one year or less. Loans are stated in the following table at contractual maturity and actual maturities could differ due to prepayments.

 

    Real estate
mortgage:
One- to four-
family
    Real estate
mortgage:
Commercial
   

Commercial
business
   
Home
equity
loans
    Home
equity
lines of
credit
   
Passbook
or
certificate
   


Other
   


Construction
   


Total
 
    (In Thousands)  

Amounts Due:

                 

Within 1 Year

  $ 116      $ 27,314      $ 26,935      $ 328      $ 307      $ 2,172      $ 180      $ 6,784      $ 64,136   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

After 1 year:

                 

1 to 3 years

    2,313        25,689        7,746        2,234        605        196        16        497        39,296   

3 to 5 years

    13,384        52,189        7,304        6,119        2,856        163        1        —          82,016   

5 to 10 years

    57,485        365,274        12,644        20,538        5,113        —          —          —          461,054   

10 to 15 years

    197,164        403,326        7,514        27,450        11,603        —          —          —          647,057   

Over 15 years

    310,150        109,963        5,118        18,942        3,526        1,434        176        —          449,309   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total due after one year

    580,496        956,441        40,326        75,283        23,703        1,793        193        497        1,678,732   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total amount due

  $ 580,612      $ 983,755      $ 67,261      $ 75,611      $ 24,010      $ 3,965      $ 373      $ 7,281      $ 1,742,868   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table shows the dollar amount of loans as of June 30, 2014 due after June 30, 2015 according to rate type and loan category.

 

   

Fixed Rates
    Floating or
Adjustable
Rates
   

Total
 
    (In Thousands)  

Real estate mortgage:

 

One- to four-family

  $ 551,259      $ 29,237      $ 580,496   

Commercial

    415,177        541,264        956,441   

Commercial business

    20,027        20,299        40,326   

Consumer:

 

Home equity loans

    75,283        —          75,283   

Home equity lines of credit

    1,560        22,143        23,703   

Passbook or certificate

    1,432        361        1,793   

Other

    128        65        193   

Construction

    497        —          497   
 

 

 

   

 

 

   

 

 

 

Total

  $ 1,065,363      $ 613,369      $ 1,678,732   
 

 

 

   

 

 

   

 

 

 

One- to Four-Family Mortgage Loans. Our lending activities include the origination of one- to four-family first mortgage loans, of which approximately $548.3 million or 94.5% are secured by properties located within New Jersey and New York as of June 30, 2014 with the remaining $32.2 million or 5.5% secured by properties in other states. Our largest outstanding balance at that date was $1.8 million, which was secured by residential property located in Little Silver, New Jersey and was performing in accordance with its terms.

During the year ended June 30, 2014, Kearny Bank originated $78.2 million of one- to four-family first mortgage loans compared to $65.1 million in the year ended June 30, 2013. To supplement loan originations, we also purchased one- to four-family first mortgages totaling $22.4 million during the year ended June 30, 2014, compared to $16.3 million during the year ended June 30, 2013. In addition to the loans originated and purchased, we also acquired one- to four-family mortgage loans with fair values totaling $72.8 million through our acquisition of Atlas Bank on June 30, 2014. The loans acquired from Atlas Bank included a small portfolio of Non-Income Verification (“NIV”) loans that were granted prior to 2011. Atlas Bank’ NIV loan program did not require the borrower to provide full financial documentation upon application. As such, Atlas Bank relied solely on the loan-to-value ratio of the property and the borrower’s credit when approving an application under this program. The NIV program was terminated by Atlas Bank in 2011. The NIV loans acquired from Atlas Bank on June 30, 2014 had outstanding balances of approximately $17.4 million. All of the NIV loans acquired from Atlas Bank on that date were current and performing as agreed with the exception of one loan with an outstanding balance of $262,000, for which principal and interest are current but certain real estate taxes are delinquent.

In total, origination, purchase and acquisition volume of one- to four-family mortgage loans outpaced loan repayments and sales during fiscal 2014 resulting in a net increase in the outstanding balance of this segment of the loan portfolio.

We will originate a one- to four-family mortgage loan on an owner-occupied property with a principal amount of up to 95% of the lesser of the appraised value or the purchase price of the property, with private mortgage insurance required if the loan-to-value ratio exceeds 80%. At June 30, 2014, one-

 

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to four-family owner-occupied properties comprised 99% of our total one- to four-family loan portfolio. Our loan-to-value limit on a non-owner-occupied property is 75%. Loans in excess of $1.0 million are handled on a case-by-case basis and are subject to lower loan-to-value limits, generally no more than 50%.

Our fixed-rate and adjustable-rate residential mortgage loans on owner-occupied properties have terms of ten to 30 years. Residential mortgage loans on non-owner-occupied properties have terms of up to 15 years for fixed-rate loans and terms of up to 20 years for adjustable-rate loans.

Our adjustable-rate loan products provide for an interest rate that is tied to the one-year Constant Maturity U.S. Treasury index and have terms of up to 30 years with initial fixed-rate periods of one, three, five, seven, or ten years according to the terms of the loan and annual rate adjustment thereafter. We also offer an adjustable-rate loan with a term of up to 30 years with a rate that adjusts every five years to the five-year Constant Maturity U.S. Treasury index. There is a 200 basis point limit on the rate adjustment in any adjustment period and the rate adjustment limit over the life of the loan is 600 basis points.

The Dodd-Frank Act prohibits lenders from making residential mortgages unless the lender makes a reasonable and good faith determination that the borrower has a reasonable ability to repay the mortgage loan according to its terms. A borrower may recover statutory damages equal to all finance charges and fees paid within three years of a violation of the ability-to-repay rule and may raise a violation as a defense to foreclosure at any time. As authorized by the Dodd-Frank Act, the Consumer Financial Protection Bureau (“CFPB”) has adopted regulations defining “qualified mortgages” that would be presumed to comply with the Dodd-Frank Act’s ability-to-repay rules. Under the CFPB regulations, qualified mortgages must satisfy the following criteria: (i) no negative amortization, interest-only payments, balloon payments or a term greater than 30 years; (ii) no points or fees in excess of 3% of the loan amount for loans over $100,000; (iii) borrower’s income and assets are verified and documented; and (iv) the borrower’s debt-to-income ratio generally may not exceed 43%. Qualified mortgages are conclusively presumed to comply with the ability-to-repay rule unless the mortgage is a “higher cost” mortgage, in which case the presumption is rebuttable. Kearny Bank will not grant a non-qualified mortgage loan unless such loan falls under the “temporary qualified mortgage” guidance and there were additional factors to support the exception (which may include a review of the borrower’s creditworthiness and whether a deposit relationship exists).

We offer a first-time homebuyer program for persons who have not previously owned real estate and are purchasing a one- to four-family property in our primary lending area for use as a primary residence. This program is also available outside these areas, but only to persons who are existing deposit or loan customers of Kearny Bank and/or members of their immediate families. The financial incentives offered under this program are a one-eighth of one percentage point rate reduction on all first mortgage loan types and the refund of the application fee at closing.

The fixed-rate residential mortgage loans that we originate generally meet the secondary mortgage market standards of the Federal Home Loan Mortgage Corporation (“Freddie Mac”). However, as our business plan continues to call for increasing total loans on both a dollar and percentage of assets basis, we generally do not sell such loans in the secondary market and do not currently expect to do so in any large capacity in the near future.

Substantially all of our residential mortgages include “due on sale” clauses, which give us the right to declare a loan immediately payable if the borrower sells or otherwise transfers an interest in the property to a third party. Property appraisals on real estate securing our one- to four-family first mortgage loans are made by state certified or licensed independent appraisers approved by Kearny Bank’s Board of Directors. Appraisals are performed in accordance with applicable regulations and policies. We require title insurance policies on all first mortgage real estate loans originated. Homeowners, liability and fire insurance and, if applicable, flood insurance, are also required.

 

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Multi-Family and Nonresidential Real Estate Mortgage Loans. We also originate commercial mortgage loans on multi-family and nonresidential properties, including loans on apartment buildings, retail/service properties and land as well as other income-producing properties, such as mixed-use properties combining residential and commercial space. Our growing strategic emphasis in commercial lending resulted in the origination of approximately $334.4 million of multi-family and commercial real estate mortgages during the year ended June 30, 2014, compared to $271.1 million during the year ended June 30, 2013. Our largest outstanding commercial mortgage loan balance at June 30, 2014 was $19.9 million, which is secured by a multi-family apartment building and performing in accordance with its terms.

Our commercial mortgage acquisition strategies also included purchases of loan participations totaling $87.0 million and $1.5 million during the years ended June 30, 2014 and 2013, respectively. Additionally, we acquired commercial mortgage loans with fair values totaling $5.7 million through our acquisition of Atlas Bank on June 30, 2014.

In total, commercial mortgage loan acquisition volume significantly outpaced loan repayments during fiscal 2014 resulting in the reported net increase in the outstanding balance of this segment of the loan portfolio. Our business plan continues to call for maintaining our strategic emphasis on the origination of commercial mortgages and increasing this segment of the portfolio on both a dollar and percentage of assets basis.

We generally require no less than a 25% down payment or equity position for mortgage loans on multi-family and nonresidential properties. For such loans, we generally require personal guarantees. Currently, these loans are made with a maturity of up to 25 years. We also offer a five-year balloon loan with a twenty-five year amortization schedule. Our commercial mortgage loans are generally secured by properties located in New Jersey and New York.

Commercial mortgage loans are generally considered to entail a greater level of risk than that which arises from one- to four-family, owner-occupied real estate lending. The repayment of these loans typically is dependent on a successful operation and income stream of the borrower and the real estate securing the loan as collateral. These risks can be significantly affected by economic conditions. In addition, commercial mortgage loans generally carry larger balances to single borrowers or related groups of borrowers than one- to four-family mortgage loans. Consequently, such loans typically require substantially greater evaluation and oversight efforts compared to residential real estate lending.

Commercial Business Loans. We also originate commercial term loans and lines of credit to a variety of professionals, sole proprietorships and small businesses in our market area including loans originated through the SBA in which Kearny Bank participates as a Preferred Lender. Kearny Bank originated approximately $24.1 million of commercial business loans during the year ended June 30, 2014 compared to $21.5 million during the year ended June 30, 2013. Our largest outstanding commercial business loan balance at June 30, 2014 was $6.7 million, which was secured by a hotel. This loan was performing in accordance with its original terms at June 30, 2014.

Our commercial business loan acquisition strategies were expanded during fiscal 2014 resulting in the purchase of C&I loan participations totaling $4.9 million during the year ended June 30, 2014. No such participations were purchased during fiscal 2013. The outstanding balance of our C&I loan participations at June 30, 2014 totaled $4.9 million comprising four loans acquired through Kearny Bank’s membership in BancAlliance, a cooperative network of lending institutions that serves as a

 

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conduit for institutional investors to participate in large commercial credits. The BancAlliance network is supported and managed on a day-to-day basis by Alliance Partners and its wholly-owned subsidiary AP Commercial LLC which acts as investment advisor and asset manager for loans acquired through the BancAlliance network while retaining a portion of such loans as an investor.

In total, commercial business loan repayments and sales outpaced loan acquisition volume during fiscal 2014 resulting in the modest decline in the outstanding balance reported for this segment of the loan portfolio. As a complement to our commercial mortgage strategies, our business plan calls for expanding our strategic emphasis on the acquisition of commercial business loans through both retail origination channels as well as purchases and participations acquired though wholesale sources with the goal of increasing this portfolio on both a dollar and percentage of assets basis.

Our commercial business loan activity during fiscal 2014 included the sale of $737,000 of SBA loan participations which resulted in the recognition of related sale gains totaling approximately $80,000 for the year ended June 30, 2014. By comparison, we sold $4.8 million of SBA loan participations during fiscal 2013 which resulted in the recognition of related sale gains totaling approximately $557,000. Notwithstanding the recent decline in SBA loan origination and sale activity, our business plan calls for an increase in SBA lending activity from the levels reported during fiscal 2014. Toward that end, we are currently evaluating our SBA lending function and expect to restructure that function in the coming year with a commitment and expectation for an increase in SBA loan origination and sale activity during fiscal 2015.

Approximately $57.8 million or 85.9% of our commercial business loans are “non-SBA” loans. Of these loans, approximately $54.3 million or 93.9% represent secured loans that are primarily collateralized by real estate or, to a lesser extent, other forms of collateral. The remaining $3.5 million or 6.1% represent unsecured loans to our business customers. We generally require personal guarantees on all “non-SBA” commercial business loans. Marketable securities may also be accepted as collateral on lines of credit, but with a loan to value limit of 50%. The loan to value limit on secured commercial lines of credit and term loans is otherwise generally limited to 70%. We also make unsecured commercial loans in the form of overdraft checking authorization up to $25,000 and unsecured lines of credit up to $25,000. Our “non-SBA” commercial term loans generally have terms of up to 20 years and are mostly fixed-rate loans. Our commercial lines of credit have terms of up to two years and are generally adjustable-rate loans. We also offer a one-year, interest-only commercial line of credit with a balloon payment.

The remaining $9.5 million or 14.1% of commercial business loans represent the retained portion of SBA loan originations. Such loans are generally secured by various forms of collateral, including real estate, business equipment and other forms of collateral. Kearny Bank generally sells the guaranteed portion of eligible SBA loans originated, which ranges from 50% to 90% of the loan’s outstanding balance while retaining the nonguaranteed portion of such loans in portfolio. Kearny Bank also retains both the guaranteed and non-guaranteed portion of those SBA originations that are generally ineligible for sale in the secondary market. At June 30, 2014, approximately $2.2 million of the retained portion of Kearny Bank’s SBA loans is guaranteed by the Small Business Administration.

Unlike single-family, owner-occupied residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans, including those originated under SBA programs, are typically made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself and the general economic environment. Commercial business loans, therefore, generally have greater credit risk than residential mortgage loans. In addition, commercial

 

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business loans may carry larger balances to single borrowers or related groups of borrowers than one- to four-family first mortgage loans. As such, commercial business lending requires substantially greater evaluation and oversight efforts compared to residential or commercial real estate lending.

Home Equity Loans and Lines of Credit. Our home equity loans are fixed-rate loans for terms of generally up to 20 years. We also offer fixed-rate and adjustable-rate home equity lines of credit with terms of up to 20 years. Kearny Bank originated $29.0 million of home equity loans and home equity lines of credit compared to $26.1 million in the year ended June 30, 2013. However, repayments of home equity loans and lines of credit outpaced loan acquisition volume during fiscal 2014 resulting in the reported net decline in the outstanding balance of this segment of the loan portfolio. Our largest outstanding home equity loan and line of credit balance at June 30, 2014 was $470,000, which was secured by a single family residence located in Ocean, New Jersey and performing in accordance with its terms.

Collateral value is determined through a property value analysis report provided by a state certified or licensed independent appraiser. In some cases, we determine collateral value by a full appraisal performed by a state certified or licensed independent appraiser. Home equity loans and lines of credit do not require title insurance but do require homeowner, liability and fire insurance and, if applicable, flood insurance.

Home equity loans and fixed-rate home equity lines of credit are generally originated in our market area and are generally made in amounts of up to 80% of value on term loans and of up to 75% of value on home equity adjustable-rate lines of credit. We originate home equity loans secured by either a first lien or a second lien on the property.

Account Loans and Other Consumer Loans. In addition to home equity loans and lines of credit, our consumer loan portfolio primarily includes loans secured by savings accounts and certificates of deposit on deposit with Kearny Bank and overdraft lines of credit as well as vehicle loans and personal loans. We will generally lend up to 90% of the account balance on a loan secured by a savings account or certificate of deposit. At June 30, 2014, passbook or certificate loans totaled $4.0 million and other consumer loans totaled $373,000. Our largest outstanding passbook or certificate loan balance was $225,000, which was secured by a certificate of deposit and performing in accordance with its terms. At June 30, 2014, our largest other consumer loan balance at that date was $40,000, which was unsecured and performing in accordance with its terms.

Consumer loans entail greater risks than residential mortgage loans, particularly consumer loans that are unsecured. Consumer loan repayment is dependent on the borrower’s continuing financial stability and is more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. The application of various federal laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on consumer loans in the event of a default.

Our underwriting standards for consumer loans include a determination of the applicant’s credit history and an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment and any additional verifiable secondary income.

Construction Lending. Our construction lending includes loans to individuals for construction of one- to four-family residences or for major renovations or improvements to an existing dwelling. Our construction lending also includes loans to builders and developers for multi-unit buildings or multi-house projects. At June 30, 2014, construction loans totaled $7.3 million. Our largest construction loan balance at that date was $1.3 million, which was secured by a residential property and performing in accordance with its terms.

 

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During the year ended June 30, 2014, construction loan disbursements were $3.8 million compared to $3.0 million during the year ended June 30, 2013. However, the repayment of construction loans more than offset these disbursements during fiscal 2014 resulting in the reported net decline in the outstanding balance of this segment of the loan portfolio.

Construction borrowers must hold title to the land free and clear of any liens. Financing for construction loans is limited to 80% of the anticipated appraised value of the completed property. Disbursements are made in accordance with inspection reports by our approved appraisal firms. Terms of financing are generally limited to one year with an interest rate tied to the prime rate published in the Wall Street Journal and may include a premium of one or more points. In some cases, we convert a construction loan to a permanent mortgage loan upon completion of construction.

We have no formal limits as to the number of projects a builder has under construction or development and make a case-by-case determination on loans to builders and developers who have multiple projects under development. The Board of Directors reviews Kearny Bank’s business relationship with a builder or developer prior to accepting a loan application for processing. We generally do not make construction loans to builders on a speculative basis. There must be a contract for sale in place. Financing is provided for up to two houses at a time in a multi-house project, requiring a contract on one of the two houses before financing for the next house may be obtained.

Construction lending is generally considered to involve a higher degree of credit risk than mortgage lending. If the initial estimate of construction cost proves to be inaccurate, we may be compelled to advance additional funds to complete the construction with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If we are forced to foreclose on a project prior to completion, there is no assurance that we will be able to recover the entire unpaid portion of the loan. In addition, we may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period.

Loans to One Borrower. Federal law generally limits the amount that a savings institution may lend to one borrower to the greater of $500,000 or 15% of the institution’s unimpaired capital and surplus. Accordingly, as of June 30, 2014, our loans-to-one-borrower limit was approximately $54.5 million.

At June 30, 2014, our largest single borrower had an aggregate outstanding loan balance of approximately $25.4 million comprising eight commercial mortgage loans. Our second largest single borrower had an aggregate outstanding loan balance of approximately $24.7 million comprising three commercial mortgage loans. Our third largest borrower had an aggregate outstanding loan balance of approximately $24.5 million comprising four commercial mortgage loans and two commercial business lines of credit with an additional $6.0 million available to the borrower through the unused portions of those lines of credit. At June 30, 2014, all of these lending relationships were current and performing in accordance with the terms of their loan agreements. By comparison, at June 30, 2013, loans outstanding to Kearny Bank’s three largest borrowers totaled approximately $20.1 million, $18.2 million and $12.6 million, respectively.

 

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Loan Originations, Purchases, Sales, Solicitation and Processing. The following table shows total loans originated, purchased, acquired and repaid during the periods indicated.

 

     For the Years Ended June 30,  
     2014     2013     2012  
     (In Thousands)  

Loans originated and purchased:

      

Loan originations:

      

Real estate mortgage:

      

One- to four-family

   $ 78,249      $ 65,051      $ 66,456   

Commercial

     334,369        271,109        95,534   

Commercial business

     24,062        21,546        17,968   

Construction

     3,802        2,953        12,004   

Consumer:

      

Home equity loans and lines of credit

     29,021        26,070        35,741   

Passbook or certificate

     1,330        1,492        2,740   

Other

     937        446        504   
  

 

 

   

 

 

   

 

 

 

Total loan originations

     471,770        388,667        230,947   
  

 

 

   

 

 

   

 

 

 

Loan purchases:

      

Real estate mortgage:

      

One- to four-family

     22,429        16,288        22,185   

Multi-family and commercial

     87,000        1,485        57,829   

Commercial business

     4,914        —          —     
  

 

 

   

 

 

   

 

 

 

Total loans purchased

     114,343        17,773        80,014   
  

 

 

   

 

 

   

 

 

 

Loans acquired from Atlas(1)

     78,725        2        —     
  

 

 

   

 

 

   

 

 

 

Loans sold:

      

One- to four-family

     (5,275     —          —     

Commercial SBA participations

     (737     (4,775     (6,462
  

 

 

   

 

 

   

 

 

 

Total loans sold

     (6,012     (4,775     (6,462
  

 

 

   

 

 

   

 

 

 

Loan principal repayments

     (281,711     (322,187     (280,578
  

 

 

   

 

 

   

 

 

 

Increase (decrease) due to other items

     1,994        (3,622     (6,386
  

 

 

   

 

 

   

 

 

 

Net increase in loan portfolio

   $ 379,109      $ 75,856      $ 17,535   
  

 

 

   

 

 

   

 

 

 

 

(1) For information on loans acquired in the Atlas Bank acquisition, see Note 2 to the audited consolidated financial statements.

Our customary sources of loan applications include loans originated by our commercial and residential loan officers, repeat customers, referrals from realtors and other professionals and “walk-in” customers. These sources are supported in varying degrees by our newspaper and electronic advertising and marketing strategies.

During prior years, we had purchased loans under the terms of loan purchase and servicing agreements with three large nationwide lenders, in order to supplement our residential mortgage loan production pipeline. The original agreements called for the purchase of loan pools that contained mortgages on residential properties in our lending area. Subsequently, we expanded our loan purchase and servicing agreements with the same nationwide lenders to include mortgage loans secured by residential real estate located outside of New Jersey. We have procedures in place for purchasing these mortgages such that the underwriting guidelines are consistent with those used in our in-house loan origination process. The evaluation and approval process ensures that the purchased loans generally conform to our normal underwriting guidelines. Our due diligence process includes full credit reviews and an examination of the title policy and associated legal instruments. We recalculate debt service and loan-to-value ratios for accuracy and review appraisals for reasonableness. All loan packages presented to Kearny Bank must meet our underwriting requirements as outlined in the purchase and servicing agreements and are subject to the same review process outlined above. Furthermore, there are stricter

 

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underwriting guidelines in place for out-of-state mortgages, including higher minimum credit scores. We did not purchase residential mortgage loans under the noted purchase and servicing agreements during the year ended June 30, 2014 but may do so in the future.

Once we purchase the loans, we continually monitor the seller’s performance by thoroughly reviewing portfolio balancing reports, remittance reports, delinquency reports and other data supplied to us on a monthly basis. We also review the seller’s financial statements and documentation as to their compliance with the servicing standards established by the Mortgage Bankers Association of America.

As of June 30, 2014, our portfolio of “out-of-state” residential mortgages includes loans located in 14 states outside of New Jersey and New York that total approximately $32.2 million or 5.5% of one- to four-family mortgage loans. The states with the three largest concentrations of such loans at June 30, 2014 were Massachusetts, Pennsylvania and Georgia, with outstanding principal balances totaling $10.7 million, $7.1 million and $2.9 million, respectively. The aggregate outstanding balances of loans in each of the remaining 11 states comprise approximately 35.5% of the total balance of out-of-state residential mortgage loans with aggregate balances by state ranging from $298,000 to $2.0 million.

We also enter into purchase agreements with a limited number of mortgage originators to supplement our loan production pipeline. These agreements call for the purchase, on a flow basis, of one- to four-family first mortgage loans with servicing released to Kearny Bank. During the year ended June 30, 2014, we purchased fixed-rate and adjustable-rate loans with principal balances totaling $22.4 million from these sellers.

In addition to purchasing one- to four-family loans, we have also purchased participations in commercial mortgage loans originated by other banks and non-bank originators. Our commercial loan acquisitions included the purchase of participations totaling $87.0 million during the year ended June 30, 2014. As of that date, the number and aggregate outstanding balance of commercial loan participations totaled 35 and $131.8 million, respectively, representing loans on a variety of multi-family and commercial real estate properties.

The participations noted above exclude those acquired through the Thrift Institutions Community Investment Corporation of New Jersey (“TICIC”), a subsidiary of the New Jersey Bankers Association that is no longer actively originating loans. At June 30, 2014, our remaining TICIC participations included a total of 18 loans with an aggregate balance of $3.1 million representing loans on multi-family and commercial real estate properties.

Loan Approval Procedures and Authority. Senior management recommends and the Board of Directors approves our lending policies and loan approval limits. Kearny Bank’s Loan Committee consists of the Chief Lending Officer, Chief Credit Officer, Divisional President and Special Assets Manager. The Committee may approve loans up to $5.0 million. Our Chief Lending Officer may approve loans up to $750,000. Loan department personnel of Kearny Bank serving in the following positions may approve loans as follows: commercial/mortgage loan managers, mortgage loans up to $500,000; mortgage loan underwriters, mortgage loans up to $250,000; consumer loan managers, consumer loans up to $250,000; and consumer loan underwriters, consumer loans up to $150,000. In addition to these principal amount limits, there are established limits for different levels of approval authority as to minimum credit scores and maximum loan to value ratios and debt to income ratios or debt service coverage. Our Chief Executive Officer and Chief Operating Officer have authorization to countersign loans for amounts that exceed $750,000 up to a limit of $1.0 million. Our Chief Lending Officer must approve loans between $750,000 and $1.0 million along with one of these designated officers. Non-conforming mortgage loans and loans over $1.0 million up to $2.0 million require the approval of the Loan Committee. Commercial loans in excess of $5.0 million require approval by the Board of Directors while such approval is also required for residential mortgage loans in excess of $2.0 million and commercial business loans in excess of $500,000.

 

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Asset Quality

Collection Procedures on Delinquent Loans. We regularly monitor the payment status of all loans within our portfolio and promptly initiate collection efforts on past due loans in accordance with applicable policies and procedures. Delinquent borrowers are notified by both mail and telephone when a loan is 30 days past due. If the delinquency continues, subsequent efforts are made to contact the delinquent borrower and additional collection notices and letters are sent. All reasonable attempts are made to collect from borrowers prior to referral to an attorney for collection. However, when a loan is 90 days delinquent, it is our general practice to refer it to an attorney for repossession, foreclosure or other form of collection action, as appropriate. In certain instances, we may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his or her financial affairs and we attempt to work with the borrower to establish a repayment schedule to cure the delinquency.

As to mortgage loans, if a foreclosure action is taken and the loan is not reinstated, paid in full or refinanced, the property is sold at judicial sale at which we may be the buyer if there are no adequate offers to satisfy the debt. Any property acquired as the result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until it is sold or otherwise disposed of. When real estate owned is acquired, it is recorded at its fair market value less estimated selling costs. The initial write-down of the property, if necessary, is charged to the allowance for loan losses. Adjustments to the carrying value of the properties that result from subsequent declines in value are charged to operations in the period in which the declines are identified.

Past Due Loans. A loan’s “past due” status is generally determined based upon its “P&I delinquency” status in conjunction with its “past maturity” status, where applicable. A loan’s “P&I delinquency” status is based upon the number of calendar days between the date of the earliest P&I payment due and the “as of” measurement date. A loan’s “past maturity” status, where applicable, is based upon the number of calendar days between a loan’s contractual maturity date and the “as of” measurement date. Based upon the larger of these criteria, loans are categorized into the following “past due” tiers for financial statement reporting and disclosure purposes: Current (including 1-29 days past due), 30-59 days, 60-89 days and 90 or more days.

Nonaccrual Loans. Loans are generally placed on nonaccrual status when contractual payments become 90 days or more past due, and are otherwise placed on nonaccrual when we do not expect to receive all P&I payments owed substantially in accordance with the terms of the loan agreement. Loans that become 90 days past maturity, but remain non-delinquent with regard to ongoing P&I payments, may remain on accrual status if: (1) we expect to receive all P&I payments owed substantially in accordance with the terms of the loan agreement, past maturity status notwithstanding, and (2) the borrower is working actively and cooperatively with us to remedy the past maturity status through an expected refinance, payoff or modification of the loan agreement that is not expected to result in a troubled debt restructuring (“TDR”) classification. All TDRs are placed on nonaccrual status for a period of no less than six months after restructuring, irrespective of past due status. The sum of nonaccrual loans plus accruing loans that are 90 days or more past due are generally defined as “nonperforming loans.”

Payments received in cash on nonaccrual loans, including both the principal and interest portions of those payments, are generally applied to reduce the carrying value of the loan for financial statement purposes. When a loan is returned to accrual status, any accumulated interest payments previously applied to the carrying value of the loan during its nonaccrual period are recognized as interest income as an adjustment to the loan’s yield over its remaining term.

 

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Loans that are not considered to be TDRs are generally returned to accrual status when payments due are brought current and we expect to receive all remaining P&I payments owed substantially in accordance with the terms of the loan agreement. Non-TDR loans may also be returned to accrual status when a loan’s payment status falls below 90 days past due and we: (1) expect receipt of the remaining past due amounts within a reasonable timeframe, and (2) expect to receive all remaining P&I payments owed substantially in accordance with the terms of the loan agreement.

Nonperforming Assets. The following table provides information regarding Kearny Bank’s nonperforming assets which are comprised of nonaccrual loans, accruing loans 90 days or more past due and real estate owned.

 

     At June 30,  
     2014     2013     2012     2011     2010  
     (Dollars in Thousands)  

Loans accounted for on a nonaccrual basis:

          

Real estate mortgage:

          

One- to four-family(1)

   $ 9,944      $ 11,675      $ 14,917      $ 4,056      $ 1,867   

Commercial

     6,935        10,163        11,008        7,429        4,358   

Commercial business

     4,919        4,836        3,941        4,866        2,298   

Consumer:

          

Home equity loans

     949        703        984        204        250   

Home equity lines of credit

     981        626        193        93        —     

Other

     2        28        6        22        1   

Construction

     1,448        2,886        1,758        1,654        468   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total(2)

     25,178        30,917        32,807        18,324        9,242   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accruing loans which are contractually past due 90 days or more:

          

Real estate mortgage:

          

One- to four-family

     —          —          —          14,923        12,321   

Multi-family and commercial

     —          —          398        —          —     

Commercial business

     —          —          293        1,718        —     

Consumer:

          

Home equity loans and lines of credit

     —          —          —          —          —     

Passbook or certificate

     —          —          —          —          —     

Other

     125        —          —          —          —     

Construction

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     125        —          691        16,641        12,321   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

   $ 25,303      $ 30,917      $ 33,498      $ 34,965      $ 21,563   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Real estate owned

   $ 1,624      $ 2,061      $ 3,811      $ 7,497      $ 146   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 26,927      $ 32,978      $ 37,309      $ 42,462      $ 21,709   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans to total loans

     1.45     2.27     2.61     2.76     2.13
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans to total assets

     0.72     0.98     1.14     1.20     0.92
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets to total assets

     0.77     1.05     1.27     1.46     0.93
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) At June 30, 2014, included $8.4 million of nonperforming one- to four-family mortgage loans acquired from Countrywide.
(2) TDRs on accrual status not included above totaled $3.3 million, $4.1 million, $2.6 million, $821,000 and $945,000 at June 30, 2014, 2013, 2012, 2011 and 2010, respectively.

Total nonperforming assets decreased by $6.1 million to $26.9 million at June 30, 2014 from $33.0 million at June 30, 2013. The decrease comprised a net decline in nonperforming loans of $5.6 million plus a net decrease in real estate owned of $437,000. For those same comparative periods, the number of nonperforming loans increased to 133 loans from 127 loans while the number of real estate owned properties decreased to seven from eight.

 

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At June 30, 2014, nonperforming loans comprised $25.2 million of “nonaccrual” loans and $125,000 of loans being reported as “accruing loans over 90 days past due.” By comparison, at June 30, 2013, nonperforming loan comprised $30.9 million of “nonaccrual” loans with no loans being reported as “accruing loans over 90 days past due.”

A significant portion of the non-performing loans reported as “accruing loans over 90 days past due” prior to fiscal 2012 were originally acquired from Countrywide Home Loans, Inc. (“Countrywide”) and continue to be serviced by their acquirer, Bank of America (“BOA”) through a subsidiary, BAC Home Loans Servicing. In accordance with our agreement, BOA advances scheduled principal and interest payments to Kearny Bank when such payments are not made by the borrower. Prior to fiscal 2012, the timely receipt of principal and interest from the servicer resulted in such loans retaining their accrual status. However, the delinquency status reported for these nonperforming loans reflected the borrower’s actual delinquency irrespective of Kearny Bank’s receipt of advances. In recognition that advances would ultimately be recouped by BOA from Kearny Bank in the event the borrower did not reinstate the loan, we included our obligation to refund such advances to the servicer, where applicable, in our impairment analyses of such loans.

Notwithstanding this prior practice, Kearny Bank reclassified the applicable nonperforming BOA loans from “accruing loans over 90 days past due” to “nonaccrual” during fiscal 2012. Since that time, interest payments received on the applicable BOA loans have been applied to reduce the carrying value of the loan for financial statement purposes rather than being recognized as interest income.

Nonperforming one- to four-family mortgage loans at June 30, 2014 include 48 nonaccrual loans totaling $9.9 million whose net outstanding balances range from $10,000 to $490,000, with an average balance of approximately $207,000 as of that date. The loans are in various stages of collection, workout or foreclosure. Of these loans, 44 are secured by New Jersey properties while an additional four loans acquired from Atlas Bank are secured by properties located in Staten Island, New York. We have identified approximately $528,000 of specific impairment relating to six of the nonperforming loans for which valuation allowances are maintained in the allowance for loan losses at June 30, 2014.

The number and balance of nonperforming one- to four-family mortgage loans at June 30, 2014 includes 36 loans totaling $8.4 million that were originally acquired from Countrywide with such loans comprising 33.2% of total nonperforming loans as of June 30, 2014. As of that same date, Kearny Bank owned a total of 77 residential mortgage loans with an aggregate outstanding balance of $33.3 million that were originally acquired from Countrywide. Of these loans, an additional two accruing loans totaling $866,000 are 30-89 days past due and are in various stages of collection.

Nonperforming commercial real estate loans, including multi-family and nonresidential mortgage loans, include 19 nonaccrual loans totaling $6.9 million. At June 30, 2014, the outstanding balances of these loans range from $27,000 to $1.5 million with an average balance of approximately $365,000 as of that date. The loans are in various stages of collection, workout or foreclosure and are secured by New Jersey properties. We have identified approximately $569,000 of specific impairment relating to six of these nonperforming loans for which valuation allowances are maintained in the allowance for loan losses at June 30, 2014.

Nonperforming commercial business loans at June 30, 2014 include 37 nonaccrual loans totaling $4.9 million. At June 30, 2014, the outstanding balances of these loans range from $6,000 to $820,000 with an average balance of approximately $133,000 as of that date. The loans are in various stages of collection, workout or foreclosure and are primarily secured by New Jersey and New York properties and,

 

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to a lesser extent, other forms of collateral. We have identified approximately $444,000 of specific impairment relating to 12 of these nonperforming loans for which valuation allowances are maintained in the allowance for loan losses at June 30, 2014.

Home equity loans and home equity lines of credit that are reported as nonperforming at June 30, 2014 include 22 nonaccrual loans totaling $1.9 million. At June 30, 2014, the outstanding balances of these loans range from $8,000 to $459,000 with an average balance of approximately $88,000 as of that date. The loans are in various stages of collection, workout or foreclosure and are primarily secured by New Jersey properties. We have identified approximately $132,000 of specific impairment relating to three of these nonperforming loans for which valuation allowances are maintained in the allowance for loan losses at June 30, 2014.

Other consumer loans that are reported as nonperforming include two unsecured nonaccrual loans totaling $2,000 and one accruing loan over 90 days past due totaling $125,000 that is fully secured by cash on deposit at Kearny Bank.

Nonperforming construction loans include four nonaccrual loans totaling $1.4 million. At June 30, 2014, the outstanding balances of these loans ranged from $355,000 to $596,000 with an average balance of approximately $362,000 as of that date. The loans are in various stages of collection, workout or foreclosure and are secured by New Jersey properties in varying stages of development. We have identified no specific impairment relating to these nonperforming loans at June 30, 2014.

During the years ended June 30, 2014, 2013 and 2012, gross interest income of $1.8 million, $2.1 million and $1.7 million, respectively, would have been recognized on loans accounted for on a nonaccrual basis if those loans had been current. Interest income recognized on such loans of $52,000, $46,000 and $134,000 was included in income for the years ended June 30, 2014, 2013 and 2012, respectively.

At June 30, 2014, 2013, and 2012, Kearny Bank had loans with aggregate outstanding balances totaling $6.4 million, $9.4 million, and $6.7 million, respectively, reported as troubled debt restructurings.

During the year ended June 30, 2014, gross interest income of $321,000 would have been recognized on loans reported as troubled debt restructurings under their original terms prior to restructuring. Actual interest income of $259,000 was recognized on such loans for the year ended June 30, 2014 reflecting the interest received under the revised terms of those restructured loans.

During the year ended June 30, 2013, gross interest income of $303,000 would have been recognized on loans reported as troubled debt restructurings under their original terms prior to restructuring. Actual interest income of $250,000 was recognized on such loans for the year ended June 30, 2013 reflecting the interest received under the revised terms of those restructured loans.

Loan Review System. We maintain a loan review system consisting of several related functions including, but not limited to, classification of assets, calculation of the allowance for loan losses, independent credit file review as well as internal audit and lending compliance reviews. We utilize both internal and external resources, where appropriate, to perform the various loan review functions. For example, we have engaged the services of a third party firm specializing in loan review and analysis to perform several loan review functions. The firm reviews the loan portfolio in accordance with the scope and frequency determined by senior management and the Asset Quality Committee of the Board of Directors. The third party loan review firm assists senior management and the Board of Directors in identifying potential credit weaknesses; in appropriately grading or adversely classifying loans; in identifying relevant trends that affect the collectability of the portfolio and identifying segments of the

 

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portfolio that are potential problem areas; in verifying the appropriateness of the allowance for loan losses; in evaluating the activities of lending personnel including compliance with lending policies and the quality of their loan approval, monitoring and risk assessment; and by providing an objective assessment of the overall quality of the loan portfolio. Currently, independent loan reviews are being conducted quarterly and include non-performing loans as well as samples of performing loans of varying types within our portfolio.

Our loan review system also includes the internal audit and compliance functions, which operate in accordance with a scope determined by the Audit and Compliance Committee of the Board of Directors. Internal audit resources assess the adequacy of, and adherence to, internal credit policies and loan administration procedures. Similarly, our compliance resources monitor adherence to relevant lending-related and consumer protection-related laws and regulations. The loan review system is structured in such a way that the internal audit function maintains the ability to independently audit other risk monitoring functions without impairing its independence with respect to these other functions.

As noted, the loan review system also comprises our policies and procedures relating to the regulatory classification of assets and the allowance for loan loss functions each of which are described in greater detail below.

Classification of Assets. In compliance with the regulatory guidelines, our loan review system includes an evaluation process through which certain loans exhibiting adverse credit quality characteristics are classified “Special Mention”, “Substandard”, “Doubtful” or “Loss”.

An asset is classified as “Substandard” if it is inadequately protected by the paying capacity and net worth of the obligor or the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Assets classified as “Doubtful” have all of the weaknesses inherent in those classified as “Substandard”, with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions and values. Assets, or portions thereof, classified as “Loss” are considered uncollectible or of so little value that their continuance as assets is not warranted.

Management evaluates loans classified as substandard or doubtful for impairment in accordance with applicable accounting requirements. As discussed in greater detail below, a valuation allowance is established through the provision for loan losses for any impairment identified through such evaluations. To the extent that impairment identified on a loan is classified as “Loss”, that portion of the loan is charged off against the allowance for loan losses.

Prior to fiscal 2012, our impaired loans with impairment were characterized by “split classifications” (e.g. Substandard/Loss) with all loan impairment being ascribed a “Loss” classification by default and charge-offs being recorded against the allowance for loan loss at the time such losses were realized. For loans primarily secured by real estate, which have historically comprised a large majority of our loan portfolio, the recognition of impairments as “charge offs” typically coincided with the foreclosure of the property securing the impaired loan at which time the property was brought into real estate owned at its fair value, less estimated selling costs, and any portion of the loan’s carrying value in excess of that amount was charged off against the allowance for loan losses (“ALLL”).

During fiscal 2012, we modified our loan classification and charge off practices to more closely align them to those of other institutions regulated by the OCC. The OCC succeeded the OTS as Kearny Bank’s primary regulator effective July 21, 2011. As a result of those changes, the classification of loan impairment as “Loss” is now based upon a confirmed expectation for loss, rather than simply equating

 

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impairment with a “Loss” classification by default. For loans primarily secured by real estate, the expectation for loss is generally confirmed when: (a) impairment is identified on a loan individually evaluated in the manner described below, and (b) the loan is presumed to be collateral-dependent such that the source of loan repayment is expected to arise solely from sale of the collateral securing the applicable loan. Impairment identified on non-collateral-dependent loans may or may not be eligible for a “Loss” classification depending upon the other salient facts and circumstances that affect the manner and likelihood of loan repayment. As a further result of these changes, loan impairment that is classified as “Loss” is now charged off against the ALLL concurrent with that classification rather than deferring the charge off of confirmed expected losses until they are realized as had been Kearny Bank’s practice prior to fiscal 2012.

The timeframe between when we first identify loan impairment and when such impairment may ultimately be charged off varies by loan type. For example, unsecured consumer and commercial loans are generally classified as “Loss” at 120 days past due, resulting in their outstanding balances being charged off at that time. For our secured loans, the condition of collateral dependency, as noted above, generally serves as the basis upon which a “Loss” classification is ascribed to a loan’s impairment thereby confirming an expected loss and triggering charge off of that impairment.

While the facts and circumstances that effect the manner and likelihood of repayment vary from loan to loan, we generally consider the referral of a loan to foreclosure, coupled with the absence of other viable sources of loan repayment, to be demonstrable evidence of collateral dependency. Depending upon the nature of the collections process applicable to a particular loan, an early determination of collateral dependency could result in a nearly concurrent charge off of a newly identified impairment. By contrast, a presumption of collateral dependency may only be determined after the completion of lengthy loan collection and/or workout efforts, including bankruptcy proceedings, which may extend several months or more after a loan’s impairment is first identified.

The adoption of this change to our charge off practices during fiscal 2012 resulted in the charge off of approximately $4.2 million of confirmed expected losses during that year for which valuation allowances had been previously established for identified impairments. Thereafter, the recognition of charge offs based upon confirmed expected losses rather than realized losses has generally accelerated the timing of their recognition compared to prior years.

In a limited number of cases, the entire net carrying value of a loan may be determined to be impaired based upon a collateral-dependent impairment analysis. However, the borrower’s adherence to contractual repayment terms precludes the recognition of a “Loss” classification and charge off. In these limited cases, a valuation allowance equal to 100% of the impaired loan’s carrying value may be maintained against the net carrying value of the asset.

Assets which do not currently expose us to a sufficient degree of risk to warrant an adverse classification but have some credit deficiencies or other potential weaknesses are designated as “Special Mention” by management. Adversely classified assets, together with those rated as “Special Mention”, are generally referred to as “Classified Assets”. Non-classified assets are internally rated within one of four “Pass” categories or as “Watch” with the latter denoting a potential deficiency or concern that warrants increased oversight or tracking by management until remediated.

Management performs a classification of assets review, including the regulatory classification of assets, generally on a monthly basis. The results of the classification of assets review are validated by our third party loan review firm during their quarterly independent review. In the event of a difference in rating or classification between those assigned by the internal and external resources, we will generally utilize the more critical or conservative rating or classification. Final loan ratings and regulatory classifications are presented monthly to the Board of Directors and are reviewed by regulators during the examination process.

 

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The following table discloses our designation of certain loans as special mention or adversely classified during each of the five years presented.

 

     At June 30,  
     2014      2013      2012      2011      2010  
     (In Thousands)  

Special Mention

   $ 12,258       $ 14,050       $ 20,297       $ 11,141       $ 10,353   

Substandard

     41,564         43,371         48,131         39,093         18,697   

Doubtful

     290         391         892         614         —     

Loss (1)

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 54,112       $ 57,812       $ 69,320       $ 50,848       $ 29,050   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Net of specific valuation allowances where applicable

At June 30, 2014, 48 loans were classified as Special Mention and 180 loans were classified as Substandard. As of that same date, four loans were classified as Doubtful. As noted above, all loans, or portions thereof, classified as Loss during fiscal 2014 were charged off against the allowance for loan losses.

Allowance for Loan Losses. Our allowance for loan loss calculation methodology utilizes a “two-tier” loss measurement process that is generally performed monthly. Based upon the results of the classification of assets and credit file review processes described earlier, we first identify the loans that must be reviewed individually for impairment. Factors considered in identifying individual loans to be reviewed include, but may not be limited to, loan type, classification status, contractual payment status, performance/accrual status and impaired status.

Prior to fiscal 2011, the loans we considered to be eligible for individual impairment review were generally limited to our larger and/or more complex loans including our commercial mortgage loans, comprising multi-family and nonresidential real estate loans, as well as our construction loans and commercial business loans. During fiscal 2011, we expanded the scope of loans that we consider eligible for individual impairment review to also include one- to four-family mortgage loans, home equity loans and home equity lines of credit with such loans being reviewed individually for impairment, where applicable, since that time.

A reviewed loan is deemed to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Once a loan is determined to be impaired, management performs an analysis to determine the amount of impairment associated with that loan.

In measuring the impairment associated with collateral-dependent loans, the fair value of the collateral securing the loan is generally used as a measurement proxy for that of the impaired loan itself as a practical expedient. In the case of real estate collateral, such values are generally determined based upon a discounted market value obtained through an automated valuation module or prepared by a qualified, independent real estate appraiser. The value of non-real estate collateral is similarly determined based upon the independent assessment of fair market value by a qualified resource.

We generally obtain independent appraisals on properties securing mortgage loans when such loans are initially placed on nonperforming or impaired status with such values updated approximately

 

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every six to twelve months thereafter throughout the collections, bankruptcy and/or foreclosure processes. Appraised values are typically updated at the point of foreclosure, where applicable, and approximately every six to twelve months thereafter while the repossessed property is held as real estate owned.

As supported by accounting and regulatory guidance, we reduce the fair value of the collateral by estimated selling costs, such as real estate brokerage commissions, to measure impairment when such costs are expected to reduce the cash flows available to repay the loan.

We establish valuation allowances in the fiscal period during which the loan impairments are identified. The results of management’s individual loan impairment evaluations are validated by our third party loan review firm during their quarterly independent review. Such valuation allowances are adjusted in subsequent fiscal periods, where appropriate, to reflect any changes in carrying value or fair value identified during subsequent impairment evaluations which are generally updated monthly by management.

The second tier of the loss measurement process involves estimating the probable and estimable losses on loans not otherwise reviewed individually for impairment as well as those individually reviewed loans that are determined to be non-impaired. Such loans include groups of smaller-balance homogeneous loans that may generally be excluded from individual impairment analysis, and therefore collectively evaluated for impairment, as well as the non-impaired loans within categories that are otherwise eligible for individual impairment review.

Valuation allowances established through the second tier of the loss measurement process utilize historical and environmental loss factors to collectively estimate the level of probable losses within defined segments of our loan portfolio. These segments aggregate homogeneous subsets of loans with similar risk characteristics based upon loan type. For allowance for loan loss calculation and reporting purposes, we currently stratify our loan portfolio into seven primary segments: residential mortgage loans, commercial mortgage loans, construction loans, commercial business loans, home equity loans, home equity lines of credit and other consumer loans.

The risks presented by residential mortgage loans are primarily related to adverse changes in the borrower’s financial condition that threaten repayment of the loan in accordance with its contractual terms. Such risk to repayment can arise from job loss, divorce, illness and the personal bankruptcy of the borrower. For collateral dependent residential mortgage loans, additional risk of loss is presented by potential declines in the fair value of the collateral securing the loan.

Home equity loans and home equity lines of credit generally share the same risks as those applicable to residential mortgage loans. However, to the extent that such loans represent junior liens, they are comparatively more susceptible to such risks given their subordinate position behind senior liens.

In addition to sharing similar risks as those presented by residential mortgage loans, risks relating to commercial mortgage loans also arise from comparatively larger loan balances to single borrowers or groups of related borrowers. Moreover, the repayment of such loans is typically dependent on the successful operation of an underlying real estate project and may be further threatened by adverse changes to demand and supply of commercial real estate as well as changes generally impacting overall business or economic conditions.

The risks presented by construction loans are generally considered to be greater than those attributable to residential and commercial mortgage loans. Risks from construction lending arise, in part, from the concentration of principal in a limited number of loans and borrowers and the effects of general economic conditions on developers and builders. Moreover, a construction loan can involve additional

 

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risks because of the inherent difficulty in estimating both a property’s value at completion of the project and the estimated cost, including interest, of the project. The nature of these loans is such that they are comparatively more difficult to evaluate and monitor than permanent mortgage loans.

Commercial business loans are also considered to present a comparatively greater risk of loss due to the concentration of principal in a limited number of loans and/or borrowers and the effects of general economic conditions on the business. Commercial business loans may be secured by varying forms of collateral including, but not limited to, business equipment, receivables, inventory and other business assets which may not provide an adequate source of repayment of the outstanding loan balance in the event of borrower default. Moreover, the repayment of commercial business loans is primarily dependent on the successful operation of the underlying business which may be threatened by adverse changes to the demand for the business’ products and/or services as well as the overall efficiency and effectiveness of the business’ operations and infrastructure.

Finally, our unsecured consumer loans generally have shorter terms and higher interest rates than other forms of lending but generally involve more credit risk due to the lack of collateral to secure the loan in the event of borrower default. Consumer loan repayment is dependent on the borrower’s continuing financial stability, and therefore is more likely to be adversely affected by job loss, divorce, illness and personal bankruptcy. By contrast, our consumer loans also include account loans that are fully secured by the borrower’s deposit accounts and generally present nominal risk to Kearny Bank.

Each primary segment is further stratified to distinguish between loans originated and purchased through third parties from loans acquired through business combinations. Commercial business loans include secured and unsecured loans as well as loans originated through SBA programs. Additional criteria may be used to further group loans with common risk characteristics. For example, such criteria may distinguish between loans secured by different collateral types or separately identify loans supported by government guarantees such as those issued by the SBA.

In regard to historical loss factors, our allowance for loan loss calculation calls for an analysis of historical charge-offs and recoveries for each of the defined segments within the loan portfolio. We currently utilize a two-year moving average of annual net charge-off rates (charge-offs net of recoveries) by loan segment, where available, to calculate our actual, historical loss experience. The outstanding principal balance of the non-impaired portion of each loan segment is multiplied by the applicable historical loss factor to estimate the level of probable losses based upon our historical loss experience.

As noted, the second tier of our allowance for loan loss calculation also utilizes environmental loss factors to estimate the probable losses within the loan portfolio. Environmental loss factors are based upon specific qualitative criteria representing key sources of risk within the loan portfolio. Such risk criteria have traditionally considered the level of and trends in nonperforming loans; the effects of changes in credit policy; the experience, ability and depth of the lending function’s management and staff; national and local economic trends and conditions; credit risk concentrations and changes in local and regional real estate values. During fiscal 2014, the environmental factors we utilized in our allowance for loan loss calculation were expanded to include changes in the nature, volume and terms of loans, changes in the quality of loan review systems and resources and the effects of regulatory, legal and other external factors.

For each category of the loan portfolio, a level of risk, developed from a number of internal and external resources, is assigned to each of the qualitative criteria utilizing a scale ranging from zero (negligible risk) to 15 (high risk) , with higher values potentially ascribed to exceptional levels of risk that exceed the standard range, as appropriate. The sum of the risk values, expressed as a whole number, is multiplied by 0.01% to arrive at an overall environmental loss factor, expressed in basis points, for each loan category.

 

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Prior to fiscal 2012, the aggregate outstanding principal balance of the non-impaired loans within each loan category was simply multiplied by the applicable environmental loss factor, as described above, to estimate the level of probable losses based upon the qualitative risk criteria. To more closely align our ALLL calculation methodology to that of other institutions regulated by the OCC, we modified our ALLL calculation methodology during fiscal 2012 to explicitly incorporate our existing credit-rating classification system into the calculation of environmental loss factors by loan type.

To do so, we implemented the use of risk-rating classification “weights” into our calculation of environmental loss factors during 2012. Our existing risk-rating classification system ascribes a numerical rating of “1” through “9” to each loan within the portfolio. The ratings “5” through “9” represent the numerical equivalents of the traditional loan classifications “Watch”, “Special Mention”, “Substandard”, “Doubtful” and “Loss”, respectively, while lower ratings, “1” through “4”, represent risk-ratings within the least risky “Pass” category. The environmental loss factor applicable to each non-impaired loan within a category, as described above, is “weighted” by a multiplier based upon the loan’s risk-rating classification. Within any single loan category, a “higher” environmental loss factor is now ascribed to those loans with comparatively higher risk-rating classifications resulting in a proportionately greater ALLL requirement attributable to such loans compared to the comparatively lower risk-rated loans within that category.

In evaluating the impact of the level and trends in nonperforming loans on environmental loss factors, we first broadly consider the occurrence and overall magnitude of prior losses recognized on such loans over an extended period of time. For this purpose, losses are considered to include both charge offs as well as loan impairments for which valuation allowances have been recognized through provisions to the allowance for loan losses, but have not yet been charged off. To the extent that prior losses have generally been recognized on nonperforming loans within a category, a basis is established to recognize existing losses on loans collectively evaluated for impairment based upon the current levels of nonperforming loans within that category. Conversely, the absence of material prior losses attributable to delinquent or nonperforming loans within a category may significantly diminish, or even preclude, the consideration of the level of nonperforming loans in the calculation of the environmental loss factors attributable to that category of loans.

Once the basis for considering the level of nonperforming loans on environmental loss factors is established, we then consider the current dollar amount of nonperforming loans by loan type in relation to the total outstanding balance of loans within the category. A greater portion of nonperforming loans within a category in relation to the total suggests a comparatively greater level of risk and expected loss within that loan category and vice-versa.

In addition to considering the current level of nonperforming loans in relation to the total outstanding balance for each category, we also consider the degree to which those levels have changed from period to period. A significant and sustained increase in nonperforming loans over a 12-24 month period suggests a growing level of expected loss within that loan category and vice-versa.

As noted above, we consider these factors in a qualitative, rather than quantitative fashion when ascribing the risk value, as described above, to the level and trends of nonperforming loans that is applicable to a particular loan category. As with all environmental loss factors, the risk value assigned ultimately reflects our best judgment as to the level of expected losses on loans collectively evaluated for impairment.

The sum of the probable and estimable loan losses calculated through the first and second tiers of

 

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the loss measurement processes as described above, represents the total targeted balance for our allowance for loan losses at the end of a fiscal period. As noted earlier, we established all additional valuation allowances in the fiscal period during which additional individually identified loan impairments and additional estimated losses on loans collectively evaluated for impairment are identified. We adjust our balance of valuation allowances through the provision for loan losses as required to ensure that the balance of the allowance for loan losses reflects all probable and estimable loans losses at the close of the fiscal period. Notwithstanding calculation methodology and the noted distinction between valuation allowances established on loans collectively versus individually evaluated for impairment, our entire allowance for loan losses is available to cover all charge-offs that arise from the loan portfolio.

Although we believe that our allowance for loans losses is established in accordance with management’s best estimate, actual losses are dependent upon future events and, as such, further additions to the level of loan loss allowances may be necessary.

 

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The following table sets forth information with respect to activity in the allowance for loan losses for the periods indicated.

 

     For the Years Ended June 30,  
     2014     2013     2012     2011     2010  
     (Dollars in Thousands)  

Allowance balance (at beginning of period)

   $ 10,896      $ 10,117      $ 11,767      $ 8,561      $ 6,434   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan losses

     3,381        4,464        5,750        4,628        2,616   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Charge-offs:

          

One- to four-family mortgage

     1,202        2,272        6,398        931        202   

Home equity loan

     47        221        135        7        16   

Commercial mortgage

     44        1,042        483        —          322   

Commercial business

     1,170        182        349        5        —     

Construction

     —          9        106        492        —     

Other

     30        2        9        7        1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     2,493        3,728        7,480        1,442        541   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

          

One- to four-family mortgage

     67        15        6        6        10   

Home equity loan

     2        10        2        —          —     

Commercial mortgage

     525        —          37        2        42   

Commercial business

     9        18        —          11        —     

Construction

     —          —          33        —          —     

Other

     —          —          2        1        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     603        43        80        20        52   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     (1,890     (3,685     (7,400     (1,422     (489
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance balance (at end of period)

   $ 12,387      $ 10,896      $ 10,117      $ 11,767      $ 8,561   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans outstanding

   $ 1,742,868      $ 1,361,718      $ 1,285,890      $ 1,269,372      $ 1,013,149   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Average loans outstanding

   $ 1,548,746      $ 1,309,085      $ 1,250,307      $ 1,172,576      $ 1,030,287   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses as a percent of total loans outstanding

     0.71     0.80     0.79     0.93     0.84
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net loan charge-offs as a percent of average loans outstanding

     0.12     0.28     0.59     0.12     0.05
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses to non-performing loans

     48.96     35.24     30.20     33.65     39.70
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Allocation of Allowance for Loan Losses. The following table sets forth the allocation of the total allowance for loan losses by loan category and segment and the percent of loans in each category’s segment to total net loans receivable at the dates indicated. The portion of the loan loss allowance allocated to each loan segment does not represent the total available for future losses which may occur within a particular loan segment since the total loan loss allowance is a valuation reserve applicable to the entire loan portfolio.

 

    At June 30,  
    2014     2013     2012     2011     2010  
    Amount     Percent of
Loans to Total
Loans
    Amount     Percent of
Loans to
Total Loans
    Amount     Percent of
Loans to
Total Loans
    Amount     Percent of
Loans to
Total Loans
    Amount     Percent of
Loans to
Total Loans
 
    (Dollars in Thousands)  

At end of period allocated to:

                   

Real estate mortgage:

                   

One- to four-family

  $ 2,729        33.31   $ 3,660        36.77   $ 4,572        43.77   $ 6,644        48.13   $ 4,302        65.52

Commercial

    7,737        56.44        5,359        48.97        3,443        37.71        3,336        30.23        3,315        20.04   

Commercial business

    1,284        3.86        1,218        5.19        1,310        6.88        880        8.27        108        1.42   

Consumer:

                   

Home equity loans

    460        4.34        490        5.93        447        7.45        322        8.78        313        10.03   

Home equity lines of credit

    88        1.38        76        1.95        54        2.30        49        2.59        34        1.12   

Other

    22        0.25        12        0.32        14        0.31        14        0.30        13        0.42   

Construction

    67        0.42        81        0.87        277        1.58        289        1.70        245        1.45   
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   
    12,387          10,896          10,117          11,534          8,330     

Unallocated

    —            —            —            233          231     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total

  $ 12,387        100.00   $ 10,896        100.00   $ 10,117        100.00   $ 11,767        100.00   $ 8,561        100.00
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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The following table sets forth the allocation of the allowance for loan losses by loan category and segment within each valuation allowance category at the dates indicated. The valuation allowance categories presented reflect the allowance for loan loss calculation methodology in effect at the time.

 

     At June 30,  
     2014      2013      2012      2011      2010  
     (Dollars in Thousands)  

Valuation allowance for loans individually evaluated for impairment:

              

Real estate mortgage:

              

One- to four-family

   $ 528       $ 697       $ 1,240       $ 4,061       $ 2,433   

Commercial

     569         514         667         1,503         1,771   

Commercial business

     444         757         776         692         5   

Consumer:

              

Home equity loans

     132         110         127         —           —     

Home equity lines of credit

     —           —           —           —           —     

Other

     —           —           —           —           —     

Construction

     —           —           —           105         106   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total valuation allowance

     1,673         2,078         2,810         6,361         4,315   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Valuation allowance for loans collectively evaluated for impairment:

              

Historical loss factors

     2,058         2,439         2,288         738         199   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
              

Environmental loss factors:

              

Real estate mortgage:

              

One- to four-family

     1,175         1,278         1,502         2,160         1,784   

Multi-family and commercial

     6,717         4,292         2,776         1,658         1,443   

Commercial business

     374         407         316         186         103   

Consumer:

              

Home equity loans

     229         239         258         312         305   

Home equity lines of credit

     88         76         54         49         34   

Other

     8         6         8         8         8   

Construction

     65         81         105         62         139   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total environmental loss factors

     8,656         6,379         5,019         4,435         3,816   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total (Factors based)

     10,714         8,818         7,307         5,173         4,015   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Unallocated general valuation allowance

                             233         231   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total allowance for loan losses

   $ 12,387       $ 10,896       $ 10,117       $ 11,767       $ 8,561   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

During the year ended June 30, 2014, the balance of the allowance for loan losses increased by approximately $1.5 million to $12.4 million or 0.71% of total loans at June 30, 2014 from $10.9 million or 0.80% of total loans at June 30, 2013. The increase resulted from provisions of $3.4 million during the year ended June 30, 2014 that were partially offset by charge-offs, net of recoveries, totaling $1.9 million.

With regard to loans individually evaluated for impairment, the balance of our allowance for loan losses attributable to such loans decreased by $405,000 to $1.7 million at June 30, 2014 from $2.1 million at June 30, 2013. The balance at June 30, 2014 reflected the allowance for impairment identified on $4.6 million of impaired loans while an additional $32.6 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 $34.9 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.

 

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With regard to loans evaluated collectively for impairment, the balance of our allowance for loan losses attributable to such loans increased by $1.9 million to $10.7 million at June 30, 2014 from $8.8 million at June 30, 2013. The increase in valuation was partly attributable to a $383.5 million increase in the aggregate outstanding balance of loans collectively evaluated for impairment to $1.71 billion at June 30, 2014 from $1.32 billion at June 30, 2013 as well as the ongoing reallocation of loans within the portfolio in favor of commercial loans against which we generally assign comparatively higher historical and environmental loss factors in our ALLL calculation. The increase in the allowance also reflected changes to certain environmental loss factors that were partially offset by decreases in historical loss factors.

Specifically, our loan portfolio experienced a net annualized average charge-off rate of 12 basis points during the year ended June 30, 2014 representing a decrease of 16 basis points from the 28 basis points of charge-offs reported for fiscal 2013. The historical loss factors used in our 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. The effect of the decline in the aggregate charge-off rate during the current year more than offset the effect of the concurrent increase in the overall balance of the unimpaired portion of the loan portfolio noted above. Together, these factors resulted in a net decrease of $381,000 in the applicable portion of the allowance to $2.1 million as of June 30, 2014 compared to $2.4 million at June 30, 2013.

As noted earlier, the loans acquired from Atlas Bank on June 30, 2014 were recorded at their fair value on the date of acquisition. Such valuations reflected any estimated impairment for potential credit losses at that time. Consequently, the historical loss factors applied to such loans were initially set to zero at June 30, 2014. The level of historical loss factors attributable to all acquired loans, including those acquired from Atlas Bank, will be updated periodically to reflect any “post-acquisition” charge off activity in accordance with our allowance for loan loss calculation methodology.

Changes to environmental loss factors during the year ended June 30, 2014 generally reflected changes to estimated impairment attributable to three primary factors. First, we updated the loss factors applicable to loans originally acquired through our acquisition of Central Jersey Bank during fiscal 2011. 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 has not exceeded the level of impairment originally ascribed to the loans at the time of acquisition. However, during fiscal 2014 we have identified and recognized additional “post-acquisition” impairment and charge-offs attributable to acquired loans that were performing at the time of acquisition. We consider such losses in developing the environmental loss factors used to calculate the required allowance applicable to the non-impaired portion of our acquired loan portfolio. As such, during the year ended June 30, 2014, we modified the following environmental loss factors applicable to loans acquired during fiscal 2011:

• National and local economic trends and conditions: Increased the loss factors within the following loan segments to reflect the continued weakness in national and local economic conditions and the increase in related impairment that continues to be recognized over time since the loan segments were originally acquired at fair value:

 

    All acquired loan segments: Increased (+3 bp) from “6” to “9”

 

 

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• Changes in the value of underlying collateral: Increased the loss factors within the following loan segments to reflect the continued weakness in applicable real estate values coupled with the adverse effects of Hurricane Sandy on collateral values and the increase in related impairment that continues to be recognized over time since the loan segments were originally acquired at fair value:

 

    All acquired loan segments: Increased (+3 bp) from “6” to “9”

Level of and trends in nonperforming loans: Increased the loss factors within the following loan segments to reflect increases in the level of nonperforming loans and realized losses and the increase in related impairment that continues to be recognized over time since the loan segments were originally acquired at fair value.

 

    Acquired SBA loan segments: Increased (+3 bp) from “12” to “15”

Given their original acquisition at fair value and limited portfolio seasoning through June 30, 2014, the environmental loss factors established for loans acquired through business combinations generally reflect a comparatively lower level of risk than those applicable to the remaining portfolio. As noted earlier, the loans acquired from Atlas Bank on June 30, 2014 were recorded at their fair value on the date of acquisition. Such valuations reflected any estimated impairment for potential credit losses at that time. Consequently, the environmental loss factors applied to such loans were initially set to zero at June 30, 2014. The level of environmental loss factors attributable to all acquired loans, including those acquired from Atlas Bank, will continue to be monitored and adjusted to reflect our best judgment as to the level of incurred “post- acquisition” impairment.

The second set of environmental loss factor changes during fiscal 2014 were primarily attributable to the significant growth in commercial mortgage loans reported during the year that necessitated changes to the applicable environmental loss factors including, but not limited to, the utilization of a new loss factor added during fiscal 2014:

National and local economic trends and conditions: Reallocated a portion of the risk factor value attributable to accelerated growth in commercial mortgage loan segments to a new loss factor added to our framework of environmental loss factors during fiscal 2014 (see below).

 

    Multi-family mortgage loans: Reallocated (-6 bp) from “15” to “9”

 

    Nonresidential mortgage loans: Reallocated (-3 bp) from “15” to “12”

• Concentration of credit: Reallocated a portion of the risk factor value attributable to accelerated growth in commercial mortgage loan segments to a new loss factor added to our framework of environmental loss factors during fiscal 2014 (see below).

 

    Multi-family mortgage loans: Reallocated (-3 bp) from “12” to “9”

 

    Nonresidential mortgage loans: Reallocated (-3 bp) from “12” to “9”

• Changes in the nature, volume and terms of loans: Added new environmental loss factor during fiscal 2014 with factor values initially reallocated from existing risk factors (see above). Additional increases were also made to the risk factor values to reflect further accelerated growth in commercial mortgage loan segments.

 

    Multi-family mortgage loans: Reallocated (+9 bp) from “0” to “9”

 

    Nonresidential mortgage loans: Reallocated (+6 bp) from “0” to “6”

 

    Multi-family mortgage loans: Increased (+6 bp) from “9” to “15”

 

    Nonresidential mortgage loans: Increased (+3 bp) from “6” to “9”

 

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The third set of environmental loss factor changes during fiscal 2014 generally reflected the modest improvement in national and local economic conditions as well as improvements in certain real estate collateral values and the resulting impact on the estimated impairment within the applicable “non-acquired” segments our loan portfolio:

• National and local economic trends and conditions: Decreased the loss factors within the following loan segments to reflect modest improvement in certain economic indicators. The improvement in such indicators generally suggests growing stability and/or improvement in national and location economic conditions that - while remaining weak – have recovered from their worst levels brought about by the global financial crisis of 2007-2008.

 

    Residential mortgage loans: Decreased (-3 bp) from “9” to “6”

 

    Home equity loans & lines of credit: Decreased (-3 bp) from “9” to “6”

 

    Construction loans: Decreased (-3 bp) from “15” to “12”

 

    Multi-family mortgage loans: Decreased (-3 bp) from “9” to “6”

 

    Nonresidential mortgage loans: Decreased (-3 bp) from “12” to “9”

 

    Commercial business loans: Decreased (-3 bp) from “15” to “12”

• Changes in collateral values: Decreased the loss factor within the following loan segment to reflect the improvement in real estate collateral values securing loans within the applicable segment.

 

    Multi-family mortgage loans: Decreased (-3 bp) from “15” to “12”

In conjunction with the net changes to the outstanding balance of the applicable loans, the increase in the environmental loss factors during the year ended June 30, 2014 resulted in a net increase of $2.3 million in the applicable valuation allowances to $8.7 million at June 30, 2014 from $6.4 million at June 30, 2013.

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 June 30, 2014, and June 30, 2013. Given their acquisition at fair value on June 30, 2014, loans acquired in conjunction with the Atlas Bank acquisition on June 30, 2014 were excluded from the ALLL calculation as of that date. Therefore, the historical and environmental loss factors applicable to the categories of loans denoted as “acquired in merger” below were applicable at June 30, 2014 to loans previously acquired in conjunction with our acquisition of Central Jersey during fiscal 2011.

 

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Allowance for Loan Losses

Allocation of Loss Factors on Loans Collectively Evaluated for Impairment

at June 30, 2014

 

Loan Category

   Historical
Loss Factors
    Environmental
Loss Factors (2)
    Total  

Residential mortgage loans

      

Originated

     0.03     0.27     0.30

Purchased

     2.56        0.75        3.31   

Acquired in merger

     3.25        0.30        3.55   

Home equity loans

      

Originated

     0.11        0.33        0.44   

Acquired in merger

     0.36        0.30        0.66   

Home equity lines of credit

      

Originated

     0.00        0.33        0.33   

Acquired in merger

     0.00        0.30        0.30   

Construction loans

      

One- to four-family

      

Originated

     0.09        0.69        0.78   

Acquired in merger

     0.00        0.30        0.30   

Multi-family

      

Originated

     0.00        0.69        0.69   

Acquired in merger

     0.00        0.30        0.30   

Nonresidential

      

Originated

     0.00        0.69        0.69   

Acquired in merger

     0.00        0.30        0.30   

Commercial mortgage loans

      

Multi-family

      

Originated

     0.00        0.72        0.72   

Acquired in merger

     0.00        0.30        0.30   

Nonresidential

      

Originated

     0.10        0.72        0.82   

Acquired in merger

     0.00        0.30        0.30   

Commercial business loans

      

Secured (One- to four-family)

      

Originated

     0.00        0.69        0.69   

Acquired in merger

     0.00        0.30        0.30   

Secured (Other)

      

Originated

     0.50        0.69        1.19   

Purchased

     1.19        0.36        1.55   

Acquired in merger

     0.06        0.30        0.36   

Unsecured

      

Originated

     0.00        0.54        0.54   

Acquired in merger

     0.00        0.21        0.21   

 

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Allowance for Loan Losses

Allocation of Loss Factors on Loans Collectively Evaluated for Impairment

at June 30, 2014 (continued)

 

Loan Category

   Historical
Loss Factors
    Environmental
Loss Factors (2)
    Total  

SBA 7A

      

Originated

     0.00     0.69     0.69

Acquired in merger

     18.91        0.33        19.24   

SBA Express

      

Originated

     0.00        0.69        0.69   

Acquired in merger

     0.00        0.33        0.33   

SBA Line of Credit

      

Originated

     0.00        0.69        0.69   

Acquired in merger

     0.53        0.33        0.86   

Other consumer loans (1)

     —          —          —     

 

(1) We generally maintain an environmental loss factor of 0.21% on other consumer loans while historical loss factors range from 0.00% to 12.34% 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”: 0.27% X 600% = 1.62%).

 

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Allowance for Loan Losses

Allocation of Loss Factors on Loans Collectively Evaluated for Impairment

at June 30, 2013

 

Loan Category

   Historical
Loss Factors
    Environmental
Loss 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

      

One- to four-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

     0.13        0.72        0.85   

Acquired in merger

     0.11        0.24        0.35   

Commercial business loans

      

Secured (One- to four-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

     0.07        0.24        0.31   

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 June 30, 2013 (continued)

 

Loan Category

   Historical
Loss Factors
    Environmental
Loss Factors (2)
    Total  

SBA 7A

      

Originated

     0.00     0.72     0.72

Acquired in merger

     1.58        0.24        1.82   

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

     0.00        0.24        0.24   

SBA Other

      

Originated

     0.00        0.72        0.72   

Acquired in merger

     0.00        0.24        0.24   

Other consumer loans (1)

     —          —          —     

 

(1) We generally maintain 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%).

An overview of the balances and activity within the allowance for loan loss during prior fiscal years reflects the lagging detrimental effects on economic and market conditions that resulted from the 2008-2009 financial crisis which have continued to adversely impact credit quality within our loan portfolio since that time.

During the fiscal year ended June 30, 2013, the balance of the allowance for loan losses increased by approximately $779,000 to $10.9 million at June 30, 2013 from $10.1 million at June 30, 2012. The increase resulted from additional provisions of $4.5 million that were partially offset by net charge offs of $3.7 million during fiscal 2013. Valuation allowances attributable to impairment identified on individually evaluated loans decreased by $732,000 to $2.1 million at June 30, 2013 from $2.8 million at June 30, 2012. For those same comparative periods, valuation allowances on loans evaluated collectively for impairment increased by approximately $1.5 million to $8.8 million from $7.3 million reflecting the overall growth in the balance of non-impaired loans in the portfolio in conjunction with changes to the historical and environmental loss factors used in the allowance for loan loss calculation during the year.

During the fiscal year ended June 30, 2012, the balance of the allowance for loan losses decreased by approximately $1.7 million to $10.1 million at June 30, 2012 from $11.8 million at June 30, 2011. The decrease resulted from net charge-offs totaling $7.4 million that were partially offset by additional provisions of $5.8 million. As noted earlier, the net charge-offs reported during fiscal 2012 reflected changes to our loan classification and charge off practices that resulted in the accelerated charge off of approximately $4.2 million of confirmed expected losses for which valuation allowances had been previously established for identified impairments. Due partly to this change, valuation allowances attributable to impairment identified on individually evaluated loans decreased by $3.6 million to $2.8 million at June 30, 2012 from $6.4 million at June 30, 2011. For those same comparative periods, valuation allowances on loans evaluated collectively for impairment increased by approximately $2.1 million to $7.3 million from $5.2 million reflecting the overall growth in the balance of non-impaired loans in the portfolio in conjunction with changes to the historical and environmental loss factors used in the allowance for loan loss calculation during the year. As noted earlier, changes to environmental loss factors during fiscal 2012 included those arising from incorporating our credit-rating classification system into the calculation of environmental loss factors by loan type. Finally, the balance of the unallocated allowance was reduced to zero at June 30, 2012 from our prior balance of $233,000 at June 30, 2011.

 

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The calculation of probable losses within a loan portfolio and the resulting allowance for loan losses is subject to estimates and assumptions that are susceptible to significant revisions as more information becomes available and as events or conditions effecting individual borrowers and the marketplace as a whole change over time. Future additions to the allowance for loan losses will likely be necessary if economic and market conditions do not improve in the future from those currently prevalent in the marketplace. In addition, the federal banking regulators, as an integral part of their examination process, periodically review our loan and foreclosed real estate portfolios and the related allowance for loan losses and valuation allowance for foreclosed real estate. The regulators may require the allowance for loan losses to be increased based on their review of information available at the time of the examination, which may negatively affect our earnings.

Securities Portfolio

Our deposits and borrowings have traditionally exceeded our outstanding balance of loans receivable. We have generally invested excess funds into investment securities with a historical emphasis on U.S. agency mortgage-backed securities and U.S. agency debentures. Such assets are a significant component of our investment portfolio at June 30, 2014 and are expected to remain so in the future. However, recent enhancements to our investment policies, strategies and infrastructure have enabled us to diversify the composition and allocation of our securities portfolio as described below.

At June 30, 2014, our securities portfolio totaled $1.36 billion and comprised 38.7% of our total assets. By comparison, at June 30, 2013, our securities portfolio totaled $1.39 billion and comprised 44.3% of our total assets.

The year-over-year net decrease in the securities portfolio totaled approximately $34.7 million which largely reflected security repayments and sales that were partially offset by security purchases during the year as well as the addition of securities with fair values totaling $26.9 million acquired in conjunction with the acquisition of Atlas Bank on June 30, 2014. The securities acquired from Atlas Bank included mortgage-backed securities, including pass-through securities and collateralized mortgage obligations, with fair values totaling $23.9 million as well as one corporate bond with a fair value of $3.0 million at June 30, 2014. All securities acquired from Atlas Bank were determined to be high-quality, investment grade securities with no “other-than-temporary” impairment.

The net decrease in the portfolio was partially offset by an increase in the fair value of the available for sale securities portfolio to an unrealized gain of $1.1 million at June 30, 2014 from an unrealized loss of $7.4 million at June 30, 2013.

The decrease in the dollar amount of the securities portfolio and its decline as a percentage of total assets from June 30, 2013 to June 30, 2014 reflects the stated goals and objectives of our business plan which continues to call for shifting the mix of our earning assets toward greater balances of loans and lesser balances of investment securities.

Our investment policy, which is approved by the Board of Directors, is designed to foster earnings and manage cash flows within prudent interest rate risk and credit risk guidelines. Generally, our investment policy is to invest funds in various categories of securities and maturities based upon our liquidity needs, asset/liability management policies, investment quality, and marketability and performance objectives. Our Chief Executive Officer, Chief Operating Officer, Chief Risk/Investment Officer and Chief Financial Officer are the executive management members of our Capital Markets

 

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Committee (“CMC”) that are generally designated by the Board of Directors as the officers primarily responsible for securities portfolio management and all transactions require the approval of at least two of these designated officers. The Board of Directors is responsible for the oversight of the securities portfolio and the CMC’s activities relating thereto.

Federally-chartered savings banks have the authority to invest in various types of liquid assets. The investments authorized for purchase under the investment policy approved by our Board of Directors include U.S. government and agency mortgage-backed securities (including U.S. agency commercial MBS), U.S. government and government agency debentures, municipal obligations (consisting of bank-qualified municipal bond obligations of state and local governments), corporate bonds, asset-backed securities and collateralized loan obligations. We also hold small balances of single-issuer trust preferred securities and non-agency mortgage-backed securities that were acquired through bank acquisitions, but generally do not purchase such securities for the portfolio. On a short-term basis, our investment policy authorizes investment in securities purchased under agreements to resell, federal funds, certificates of deposits of insured banks and savings institutions and Federal Home Loan Bank term deposits.

The carrying value of our mortgage-backed securities totaled $732.9 million at June 30, 2014 and comprised 54.0% of total investments and 20.9% of total assets as of that date. Mortgage-backed securities generally include mortgage pass-through securities and collateralized mortgage obligations which are typically issued with stated principal amounts and backed by pools of mortgage loans. Mortgage originators use intermediaries (generally government agencies and government-sponsored enterprises, but also a variety of non-agency corporate issuers) to pool and package mortgage loans into mortgage-backed securities. The cash flow and re-pricing characteristics of a mortgage pass-through security generally approximate those of the underlying mortgages. By comparison, the cash flow and re-pricing characteristics of collateralized mortgage obligations are determined by those assigned to an individual security, or “tranche”, within the terms of a larger investment vehicle which allocates cash flows to its component tranches based upon a predetermined structure as payments are received from the underlying mortgagors.

We generally invest in mortgage-backed securities issued by U.S. government agencies or government-sponsored entities, such as the Government National Mortgage Association (“Ginnie Mae”), Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Federal National Mortgage Association (“Fannie Mae”). Mortgage-backed securities issued or sponsored by U.S. government agencies and government-sponsored entities are guaranteed as to the payment of principal and interest to investors. Mortgage-backed securities generally yield less than the mortgage loans underlying such securities because of the costs of servicing and of their payment guarantees or credit enhancements which minimize the level of credit risk to the security holder.

In addition to our investments in agency mortgage-backed securities, we formerly had an investment in the AMF Ultra Short Mortgage Fund (“AMF Fund”), a mutual fund acquired during 2002 as the result of a merger, which invested primarily in agency and non-agency mortgage-backed securities of short duration. The housing and credit crises negatively impacted the market value of certain securities in the fund’s portfolio resulting in a continuing decline in the net asset value of this fund. Due to a continuing decline in the net asset value of the AMF Fund, we elected to withdraw our investment in the fund by invoking a redemption-in-kind option during fiscal 2009 in lieu of cash. The shares redeemed for cash and the shares redeemed for the underlying securities were initially written down to fair value as of the trade date. However, additional losses in the form of other-than-temporary impairments (“OTTI”) were recognized through earnings during fiscal 2009 and 2010 due to further declines in the value of the applicable non-agency securities.

 

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During the year ended June 30, 2014, non-agency CMOs totaling $34,000 fell below our investment grade threshold triggering their sale resulting in sale losses totaling $6,000. Similar sales were executed during fiscal 2013 and fiscal 2012 for CMOs totaling $24,000 and $38,000, respectively, resulting in losses on sale of $6,000 and $6,000, respectively.

We acquired one additional non-agency CMO with a fair value of $210,000 in conjunction with the acquisition of Atlas Bank on June 30, 2014. The acquisition increased the aggregate number and carrying value of our non-agency CMOs to five and $264,000, respectively. Of these securities, three non-agency CMOs with carrying values of $31,200 were impaired at June 30, 2014, but maintained their credit-ratings at levels supporting our investment grade assessment with such ratings equaling “A” by Standard & Poor’s Financial Services (“S&P”) and/or “Baa2” by Moody’s Investor Service (“Moody’s”), where rated by those agencies.

The carrying value of our U.S. agency debt securities totaled $148.6 million at June 30, 2014 and comprised 10.9% of total investments and 4.2% of total assets as of that date. Such securities included $144.3 million of fixed-rate U.S. agency debentures as well as $4.2 million of securitized pools of loans issued and fully guaranteed by the SBA.

The carrying value of our securities representing obligations of state and political subdivisions totaled $98.8 million at June 30, 2014 and comprised 7.3% of total investments and 2.8% of total assets as of that date. Such securities include approximately $95.7 million of highly-rated, fixed-rate bank-qualified securities representing general obligations of municipalities located within the U.S. or the obligations of their related entities such as boards of education or school districts. The portfolio also includes a nominal balance of non-rated municipal obligations totaling approximately $3.1 million comprising seven short-term, bond anticipation notes (“BANs”) issued by a total of four New Jersey municipalities with whom we also maintain or seek to maintain deposit relationships. At June 30, 2014, the fair value of each of our BANs equaled or exceeded their respective carrying values resulting in no reported impairment on those securities as of that date. Each of our impaired municipal obligations were consistently rated by Moody’s and S&P well above the thresholds that generally support our investment grade assessment with such ratings equaling or exceeding “A” or higher by S&P and/or “A1” or higher by Moody’s, where rated by those agencies. In the absence of such ratings, we rely upon our own internal analysis of the issuer’s financial condition to validate its investment grade assessment.

The carrying value of our asset-backed securities totaled $87.3 million at June 30, 2014 and comprised 6.4% of total investments and 2.5% of total assets as of that date. This category of securities is comprised entirely of structured, floating-rate securities representing securitized federal education loans with 97% U.S. government guarantees. The securities represent tranches of a larger investment vehicle designed to reallocate credit risk among the individual tranches comprised within that vehicle. Through this process, investors in different tranches are subject to varying degrees of risk that the cash flows of their tranche will be adversely impacted by borrowers defaulting on the underlying loans. Our securities represent the highest credit-quality tranches within the overall structures with each being rated “AA+” by S&P at June 30, 2014.

The outstanding balance of our collateralized loan obligations totaled $119.6 million at June 30, 2014 and comprised 8.8% of total investments and 3.4% of total assets as of that date. This category of securities is comprised entirely of structured, floating-rate securities comprised of securitized commercial loans to large, U.S. corporations. Our securities represent tranches of a larger investment vehicle designed to reallocate cash flows and credit risk among the individual tranches comprised within that vehicle. Through this process, investors in different tranches are subject to varying degrees of risk that the cash flows of their tranche will be adversely impacted by borrowers defaulting on the underlying loans. At June 30, 2014, each of our collateralized loan obligations were consistently rated by Moody’s

 

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and S&P well above the thresholds that generally support our investment grade assessment with such ratings equaling or exceeding “AA” or higher by S&P and/or “Aa2” or higher by Moody’s, where rated by those agencies.

The carrying value of our corporate bonds totaled $162.2 million at June 30, 2014 and comprised 12.0% of total investments and 4.6% of total assets as of that date. This category of securities is comprised entirely of floating-rate corporate debt obligations of large financial institutions. At June 30, 2014, each of our corporate bonds were consistently rated by Moody’s and S&P well above the thresholds that generally support our investment grade assessment with such ratings equaling or exceeding “A-” or higher by S&P and/or “Baa1” or higher by Moody’s, where rated by those agencies.

The carrying value of our trust preferred securities totaled $7.8 million at June 30, 2014 and comprised less than 1.0% of total investments and total assets as of that date. The category comprises a total of five “single-issuer” (i.e. non-pooled) trust preferred securities that were originally issued by four separate financial institutions. As a result of bank mergers involving the issuers of these securities, our five trust preferred securities currently represent the de-facto obligations of three separate financial institutions. At June 30, 2014, two of the securities at an amortized cost of $3.0 million were consistently rated by Moody’s and S&P above the thresholds that generally support our investment grade assessment, with such ratings equaling “BBB” by S&P and “Baa2” by Moody’s. The securities were originally issued through Chase Capital II and currently represent de-facto obligations of JP Morgan Chase & Co. We also owned two trust preferred securities at an amortized cost of $4.9 million whose external credit ratings by both S&P and Moody’s fell below the thresholds that we normally associate with investment grade securities, with such ratings equaling “BB+” by S&P and “Ba1” by Moody’s. The securities were originally issued through BankBoston Capital Trust IV and MBNA Capital B and currently represent de-facto obligations of Bank of America Corporation. We hold one non-rated trust preferred security with a par value of $1.0 million representing a de-facto obligation of Mercantil Commercebank Florida Bancorp, Inc.

Current accounting standards require that securities be categorized as “held to maturity”, “trading securities” or “available for sale”, based on management’s intent as to the ultimate disposition of each security. These standards allow debt securities to be classified as “held to maturity” and reported in financial statements at amortized cost only if the reporting entity has the positive intent and ability to hold these securities to maturity. Securities that might be sold in response to changes in market interest rates, changes in the security’s prepayment risk, increases in loan demand, or other similar factors cannot be classified as “held to maturity”.

We do not currently use or maintain a trading account. Securities not classified as “held to maturity” are classified as “available for sale”. These securities are reported at fair value and unrealized gains and losses on the securities are excluded from earnings and reported, net of deferred taxes, as adjustments to accumulated other comprehensive income, a separate component of equity. As of June 30, 2014, our held to maturity securities portfolio had a carrying value of $512.1 million or 37.7 % of our total securities with the remaining $845.1 million or 62.3% of securities classified as available for sale.

Other than mortgage-backed or debt securities issued or guaranteed by the U.S. government or its agencies, we did not hold securities of any one issuer having an aggregate book value in excess of 10% of our equity at June 30, 2014. All of our securities carry market risk insofar as increases in market rates of interest may cause a decrease in their market value. We have determined that none of our securities with unrealized losses at June 30, 2014 are other than temporarily impaired as of that date.

Purchases of securities are made based on certain considerations, which include the interest rate, tax considerations, volatility, yield, settlement date and maturity of the security, our liquidity position and

 

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anticipated cash needs and sources. The effect that the proposed security would have on our credit and interest rate risk and risk-based capital is also considered. We do not purchase securities that are determined to be below investment grade.

During the years ended June 30, 2014, 2013 and 2012, proceeds from sales of securities available for sale totaled $170.9 million, $442.8 million and $51.3 million, which resulted in gross gains of $3.6 million, $10.6 million and $53,000 and gross losses of $2.1 million, $135,000, and $0, respectively. Proceeds from sale of securities held to maturity during the years ended June 30, 2014, 2013 and 2012 totaled $28,000, $18,000 and $32,000, with gross losses of $6,000, $6,000 and $6,000, respectively.

 

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The following table sets forth the carrying value of our securities portfolio at the dates indicated. Mortgage-backed securities include mortgage pass-through securities and collateralized mortgage obligations.

 

     At June 30,  
     2014      2013      2012      2011      2010  
     (In Thousands)  

Debt Securities Available for Sale:

              

U.S. agency obligations

   $ 4,205       $ 5,015       $ 5,889       $ 6,591       $ 3,942   

Obligations of states and political subdivisions

     26,773         25,307         —           30,635         18,955   

Asset-backed securities

     87,316         24,798         —           —           —     

Collateralized loan obligations

     119,572         78,486         —           —           —     

Corporate bonds

     162,234         159,192         —           —           —     

Trust preferred securities

     7,798         7,324         6,713         7,447         6,600   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total debt securities available for sale

     407,898         300,122         12,602         44,673         29,497   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Debt Securities Held to Maturity:

              

U.S. agency obligations

     144,349         144,747         32,426         103,458         255,000   

Obligations of states and political subdivisions

     72,065         65,268         2,236         3,009         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total debt securities held to maturity

     216,414         210,015         34,662         106,467         255,000   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Mortgage-Backed Securities Available for Sale:

              

Government National Mortgage Association

     3,276         6,333         11,690         13,581         15,628   

Federal Home Loan Mortgage Corporation

     231,910         299,833         460.509         390,448         273,704   

Federal National Mortgage Association

     201,827         474,486         757,905         656,218         414,123   

Non-agency

     210         —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities available for sale

     437,223         780,652         1,230,104         1,060,247         703,455   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Mortgage-Backed Securities Held to Maturity:

              

Government National Mortgage Association

     9         —           —           —           —     

Federal Home Loan Mortgage Corporation

     303         120         158         212         267   

Federal National Mortgage Association

     295,292         100,889         786         930         1,123   

Non-agency

     54         105         146         203         310   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total mortgage-backed securities held to maturity

     295,658         101,114         1,090         1,345         1,700   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,357,193       $ 1,391,903       $ 1,278,458       $ 1,212,732       $ 989,652   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following table sets forth certain information regarding the carrying values, weighted average yields and maturities of our securities portfolio at June 30, 2014. This table shows contractual maturities and does not reflect re-pricing or the effect of prepayments. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without prepayment penalties. At June 30, 2014, securities with a carrying value of $152.6 million are callable within one year.

 

    At June 30, 2014  
    One Year or Less     More Than
One to Five Years
    More Than
Five to Ten Years
    More Than
Ten Years
    Total Securities  
    Carrying
Value
    Weighted
Average
Yield
    Carrying
Value
    Weighted
Average
Yield
    Carrying
Value
    Weighted
Average
Yield
    Carrying
Value
    Weighted
Average
Yield
    Carrying
Value
    Weighted
Average
Yield
    Market
Value
 
    (Dollars in Thousands)  

U.S. agency obligations

  $ 1,022        2.53   $ 143,357        0.90   $ 826        0.62   $ 3,349        2.41   $ 148,554        0.94   $ 147,152   

Obligations of states and political subdivisions

    4,787        1.14     2,752        1.22     45,381        1.71     45,918        2.30     98,838        1.94     97,298   

Asset-backed securities

    —          —       —          —       —          —       87,316        1.08     87,316        1.08     87,316   

Collateralized loan obligations

    —          —       —          —       19,973        1.57     99,599        1.97     119,572        1.90     119,572   

Corporate bonds

    —          —       20,190        1.09     142,044        1.21     —          —       162,234        1.19     162,234   

Trust preferred securities

    —          —       —          —       —          —       7,798        2.02     7,798        2.02     7,798   

Mortgage-backed securities:

                     

Residential pass-through:

                     

Government National Mortgage Association

    —          —       61        8.65     2,472        7.27     752        7.84     3,285        7.42     3,285   

Federal Home Loan Mortgage Corporation

    —          —       7,608        4.61     39,871        3.00     151,694        2.35     199,173        2.57     199,177   

Federal National Mortgage Association

    —          —       10,547        4.33     66,499        2.49     189,017        3.13     266,063        3.02     266,120   

Commercial pass-through:

                     

Federal National Mortgage Association

    —          —          —          —          180,752        2.56     —          —          180,752        2.56     178,783   

Collateralized mortgage obligations:

                     

Federal Home Loan Mortgage Corporation

    —          —       —          —       —          —       33,040        2.02     33,040        2.02     33,042   

Federal National Mortgage Association

    —          —       —          —       —          —       50,304        1.84     50,304        1.84     50,334   

Non-agency

    —          —       —          —       —          —       264        3.74     264        3.74     263   
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

Total

  $ 5,809        1.38   $ 184,515        1.28   $ 497,818        2.10   $ 669,051        2.29   $ 1,357,193        2.08   $ 1,352,374   
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

     

 

 

 

 

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Sources of Funds

General. Retail deposits are our primary source of funds for lending and other investment purposes. In addition, we derive funds from loan and mortgage-backed securities principal repayments and proceeds from the maturities and calls of non-mortgage-backed securities. Loan and securities payments are a relatively stable source of funds, while deposit inflows are significantly influenced by general interest rates and money market conditions. Wholesale funding sources including, but not limited to, borrowings from the FHLB of New York, wholesale deposits and other short term-borrowings are also used to supplement the funding for loans and investments.

Deposits. Our current deposit products include interest-bearing and non-interest-bearing checking accounts, money market deposit accounts, savings accounts and certificates of deposit accounts ranging in terms from 30 days to five years. Certificates of deposit with terms ranging from one year to five years are available for individual retirement account plans. Deposit account terms, such as interest rate earned, applicability of certain fees and service charges and funds accessibility, will vary based upon several factors including, but not limited to, minimum balance, term to maturity, and transaction frequency and form requirements.

Deposits are obtained primarily from within New Jersey and New York through Kearny Bank’s network of retail branches. Traditional methods of advertising are used to attract new customers and deposits, including radio, print media, outdoor advertising, direct mail and inserts included with customer statements. Premiums or incentives for opening accounts are sometimes offered. One of our key retail products in recent years has been “Star Banking”, which bundles a number of banking services and products together for those customers with a checking account with direct deposit and combined deposits of $20,000 or more, including Internet banking, bill pay, telephone banking, reduced rates on home equity loans and a 15 basis point premium on certificates of deposit with a term of at least one year, excluding special promotions. We also offer “High Yield Checking” which is primarily designed to attract core deposits in the form of customers’ primary checking accounts through interest rate and fee reimbursement incentives to qualifying customers. The comparatively higher interest expense associated with the “High Yield Checking” product in relation to our other checking products is partially offset by the transaction fee income associated with the account.

We may also offer a 15 basis point premium on certificate of deposit accounts with a term of at least one year, excluding special promotions, to certificate of deposit accountholders that have $500,000 or more on deposit with Kearny Bank. Though certificates of deposit with non-standard maturities are popular in our market, we generally promote certificates of deposit with traditional maturities, including three and six months and one, two, three, four and five years. During the term of our non-standard 17-month and 29-month certificates of deposit, we offer customers a “one-time option” to “step up” the rate paid from the original rate set on the certificate to the current rate being offered by Kearny Bank for certificates of that particular maturity.

The determination of interest rates on retail deposits is based upon a number of factors, including: (1) our need for funds based on loan demand, current maturities of deposits and other cash flow needs; (2) a current survey of a selected group of competitors’ rates for similar products; (3) our current cost of funds, yield on assets and asset/liability position; and (4) the alternate cost of funds on a wholesale basis, in particular the cost of borrowing from the FHLB. Interest rates are reviewed by senior management on a weekly basis.

 

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We also utilize “non-retail” deposits as an alternative source of wholesale funding to traditional borrowings such as FHLB advances. Such funds are generally used to manage our exposure to interest rate risk and liquidity risk in conjunction with our overall asset/liability management process. At June 30, 2014, the balance of our interest-bearing checking accounts includes a total of $213.5 million of brokered money market deposits acquired through Promontory’s IND program. The terms of the program generally establish a reciprocal commitment for Promontory to deliver and Kearny Bank to accept such deposits for a period of no less than five years during which time total aggregate balances shall be maintained within a range of $200.0 million to $230.0 million. Such deposits are generally sourced by Promontory from large retail and institutional brokerage firms whose individual clients seek to have a portion of their investments held in interest-bearing accounts at FDIC-insured institutions.

We also acquired a small portfolio of longer-term, brokered certificates of deposit during fiscal 2014 whose balances and weighted average remaining term to maturity totaled approximately $18.5 million and 7.0 years, respectively, at June 30, 2014. In combination with Promontory IND money market deposits noted above, Kearny Bank’s brokered deposits totaled $232.0 million, or 9.7% of deposits, at June 30, 2014.

During fiscal 2014, we began to utilize the QwickRate deposit listing service through which we have attracted “non-brokered” wholesale time deposits targeting institutional investors with a three-to-five year investment horizon. The balance of time deposits we acquired through the QwickRate listing during fiscal 2014 totaled $54.2 million at June 30, 2014 with such funds having a weighted average remaining term to maturity of 3.9 years. We generally prohibit the withdrawal of our listing service deposits prior to maturity.

Additional sources of non-retail deposits including, but not limited to, deposits acquired through listing services and other sources of brokered deposits, may be utilized in the future as additional, alternative sources of wholesale funding.

A large percentage of our deposits are in certificates of deposit, which represented 41.8% and 41.4% of total deposits at June 30, 2014 and June 30, 2013, respectively. Our liquidity could be reduced if a significant amount of certificates of deposit maturing within a short period were not renewed. At June 30, 2014 and June 30, 2013, certificates of deposit maturing within one year were $581.5 million and $646.6 million, respectively. Historically, a significant portion of the certificates of deposit remain with us after they mature and we believe that this will continue.

At June 30, 2014, $476.6 million or 46.0% of our certificates of deposit were certificates of $100,000 or more compared to $389.1 million or 39.6% at June 30, 2013. The general level of market interest rates and money market conditions significantly influence deposit inflows and outflows. The effects of these factors are particularly pronounced on deposit accounts with larger balances. In particular, certificates of deposit with balances of $100,000 or greater are traditionally viewed as being a more volatile source of funding than comparatively lower balance certificates of deposit or non-maturity transaction accounts. In order to retain certificates of deposit with balances of $100,000 or more, we may have to pay a premium rate, resulting in an increase in our cost of funds. In a rising rate environment, we may be unwilling or unable to pay a competitive rate. To the extent that such deposits do not remain with us, they may need to be replaced with borrowings, which could increase our cost of funds and negatively impact our interest rate spread and our financial condition.

The balance of deposits reported at June 30, 2014 included deposit balances with fair values totaling $86.1 million assumed in conjunction with the acquisition of Atlas Bank on June 30, 2014.

 

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Deposit balances assumed from Atlas Bank included non-interest-bearing and interest-bearing accounts totaling $14.6 million and $71.5 million respectively with the latter comprising interest-bearing checking accounts, savings accounts and certificates of deposit totaling $2.8 million, $31.4 million and $37.3 million, respectively. Kearny Bank also recognized a core deposit intangible of $398,000 in conjunction with the acquisition of Atlas Bank’s non-maturity deposits.

The balance of certificates of deposit assumed by Kearny Bank in conjunction with the acquisition of Atlas Bank included $6.4 million of predominantly short-term time deposits acquired by Atlas Bank through the QwickRate deposit listing service. In combination with the balance of longer-term time deposits we acquired through our relationship with QwickRate, the aggregate balance of “non-brokered” listing service deposits totaled $60.6 million, or 2.4% of deposits, at June 30, 2014.

The following table sets forth the distribution of average deposits for the periods indicated and the weighted average nominal interest rates for each period on each category of deposits presented.

 

     For the Years Ended June 30,  
     2014     2013     2012  
     Average
Balance
     Percent
of Total
Deposits
    Weighted
Average
Nominal
Rate
    Average
Balance
     Percent
of Total
Deposits
    Weighted
Average
Nominal
Rate
    Average
Balance
     Percent
of Total
Deposits
    Weighted
Average
Nominal
Rate
 
     (Dollars in Thousands)  

Non-interest-bearing demand

   $ 196,490         8.30     0.00   $ 172,954         8.04     0.00   $ 145,458         6.78     0.00

Interest-bearing demand

     722,999         30.53        0.52        494,625         23.00        0.37        454,166         21.19        0.59   

Savings and club

     473,917         20.01        0.16        445,470         20.72        0.20        414,560         19.34        0.33   

Certificates of deposit

     974,426         41.16        1.03        1,037,150         48.24        1.16        1,128,802         52.69        1.44   
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

   

Total deposits

   $ 2,367,832         100.00     0.61   $ 2,150,199         100.00     0.69   $ 2,142,986         100.00     0.95
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

   

 

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The following table sets forth certificates of deposit classified by interest rate as of the dates indicated.

 

     At June 30,  
     2014      2013      2012  
     (In Thousands)  

Interest Rate

        

0.00-0.99%

   $ 618,650       $ 544,763       $ 516,645   

1.00-1.99%

     299,387         313,361         389,408   

2.00-2.99%

     100,596         119,309         165,132   

3.00-3.99%

     18,582         4,028         12,409   

4.00-4.99%

     3         3         16,091   

5.00-5.99%

     —           —           5,242   
  

 

 

    

 

 

    

 

 

 

Total

   $ 1,037,218       $ 981,464       $ 1,104,927   
  

 

 

    

 

 

    

 

 

 

The following table shows the amount of certificates of deposit of $100,000 or more by time remaining until maturity as of the date indicated.

 

     At June 30, 2014  
     (In Thousands)  

Maturity Period

  

Within three months

   $ 89,734   

Three through six months

     57,948   

Six through twelve months

     77,313   

Over twelve months

     251,637   
  

 

 

 

Total

   $ 476,632   
  

 

 

 

The following table sets forth the amount and maturities of certificates of deposit at June 30, 2014.

 

     Amount Due  
     Within
One Year
     Over One Year
to Two Years
     Over Two
Years to
Three Years
     Over Three
Years to
Four Years
     Over Four
Years to Five
Years
     Over Five
Years
     Total  
     (In Thousands)  

0.00-0.99%

   $ 480,131       $ 120,354       $ 17,439       $ 564       $ 162       $ —         $ 618,650   

1.00-1.99%

     70,319         19,924         54,537         88,146         66,461         —           299,387   

2.00-2.99%

     29,875         36,220         18,102         2,211         14,188         —           100,596   

3.00-3.99%

     1,215         10,903         —           —           —           6,464         18,582   

4.00-4.99%

     3         —           —           —           —           —           3   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 581,543       $ 187,401       $ 90,078       $ 90,921       $ 80,811       $ 6,464       $ 1,037,218   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Borrowings. The sources of wholesale funding we utilize include borrowings in the form of advances from the FHLB of New York as well as other forms of borrowings. We generally use wholesale funding to manage our exposure to interest rate risk and liquidity risk in conjunction with our overall asset/liability management process. Toward that end, FHLB advances are primarily utilized to extend the duration of funding to partially offset the interest rate risk presented by our investment in longer-term fixed-rate loans and mortgage-backed securities. Extending the duration of funding may be achieved by simply utilizing fixed-rate borrowings with longer terms to maturity. Alternately, we may utilize derivatives such as interest rate swaps and caps in conjunction with either short-term fixed-rate or floating-rate borrowings to effectively extend the duration of those funding sources.

Advances from the FHLB are typically secured by our FHLB capital stock and certain investment securities as well as residential and multi-family mortgage loans that we choose to utilize as collateral for such borrowings. Additional information regarding our FHLB advances is included under Note 14 to the audited consolidated financial statements.

Short-term FHLB advances generally have original maturities of less than one year and include overnight borrowings which Kearny Bank typically utilizes to address short term funding needs as they arise. At June 30, 2014, we had a total of $320.0 million of short-term FHLB advances at a weighted average interest rate of 0.38%. Such advances included $300.0 million of 90-day FHLB term advances that are generally forecasted to be periodically redrawn at maturity for the same 90 day term as the original advance. Based on this presumption, we utilized interest rate swaps to effectively extend the duration of each of these advances at the time they were drawn to effectively fix their cost for a period of five years. Short-term advances at June 30, 2014 also included $17.0 million of overnight borrowings from the FHLB drawn for daily liquidity management purposes.

Also included in short-term FHLB advances at June 30, 2014 was a fixed-rate advance with a fair value of $3.0 million assumed in conjunction with our acquisition of Atlas Bank on June 30, 2014. The advance had a coupon of 0.35% and matured in July 2014.

Long-term advances generally include term advances with original maturities of greater than one year. At June 30, 2014, our outstanding balance of long-term FHLB advances totaled $161.5 million. Such advances included $145.0 million of advances at a weighted average interest rate of 3.04% as well as a $765,000 amortizing advance at a rate of 4.94%.

Also included in long-term FHLB advances at June 30, 2014 were four FHLB advances with fair values totaling $15.7 million assumed in conjunction with our acquisition of Atlas Bank on June 30, 2014. Such advances had a weighted average coupon of 1.11% and a weighted average remaining term of 2.6 years.

 

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Our FHLB advances mature as follows:

 

Maturing in Years Ending June 30,

   (In Thousands)  

2015

   $ 320,000   

2016

     7,500   

2017

     3,000   

2018

     5,225   

2021

     765   

2023

     145,000   
  

 

 

 
     481,490   

Fair value adjustments

     29   
  

 

 

 

Total

   $ 481,519   
  

 

 

 

Based upon the market value of investment securities and mortgage loans that are posted as collateral for FHLB advances at June 30, 2014, we are eligible to borrow up to an additional $327.2 million of advances from the FHLB as of that date. We are further authorized to post additional collateral in the form of other unencumbered investments securities and eligible mortgage loans that may expand our borrowing capacity with the FHLB up to 30% of our total assets. Additional borrowing capacity up to 50% of our total assets may be authorized with the approval of the FHLB’s Board of Directors or Executive Committee.

The balance of borrowings at June 30, 2014 also included overnight borrowings in the form of depositor sweep accounts totaling $30.7 million. Depositor sweep accounts are short-term borrowings representing funds that are withdrawn from a customer’s non-interest bearing deposit account and invested in an uninsured overnight investment account that is collateralized by specified investment securities owned by Kearny Bank.

Interest Rate Derivatives and Hedging

We utilize derivative instruments in the form of interest rate swaps and caps to hedge our exposure to interest rate risk in conjunction with our overall asset/liability management process. In accordance with accounting requirements, we formally designate all of our hedging relationships as either fair value hedges, intended to offset the changes in the value of certain financial instruments due to movements in interest rates, or cash flow hedges, intended to offset changes in the cash flows of certain financial instruments due to movement in interest rates, and documents the strategy for undertaking the hedge transactions and its method of assessing ongoing effectiveness.

At June 30, 2014, our derivative instruments are comprised entirely of interest rate swaps and caps with total notional amounts of $425.0 million and $75.0 million, respectively with Wells Fargo Bank, N.A. serving as the counterparty to each of the transactions. These instruments are intended to manage the interest rate exposure relating to certain wholesale funding positions drawn at June 30, 2014.

Additional information regarding our use of interest rate derivatives and our hedging activities is presented in Note 1 and
Note 15 to the audited consolidated financial statements.

Subsidiary Activity

At June 30, 2014, Kearny Federal Savings Bank was the only wholly-owned operating subsidiary of Kearny Financial Corp. As of that date, Kearny Federal Savings Bank, had two wholly owned subsidiaries: KFS Financial Services, Inc. and CJB Investment Corp. KFS Financial Services, Inc. was

 

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incorporated as a New Jersey corporation in 1994 under the name of South Bergen Financial Services, Inc., was acquired in Kearny Bank’s merger with South Bergen Savings Bank in 1999 and was renamed KFS Financial Services, Inc. in 2000. It is a service corporation subsidiary originally organized for selling insurance products to Kearny Bank customers and the general public through a third party networking arrangement.

During the year ended June 30, 2014, KFS Insurance Services, Inc. was created as a wholly owned subsidiary of KFS Financial Services, Inc. for the primary purpose of acquiring insurance agencies. Both KFS Financial Services Inc. and KFS Insurance Services, Inc. were considered inactive during the year ended June 30, 2014.

CJB Investment Corp. was acquired by Kearny Bank through our acquisition of Central Jersey Bancorp in November 2010. CJB Investment Corp was organized under New Jersey law as a New Jersey Investment Company and remained active through the three-year period ended June 30, 2014.

In addition to the subsidiaries noted above, Kearny Bank dissolved its wholly owned subsidiary KFS Investment Corp. during fiscal 2014 which had remained inactive during the two years ended June 30, 2012 and 2013 and through the date of its dissolution during the year ended June 30, 2014.

Personnel

As of June 30, 2014, we had 410 full-time employees and 64 part-time employees equating to a total of 442 full time equivalent (“FTE”) employees. The number of employees at June 30, 2014 includes 19 full-time employees employed by Atlas Bank as of that date. By comparison, at June 30, 2013, we had 398 full-time employees and 55 part-time employees equating to a total of 426 FTEs. Our employees are not represented by a collective bargaining unit and we consider our working relationship with our employees to be good.

 

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REGULATION

General

Kearny Bank and Kearny-Federal operate in a highly regulated industry. This regulation establishes a comprehensive framework of activities in which a savings and loan holding company and federal savings bank may engage and is intended primarily for the protection of the deposit insurance fund and depositors. Set forth below is a brief description of certain laws that relate to the regulation of Kearny Bank and Kearny-Federal. The description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.

Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution and its holding company, the classification of assets by the institution and the adequacy of an institution’s allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, including changes in the regulations governing savings and loan holding companies, could have a material adverse impact on Kearny-Federal, Kearny Bank and their operations. The adoption of regulations or the enactment of laws that restrict the operations of Kearny Bank and/or Kearny-Federal or impose burdensome requirements upon one or both of them could reduce their profitability and could impair the value of Kearny Bank’s franchise, resulting in negative effects on the trading price of our common stock.

Regulation of Kearny Bank

General. As a federally-chartered savings bank with deposits insured by the FDIC, Kearny Bank is subject to extensive regulation by federal banking regulators. This regulatory structure gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies regarding the classification of assets and the level of the allowance for loan losses. The activities of federal savings banks are subject to extensive regulation including restrictions or requirements with respect to loans to one borrower, the percentage of non-mortgage loans or investments to total assets, capital distributions, permissible investments and lending activities, liquidity, transactions with affiliates and community reinvestment. Federal savings banks are also subject to reserve requirements imposed by the Federal Reserve Board. Both state and federal law regulate a federal savings bank’s relationship with its depositors and borrowers, especially in such matters as the ownership of savings accounts and the form and content of Kearny Bank’s mortgage documents.

As a result of the Dodd-Frank Act, the OCC assumed principal regulatory responsibility for federal savings banks from the OTS effective July 21, 2011. Under the Dodd-Frank Act, all existing OTS guidance, orders, interpretations, procedures and other advisory in effect prior to that date remained in effect and enforceable against the OCC until modified, terminated, set aside or superseded by the OCC in accordance with applicable law. The OCC has adopted most of the substantive OTS regulations on an interim final basis.

Kearny Bank must file reports with the OCC concerning its activities and financial condition and must obtain regulatory approvals prior to entering into certain transactions such as mergers with or acquisitions of other financial institutions. The OCC regularly examines Kearny Bank and prepares reports to Kearny Bank’s Board of Directors on deficiencies, if any, found in its operations. The OCC has substantial discretion to take enforcement action with respect to an institution that fails to comply with applicable regulatory requirements or engages in violations of law or unsafe and unsound practices. Such

 

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actions can include, among others, the issuance of a cease and desist order, assessment of civil money penalties, removal of officers and directors and the appointment of a receiver or conservator. In addition, the FDIC has the authority to recommend to the Comptroller of the Currency to take enforcement action with respect to a particular federally-chartered savings bank and, if the Comptroller does not take action, the FDIC has authority to take such action under certain circumstances.

Federal Deposit Insurance. Kearny Bank’s deposits are insured to applicable limits by the FDIC. Under the Dodd-Frank Act, the maximum deposit insurance amount has been permanently increased from $100,000 to $250,000.

The FDIC has adopted a risk-based premium system that provides for quarterly assessments. Assessments are based on an insured institution’s classification among four risk categories determined from their examination ratings and capital and other financial ratios. The institution is assigned to a category and the category determines its assessment rate, subject to certain specified risk adjustments. Insured institutions deemed to pose less risk to the deposit insurance fund pay lower assessments, while greater risk institutions pay higher assessments.

In February 2011, the FDIC published a final rule under the Dodd-Frank Act to reform the deposit insurance assessment system. Under the rule, assessments are based on an institution’s average consolidated total assets minus average tangible equity instead of deposits, which was the FDIC’s prior practice. The rule revised the assessment rate schedule to establish assessments ranging from 2.5 to 45 basis points, based on an institution’s risk classification and possible risk adjustments.

In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended June 30, 2014, the annualized FICO assessment was equal to 0.62 of a basis point of total assets less tangible capital.

The Dodd-Frank Act increased the minimum target Deposit Insurance Fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The FDIC must seek to achieve the 1.35% ratio by June 30, 2020. It is intended that insured institutions with assets of $10 billion or more will fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving the maximum ratio to the discretion of the FDIC. The FDIC has exercised that discretion by establishing a long-term goal of a fund ratio of 2.0%.

The FDIC has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of Kearny Bank. Management cannot predict what assessment rates will be in the future.

Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that may lead to termination of our deposit insurance.

Regulatory Capital Requirements. Under the OCC’s regulations, federal savings banks such as Kearny Bank are required to comply with minimum leverage capital requirements. For an institution not anticipating or experiencing significant growth and deemed by the OCC to be, in general, a strong banking organization rated composite 1 under Uniform Financial Institutions Ranking System, the

 

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minimum capital leverage requirement is a ratio of Tier 1 capital to total assets of 3.0%. For all other institutions, the minimum leverage capital ratio is 4.0%. Tier 1 capital is the sum of common stockholder’s equity, noncumulative perpetual preferred stock (including any related surplus) and minority investments in certain subsidiaries, less intangible assets (except for certain servicing rights and credit card relationships) and certain other specified items.

OCC regulations also require federal savings institutions to maintain certain ratios of regulatory capital to regulatory risk-weighted assets, or “risk-based capital ratios.” Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items to risk-weighted categories ranging from 0.0% to 200.0%. Institutions must maintain a minimum ratio of total capital to risk-weighted assets of at least 8.0%, of which at least one-half must be Tier 1 capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary capital items, which include allowances for loan losses in an amount of up to 1.25% of risk-weighted assets, cumulative preferred stock, subordinated debentures and certain other capital instruments, and a portion of the net unrealized gain on equity securities. The includable amount of Tier 2 capital cannot exceed the amount of the institution’s Tier 1 capital.

Federal savings institutions must also meet a “tangible capital” standard of 1.5% of total adjusted assets. Tangible capital is generally defined as Tier 1 capital less intangible assets except for certain mortgage servicing rights.

In July 2013, the OCC and the other federal bank regulatory agencies issued a final rule to revise the risk-based and leverage capital requirements and the method for calculating risk-weighted assets, to make them consistent with the agreements that were reached by the international Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and top-tier savings and loan holding companies (“banking organizations”). Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), sets the minimum leverage ratio for all institutions at a uniform 4% of total assets, increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt out is exercised. The final rule limits a banking organization’s dividends, stock repurchases and other capital distributions, and certain discretionary bonus payments to executive officers, if the bank organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above regulatory minimum risk-based requirements. The final rule becomes effective for us on January 1, 2015. The capital conservation buffer requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective.

In assessing an institution’s capital adequacy, the OCC considers not only these numeric factors but also qualitative risk factors and has authority to establish higher capital requirements for individual institutions as deemed necessary.

Prompt Corrective Regulatory Action. Federal law requires that federal bank regulatory authorities take “prompt corrective action” with respect to institutions that do not meet minimum capital requirements. For these purposes, the law establishes five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.

 

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The OCC has adopted regulations to implement the prompt corrective action legislation. An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater and a leverage ratio of 5.0% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, and generally a leverage ratio of 4.0% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or generally a leverage ratio of less than 4.0%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0%, or a leverage ratio of less than 3.0%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2.0%.

“Undercapitalized” banks must adhere to growth, capital distribution (including dividend) and other limitations and are required to submit a capital restoration plan. A bank’s compliance with such a plan must be guaranteed by any company that controls the undercapitalized institution in an amount equal to the lesser of 5% of the institution’s total assets when deemed undercapitalized or the amount necessary to achieve the status of adequately capitalized. If an “undercapitalized” bank fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” banks must comply with one or more of a number of additional measures, including, but not limited to, a required sale of sufficient voting stock to become adequately capitalized, a requirement to reduce total assets, cessation of taking deposits from correspondent banks, the dismissal of directors or officers and restrictions on interest rates paid on deposits, compensation of executive officers and capital distributions by the parent holding company. “Critically undercapitalized” institutions are subject to additional measures including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status. These actions are in addition to other discretionary supervisory or enforcement actions that the OCC may take.

The recently adopted final rule that will increase regulatory capital requirements will adjust the prompt corrective action categories accordingly.

Dividend and Other Capital Distribution Limitations. Federal regulations impose various restrictions or requirements on the ability of savings institutions to make capital distributions, including cash dividends. A savings institution that is a subsidiary of a savings and loan holding company, such as Kearny Bank, must file notice with the Federal Reserve Board and an application or a notice with the OCC at least thirty days before making a capital distribution, such as paying a dividend to Kearny-Federal. A savings institution must file an application with the OCC for prior approval of a capital distribution if: (i) it is not eligible for expedited treatment under the applications processing rules; (ii) the total amount of all capital distributions, including the proposed capital distribution, for the applicable calendar year would exceed an amount equal to the savings institution’s net income for that year to date plus the institution’s retained net income for the preceding two years; (iii) it would not adequately be capitalized after the capital distribution; or (iv) the distribution would violate an agreement with the OCC or applicable regulations. The Federal Reserve Board may disapprove a notice and the OCC may disapprove a notice or deny an application for a capital distribution if: (i) the savings institution would be undercapitalized following the capital distribution; (ii) the proposed capital distribution raises safety and soundness concerns; or (iii) the capital distribution would violate a prohibition contained in any statute, regulation, enforcement action or agreement or condition imposed in connection with an application.

 

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Qualified Thrift Lender Test. Federal savings institutions must meet a qualified thrift lender test or they become subject to the business activity restrictions and branching rules applicable to national banks. In addition, the Dodd-Frank Act made failure to satisfy the qualified thrift lender test potentially subject to enforcement action as a violation of law. To meet the qualified thrift lender requirement, a savings institution must either (i) be deemed a “domestic building and loan association” under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”) by maintaining at least 60% of its total assets in specified types of assets, including cash, certain government securities, loans secured by and other assets related to residential real property, educational loans and investments in premises of the institution or (ii) satisfy the statutory qualified thrift lender test set forth in the Home Owners’ Loan Act by maintaining at least 65% of its portfolio assets in qualified thrift investments (defined to generally include residential mortgages and related equity investments, certain mortgage-related securities, small business loans, student loans and credit card loans). For purposes of the statutory qualified thrift lender test, portfolio assets are defined as total assets minus goodwill and other intangible assets, the value of property used by the institution in conducting its business and specified liquid assets up to 20% of total assets. A savings institution must maintain its status as a qualified thrift lender in at least nine out of every twelve months.

A savings institution that fails the qualified thrift lender test and does not convert to a bank charter will generally be prohibited from: (1) engaging in any new activity not permissible for a national bank; (2) paying dividends not permissible under national bank regulations; and (3) establishing any new branch office in a location not permissible for a national bank in the institution’s home state. Its holding company would become regulated as a bank holding company rather than a savings and loan holding company. In addition, if the institution does not requalify under the qualified thrift lender test within three years after failing the test, the institution would be prohibited from making any investment or engaging in any activity not permissible for a national bank.

Transactions with Related Parties. Transactions between a savings institution (and, generally, its subsidiaries) and its related parties or affiliates are limited by Sections 23A and 23B of the Federal Reserve Act. An affiliate of an institution is any company or entity that controls, is controlled by or is under common control with the institution. In a holding company context, the parent holding company and any companies which are controlled by such parent holding company are affiliates of the institution. Generally, Section 23A of the Federal Reserve Act limits the extent to which the institution or its subsidiaries may engage in “covered transactions” with any one affiliate to 10% of such institution’s capital stock and surplus and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such institution’s capital stock and surplus. The term “covered transaction” includes an extension of credit, purchase of assets, issuance of a guarantee or letter of credit and similar transactions. In addition, loans or other extensions of credit by the institution to the affiliate are required to be collateralized in accordance with specified requirements. The law also requires that affiliate transactions be on terms and conditions that are substantially the same, or at least as favorable to the institution, as those provided to non-affiliates.

Kearny Bank’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things and subject to certain exceptions, these provisions generally require that extensions of credit to insiders:

 

    be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and

 

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    not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Kearny Bank’s capital.

In addition, extensions of credit in excess of certain limits must be approved by Kearny Bank’s board of directors. Extensions of credit to executive officers are subject to additional limits based on the type of extension involved.

Community Reinvestment Act. Under the CRA, every insured depository institution, including Kearny Bank, has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the OCC to assess the depository institution’s record of meeting the credit needs of its community and to consider such record in its evaluation of certain applications by such institution, such as a merger or the establishment of a branch office by Kearny Bank. The OCC may use an unsatisfactory CRA examination rating as the basis for the denial of an application. Kearny Bank received a “satisfactory” CRA rating in its most recent CRA examination.

Federal Home Loan Bank System. Kearny Bank is a member of the FHLB of New York, which is one of twelve regional Federal Home Loan Banks. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by financial institutions and proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members pursuant to policies and procedures established by the board of directors of the FHLB.

As a member, Kearny Bank is required to purchase and maintain stock in the FHLB of New York in specified amounts. The FHLB imposes various limitations on advances such as limiting the amount of certain types of real estate related collateral and limiting total advances to a member.

The FHLB of New York may pay periodic dividends to members. These dividends are affected by factors such as the FHLB’s operating results and statutory responsibilities that may be imposed such as providing certain funding for affordable housing and interest subsidies on advances targeted for low- and moderate-income housing projects. The payment of such dividends or any particular amount cannot be assumed.

Other Laws and Regulations

Interest and other charges collected or contracted for by Kearny Bank are subject to state usury laws and federal laws concerning interest rates. Kearny Bank’s operations are also subject to federal laws (and their implementing regulations) applicable to credit transactions, such as the:

 

    Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

    Real Estate Settlement Procedures Act, requiring that borrowers for mortgage loans for one- to four-family residential real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing and escrow account practices, and prohibiting certain practices that increase the cost of settlement services;

 

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    Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

    Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

    Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;

 

    Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

 

    Truth in Savings Act, prescribing disclosure and advertising requirements with respect to deposit accounts.

The operations of Kearny Bank also are subject to the:

 

    Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

    Electronic Funds Transfer Act and Regulation E promulgated thereunder, governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;

 

    Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check;

 

    USA PATRIOT Act, which requires institutions operating to, among other things, establish broadened anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and

 

    Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties.

 

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Regulation of Kearny-Federal

General. Kearny-Federal is a savings and loan holding company within the meaning of Section 10 of the Home Owners’ Loan Act. As a result of the Dodd-Frank Act, it is required to file reports with, and is be subject to regulation and examination by, the Federal Reserve Board, as successor to the OTS. Kearny-Federal must also obtain regulatory approval from the Federal Reserve Board before engaging in certain transactions, such as mergers with or acquisitions of other financial institutions. In addition, the Federal Reserve Board has enforcement authority over Kearny-Federal and any non-savings institution subsidiaries. This permits the Federal Reserve Board to restrict or prohibit activities that are determined to pose a serious risk to Kearny Bank. This regulation is intended primarily for the protection of the depositors and not for the benefit of stockholders of Kearny-Federal.

The Federal Reserve Board has indicated that, to the greatest extent possible taking into account any unique characteristics of savings and loan holding companies and the requirements of the Home Owners’ Loan Act, it intends to apply to savings and loan holding companies its supervisory approach to the supervision of bank holding companies. The stated objective of the Federal Reserve Board is to ensure the savings and loan holding company and its non-depository subsidiaries are effectively supervised, can serve as a source of strength for, and do not threaten the safety and soundness of, the subsidiary depository institutions. The Federal Reserve Board has generally adopted the substantive provisions of OTS regulations governing savings and loan holding companies on an interim final basis with certain modifications as discussed below.

Activities Restrictions. As a savings and loan holding company, Kearny-Federal is subject to statutory and regulatory restrictions on its business activities. The non-banking activities of Kearny-Federal and its non-savings institution subsidiaries is restricted to certain activities specified by the Federal Reserve Board regulation, which include performing services and holding properties used by a savings institution subsidiary, activities authorized for savings and loan holding companies as of March 5, 1987 and non-banking activities permissible for bank holding companies pursuant to Bank Holding Company Act of 1956 or authorized for financial holding companies pursuant to the Gramm-Leach-Bliley Act. Before engaging in any non-banking activity or acquiring a company engaged in any such activities, Kearny-Federal must file with the Federal Reserve Board either a prior notice or (in the case of non-banking activities permissible for bank holding companies) an application regarding its planned activity or acquisition. Under the Dodd-Frank Act, a savings and loan holding company may only engage in activities authorized for financial holding companies if they meet all of the criteria to qualify as a financial holding company. Accordingly, the Federal Reserve Board will require savings and loan holding companies to elect to be treated as financial holding companies in order to engage in financial holding company activities. In order to make such an election, the savings and loan holding company and its depository institution subsidiaries must be well capitalized and well managed.

Mergers and Acquisitions. Kearny-Federal must obtain approval from the Federal Reserve Board before acquiring, directly or indirectly, more than 5% of the voting stock of another savings institution or savings and loan holding company or acquiring such an institution or holding company by merger, consolidation, or purchase of its assets. Federal law also prohibits a savings and loan holding company from acquiring more than 5% of a company engaged in activities other than those authorized for savings and loan holding companies by federal law or acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating an application for Kearny-Federal to acquire control of a savings institution, the Federal Reserve Board would consider factors such as the financial and managerial resources and future prospects of Kearny-Federal and the target institution, the effect of the acquisition on the risk to the insurance funds, the convenience and the needs of the community and competitive factors.

 

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Consolidated Capital Requirements. Savings and loan holding companies have historically not been subjected to consolidated regulatory capital requirements. The Dodd-Frank Act, however, required the Federal Reserve Board to promulgate consolidated capital requirements for bank and savings and loan holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to their subsidiary depository institutions. Instruments such as cumulative preferred stock and trust-preferred securities, which are currently includable as Tier 1 capital, by bank holding companies within certain limits will no longer be includable as Tier 1 capital, subject to certain grandfathering. The previously discussed final rule regarding regulatory capital requirements implements the Dodd-Frank Act’s directives as to holding company capital requirements. Consolidated regulatory capital requirements identical to those applicable to the subsidiary depository institutions will apply to savings and loan holding companies as of January 1, 2015. As is the case with institutions themselves, the capital conservation buffer will be phased in between 2016 and 2019.

Source of Strength Doctrine. The Dodd-Frank Act also extended the “source of strength” doctrine, which has long applied to bank holding companies, to savings and loan holding companies as well. The Federal Reserve Board has promulgated regulations implementing the “source of strength” policy, which requires holding companies to act as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial distress. Further, the Federal Reserve Board has issued a policy statement regarding the payment of dividends by bank holding companies that it has also applied to savings and loan holding companies. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for consultation with a holding company’s Federal Reserve Board as to capital distributions in certain circumstances such as where our net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or our overall rate of earnings retention is inconsistent with our capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary depository institution becomes undercapitalized. In addition, a subsidiary savings institution of a savings and loan holding company must file prior notice with the Federal Reserve Board, and receive its nonobjection, as well as filing an application or notice with the OCC, and receiving OCC approval or nonobjection, before paying dividends to the parent savings and loan holding company. Federal Reserve Board guidance also provides for regulatory review of certain stock redemption and repurchase proposals by holding companies. These regulatory policies could affect the ability of Kearny-Federal to pay dividends, engage in stock redemptions or repurchases or otherwise engage in capital distributions.

Acquisition of Control. Under the federal Change in Bank Control Act, a notice must be submitted to the Federal Reserve Board if any person (including a company), or group acting in concert, seeks to acquire “control” of a savings and loan holding company. An acquisition of “control” can occur upon the acquisition of 10% or more of the voting stock of a savings and loan holding company or as otherwise defined by the Federal Reserve Board. Under the Change in Bank Control Act, the Federal Reserve Board has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that so acquires control is then subject to regulation as a savings and loan holding company.

 

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Item 1A. Risk Factors

The following is a summary of what management currently believes to be the material risks related to an investment in the Company’s securities.

Changes in interest rates may adversely affect our profitability and financial condition.

We derive our income mainly from the difference or “spread” between the interest earned on loans, securities and other interest-earning assets and interest paid on deposits, borrowings and other interest-bearing liabilities. In general, the larger the spread, the more we earn. When market rates of interest change, the interest we receive on our assets and the interest we pay on our liabilities will fluctuate. This can cause decreases in our spread and can adversely affect our income.

From an interest rate risk perspective, we have generally been liability sensitive, which indicates that liabilities generally re-price faster than assets.

In response to negative economic developments, the Federal Reserve Board’s Open Market Committee steadily reduced its federal funds rate target from 5.25% in September 2007 to between 0.00% and 0.25% currently, which has had the effect of reducing our cost of funds. Given our historic liability sensitivity, the decline in our cost of funds initially outpaced the decline in yield on our earning assets thereby having a positive impact on our net interest rate spread and net interest margin during the years preceding fiscal 2012. However, from fiscal 2012 through fiscal 2014, the rate of reduction in our cost of interest-bearing liabilities slowed in relation to the continuing decline in the yield on our interest-earning assets. Consequently, our net interest rate spread decreased by two basis points to 2.32% for the year ended June 30, 2014 from 2.34% for the year ended June 30, 2013. Our net interest margin declined six basis points to 2.44% for the year ended June 30, 2014 from 2.50% for the year ended June 30, 2013. Our net interest spread declined 12 basis points during fiscal 2013 from 2.46% for the preceding fiscal year ended June 30, 2012. Our net interest margin declined an additional 15 basis points during fiscal 2013 from 2.65% for the preceding fiscal year ended June 30, 2012.

We continue to be at risk of additional reductions in our net interest rate spread and net interest margin resulting from further declines in our yield on interest-earning assets that may outpace any subsequent reductions in our cost of funds. In particular, our ability to further reduce the cost of our interest-bearing deposits is increasingly limited given that most deposit offering rates are already well below 1.00% at June 30, 2014. Moreover, our liability sensitivity may adversely affect net income in the future when market interest rates ultimately increase from historical lows and our cost of interest-bearing liabilities rises faster than our yield on interest-earning assets.

Interest rates also affect how much money we lend. For example, when interest rates rise, the cost of borrowing increases and loan originations tend to decrease. In addition, changes in interest rates can affect the average life of loans and securities. A reduction in interest rates generally results in increased prepayments of loans and mortgage-backed securities, as borrowers refinance their debt in order to reduce their borrowing cost. This causes reinvestment risk, because we generally are not able to reinvest prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities.

Changes in market interest rates could also reduce the value of our interest-earning assets including, but not limited to, our securities portfolio. In particular, the unrealized gains and losses on securities available for sale are reported, net of tax, in accumulated other comprehensive income which is a component of stockholders’ equity. As such, declines in the fair value of such securities resulting from increases in market interest rates may adversely affect stockholders’ equity.

 

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If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings will decrease.

We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the required amount of the allowance for loan losses, we evaluate certain loans individually and establish loan loss allowances for specifically identified impairments. For all non-impaired loans, including those not individually reviewed, we estimate losses and establish loan loss allowances based upon historical and environmental loss factors. If the assumptions used in our calculation methodology are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in further additions to our allowance. While our allowance for loan losses was 0.71% of total loans at June 30, 2014, significant additions to our allowance could materially decrease our net income.

In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities might have a material adverse effect on our financial condition and results of operations.

A significant portion of our assets consists of investment securities, which generally have lower yields than loans, and we classify a significant portion of our investment securities as available for sale which creates potential volatility in our equity and may have an adverse impact on our net income.

As of June 30, 2014, our securities portfolio, which includes mortgage-backed securities and collateralized mortgage obligations, totaled $1.36 billion, or 38.7% of our total assets. Investment securities typically have lower yields than loans. For fiscal 2014, the weighted average yield of our investment securities portfolio was 2.08% as compared to 4.31% for our loan portfolio. Accordingly, our net interest margin is lower than it would have been if a higher proportion of our interest-earning assets had been invested in loans. Additionally, $845.1 million, or 62.3% of our investment securities, are classified as available for sale and reported at fair value with unrealized gains or losses excluded from earnings and reported in other comprehensive income which affects our reported equity. Accordingly, given the significant size of the investment securities portfolio classified as available for sale and due to possible mark-to-market adjustments of that portion of the portfolio resulting from market conditions, we may experience greater volatility in the value of reported equity. Moreover, given that we actively manage our investment securities portfolio classified as available for sale, we may sell securities which could result in a realized loss, thereby reducing our net income.

Our increased commercial lending exposes us to additional risk.

Our commercial loans increased to 60.3% of total loans at June 30, 2014 from 21.5% of total loans at June 30, 2010. Our commercial lending operations include commercial mortgages, multi-family loans and other non-residential mortgage loans. We intend to continue increasing our commercial lending as part of our planned transition from a traditional thrift to a full-service community bank. We have also increased our commercial lending staff and are seeking additional commercial lenders to help grow the commercial loan portfolio. Our increased commercial lending, however, exposes us to greater risks than one- to four-family residential lending. Unlike single-family, owner-occupied residential mortgage loans,

 

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which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income and are secured by real property whose value tends to be more easily ascertainable and realizable, the repayment of commercial loans typically is dependent on the successful operation and income stream of the borrower, which can be significantly affected by economic conditions, and are secured, if at all, by collateral that is more difficult to value or sell or by collateral which may depreciate in value. In addition, commercial loans generally carry larger balances to single borrowers or related groups of borrowers than one- to four-family mortgage loans, which increases the financial impact of a borrower’s default.

Our loan portfolio contains a significant portion of loans that are unseasoned. It is difficult to evaluate the future performance of unseasoned loans.

Our net loan portfolio has grown to $1.73 billion at June 30, 2014, from $1.00 billion at June 30, 2010. A portion of this increase is due to increases in commercial real estate and commercial business loans resulting from originations and from purchases of and participations in loans originated by other financial institutions. It is difficult to assess the future performance of these loans recently added to our portfolio because our relatively limited experience with such loans does not provide us with a significant payment history from which to evaluate future collectability. These loans may experience higher delinquency or charge-off levels than our historical loan portfolio experience, which could adversely affect our future performance.

Because we intend to continue to increase our commercial business loan originations, our credit risk will increase.

We intend to increase our originations of commercial business loans, including C&I and SBA loans, which generally have more risk than one- to four-family residential mortgage loans. Since repayment of commercial business loans may depend on the successful operation of the borrower’s business, repayment of such loans can be affected by adverse conditions in the real estate market or the local economy. Because we plan to continue to increase our originations of these loans, it may be necessary to increase the level of our allowance for loan losses because of the increased risk characteristics associated with these types of loans. Any such increase to our allowance for loan losses would adversely affect our earnings. Additionally, Kearny Bank historically has not had a significant portfolio of commercial business loans.

Kearny Bank’s reliance on brokered deposits could adversely affect its liquidity and operating results.

Among other sources of funds, Kearny Bank relies on brokered deposits to provide funds with which to make loans and provide for other liquidity needs. On June 30, 2014, brokered deposits totaled $232.0 million, or approximately 9.7% of total deposits. Kearny Bank’s primary source for brokered money market deposits is the Promontory Interfinancial Network’s (“Promontory”) Insured Network Deposits (“IND”), a brokered deposit network that is sourced by Promontory from large retail and institutional brokerage firms whose individual clients seek to have a portion of their investments held in interest-bearing accounts at FDIC-insured institutions. Our Promontory IND deposits totaled $213.5 million at June 30, 2014. These funds were augmented by a small portfolio of longer-term, brokered certificates of deposit acquired during fiscal 2014 which totaled approximately $18.5 million at June 30, 2014.

Generally brokered deposits may not be as stable as other types of deposits. In the future, those depositors may not replace their brokered deposits with us as they mature, or we may have to pay a higher

 

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rate of interest to keep those deposits or to replace them with other deposits or other sources of funds. Not being able to maintain or replace those deposits as they mature would adversely affect our liquidity. Paying higher deposit rates to maintain or replace brokered deposits would adversely affect our net interest margin and operating results.

We may be required to record additional impairment charges with respect to our investment securities portfolio.

We review our securities portfolio at the end of each quarter to determine whether the fair value is below the current carrying value. When the fair value of any of our investment securities has declined below its carrying value, we are required to assess whether the impairment is other than temporary. If we conclude that the impairment is other than temporary, we are required to write down the value of that security. The “credit-related” portion of the impairment is recognized through earnings whereas the “noncredit-related” portion is generally recognized through other comprehensive income in the circumstances where the future sale of the security is unlikely.

At June 30, 2014, we had investment securities with fair values of approximately $1.35 billion on which we had approximately $14.3 million in gross unrealized losses. All unrealized losses on investment securities at June 30, 2014 represented temporary impairments of value. However, if changes in the expected cash flows of these securities and/or prolonged price declines result in our concluding in future periods that the impairment of these securities is other than temporary, we will be required to record an impairment charge against income equal to the credit-related impairment.

Our investments in corporate and municipal debt securities and collateralized loan obligations expose us to additional credit risks.

The composition and allocation of our investment portfolio has historically emphasized U.S. agency mortgage-backed securities and U.S. agency debentures. While such assets remain a significant component of our investment portfolio at June 30, 2014, recent enhancements to our investment policies, strategies and infrastructure have enabled us to diversify the composition and allocation of our securities portfolio. Such diversification has included investing in bank-qualified municipal obligations, bonds issued by financial institutions and collateralized loan obligations. Unlike U.S. agency securities, the municipal and corporate debt securities acquired are backed only by the credit of their issuers while investments in collateralized loan obligations generally rely on the structural characteristics of an individual tranche within a larger investment vehicle to protect the investor from credit losses arising from borrowers defaulting on the underlying securitized loans.

While we have invested primarily in investment grade securities, these securities are not backed by the federal government and expose us to a greater degree of credit risk than U.S. agency securities. Any decline in the credit quality of these securities exposes us to the risk that the market value of the securities could decrease which may require us to write down their value and could lead to a possible default in payment.

We hold certain intangible assets that could be classified as impaired in the future. If these assets are considered to be either partially or fully impaired in the future, our earnings would decrease.

At June 30, 2014, we had approximately $109.4 million in intangible assets on our balance sheet comprising $108.6 million of goodwill and $790,000 of core deposit intangibles. We are required to periodically test our goodwill and identifiable intangible assets for impairment. The impairment testing process considers a variety of factors, including the current market price of our common stock, the

 

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estimated net present value of our assets and liabilities, and information concerning the terminal valuation of similarly situated insured depository institutions. If an impairment determination is made in a future reporting period, our earnings and the book value of these intangible assets will be reduced by the amount of the impairment. If an impairment loss is recorded, it will have little or no impact on the tangible book value of our common stock or our regulatory capital levels, but recognition of such an impairment loss could significantly restrict Kearny Bank’s ability to make dividend payments to the parent company and Kearny-Federal’s ability to pay dividends to stockholders.

Recently enacted financial reform legislation could substantially increase our compliance burden and costs and necessitate changes in the conduct of our business.

On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank Act is having a broad impact on the financial services industry, including significant regulatory and compliance changes. Many of the requirements called for in the Dodd-Frank Act are being implemented over time. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is unclear and may not be known for many years. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business. In particular, the following provisions of the Dodd-Frank Act, among others, are impacting our operations and activities, both currently and prospectively:

 

    elimination of the OTS as our primary federal regulator, which requires us to continue adapting to a new regulatory regime;

 

    weakening of federal preemption standards applicable to Kearny Bank, which exposes us to additional state regulation;

 

    changes in methodologies for calculating deposit insurance premiums and increases in required deposit insurance fund reserve levels, which could increase our deposit insurance expense;

 

    application of regulatory capital requirements to Kearny-Federal; and

 

    imposition of comprehensive, new consumer protection requirements, which could substantially increase our compliance burden and potentially expose us to new liabilities.

Further, we may be required to invest significant management attention and resources to evaluate and continue to make any changes necessary to comply with new statutory and regulatory requirements under the Dodd-Frank Act. Failure to comply with the new requirements may negatively impact our results of operations and financial condition. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on us, these changes could be materially adverse to our investors.

Strong competition within our market area may limit our growth and profitability.

Competition is intense within the banking and financial services industry in New Jersey and New York. In our market area, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment

 

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banking firms operating locally and elsewhere. Many of these competitors have substantially greater resources, higher lending limits and offer services that we do not or cannot provide. This competition makes it more difficult for us to originate new loans and retain and attract new deposits. Price competition for loans may result in originating fewer loans, or earning less on our loans and price competition for deposits may result in a reduction of our deposit base or paying more on our deposits.

Our business is geographically concentrated in New Jersey and New York and a downturn in economic conditions within the region could adversely affect our profitability.

A substantial majority of our loans are to individuals and businesses in New Jersey and New York. The decline in the economy of the region could continue to have an adverse impact on our earnings. We have a significant amount of real estate mortgages, such that continuing decreases in local real estate values may adversely affect the value of property used as collateral. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which may adversely influence our profitability.

The short-term and long-term impact of the changing regulatory capital requirements and new capital rules is uncertain.

The federal banking agencies have recently adopted proposals that when effective will substantially amend the regulatory risk-based capital rules applicable to Kearny-Federal and Kearny Bank. The amendments implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. The new rules will apply regulatory capital requirements to Kearny-Federal. The amended rules include new minimum risk-based capital and leverage ratios, which will become effective in January 2015 with certain requirements to be phased in beginning in 2016, and will refine the definition of what constitutes “capital” for purposes of calculating those ratios.

The new minimum capital level requirements applicable to Kearny Bank would include: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The amended rules also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital ratios, and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement will be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that could be utilized for such actions.

The Basel III changes and other regulatory capital requirements will result in generally higher regulatory capital standards. However, it is difficult at this time to predict the precise effect on us. The application of more stringent capital requirements to Kearny-Federal and Kearny Bank could, among other things, result in lower returns on invested capital, require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements. Furthermore, the imposition of liquidity requirements in connection with the implementation of Basel III could result in our having to lengthen the term of our funding, restructure our business models, and/or increase our holdings of liquid assets. Implementation of changes to asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its business strategy and could further limit our ability to make distributions, including paying out dividends or buying back shares.

 

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A natural disaster could harm our business.

Natural disasters can disrupt our operations, result in damage to our properties, reduce or destroy the value of the collateral for our loans and negatively affect the local economies in which we operate, which could have a material adverse effect on our results of operations and financial condition. The occurrence of a natural disaster could result in one or more of the following: (i) an increase in loan delinquencies; (ii) an increase in problem assets and foreclosures; (iii) a decrease in the demand for our products and services; or (iv) a decrease in the value of the collateral for loans, especially real estate, in turn reducing customers’ borrowing power, the value of assets associated with problem loans and collateral coverage.

Acts of terrorism and other external events could impact our ability to conduct business.

Financial institutions have been, and continue to be, targets of terrorist threats aimed at compromising operating and communication systems and the metropolitan New York area and northern New Jersey remain central targets for potential acts of terrorism. Such events could cause significant damage, impact the stability of our facilities and result in additional expenses, impair the ability of our borrowers to repay their loans, reduce the value of collateral securing repayment of our loans, and result in the loss of revenue. While we have established and regularly test disaster recovery procedures, the occurrence of any such event could have a material adverse effect on our business, operations and financial condition.

Because the nature of the financial services business involves a high volume of transactions, we face significant operational risks.

We operate in diverse markets and rely on the ability of our employees and systems to process a high number of transactions. Operational risk is the risk of loss resulting from our operations, including but not limited to, the risk of fraud by employees or persons outside Kearny-Federal, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements, and business continuation and disaster recovery. Insurance coverage may not be available for such losses, or where available, such losses may exceed insurance limits. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, we could suffer financial loss, face regulatory action, and suffer damage to our reputation.

Our risk management framework may not be effective in mitigating risk and reducing the potential for significant losses.

Our risk management framework is designed to minimize risk and loss to us. We seek to identify, measure, monitor, report and control our exposure to risk, including strategic, market, liquidity, compliance and operational risks. While we use a broad and diversified set of risk monitoring and mitigation techniques, these techniques are inherently limited because they cannot anticipate the existence or future development of currently unanticipated or unknown risks. Recent economic conditions and heightened legislative and regulatory scrutiny of the financial services industry, among other developments, have increased our level of risk. Accordingly, we could suffer losses as a result of our failure to properly anticipate and manage these risks.

 

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We could be adversely affected by failure in our internal controls.

A failure in our internal controls could have a significant negative impact not only on our earnings, but also on the perception that customers, regulators and investors may have of us. We continue to devote a significant amount of effort, time and resources to continually strengthening our controls and ensuring compliance with complex accounting standards and banking regulations.

Risks associated with system failures, interruptions, or breaches of security could negatively affect our earnings.

Information technology systems are critical to our business. We use various technology systems to manage our customer relationships, general ledger, securities investments, deposits, and loans. We have established policies and procedures to prevent or limit the effect of system failures, interruptions, and security breaches, but such events may still occur or may not be adequately addressed if they do occur. In addition, any compromise of our systems could deter customers from using our products and services. Although we rely on security systems to provide security and authentication necessary to effect the secure transmission of data, these precautions may not protect our systems from security breaches.

In addition, we outsource a majority of our data processing to certain third-party providers. If these third-party providers encounter difficulties, or if we have difficulty communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely affected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.

The occurrence of any system failures, interruption, or breach of security could damage our reputation and result in a loss of customers and business thereby subjecting us to additional regulatory scrutiny, or could expose us to litigation and possible financial liability. Any of these events could have a material adverse effect on our financial condition and results of operations.

Acquisitions may disrupt our business and dilute stockholder value.

We regularly evaluate merger and acquisition opportunities with other financial institutions and financial services companies. As a result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We would seek acquisition partners that offer us either significant market presence or the potential to expand our market footprint and improve profitability through economies of scale or expanded services.

Future acquisitions of other banks, businesses, or branches may have an adverse effect on our financial results and may involve various other risks commonly associated with acquisitions, including, among other things:

 

    difficulty in estimating the value of the target company;

 

    payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term;

 

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    potential exposure to unknown or contingent liabilities of the target company;

 

    exposure to potential asset quality problems of the target company;

 

    potential volatility in reported income associated with goodwill impairment losses;

 

    difficulty and expense of integrating the operations and personnel of the target company;

 

    inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits;

 

    potential disruption to our business;

 

    potential diversion of our management’s time and attention;

 

    possible loss of key employees and customers of the target company; and

 

    potential changes in banking or tax laws or regulations that may affect the target company.

Our inability to achieve profitability on new branches may negatively affect our earnings.

We have expanded our presence throughout our market area and we intend to pursue further expansion through de novo branching or the purchase of branches from other financial institutions. The profitability of our expansion strategy will depend on whether the income that we generate from the new branches will offset the increased expenses resulting from operating these branches. We expect that it may take a period of time before these branches can become profitable, especially in areas in which we do not have an established presence. During this period, the expense of operating these branches may negatively affect our net income.

Item 1B. Unresolved Staff Comments

Not applicable.

 

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Item 2. Properties

The Company and the Bank conduct business from their administrative headquarters at 120 Passaic Avenue in Fairfield, New Jersey and 42 branch offices located in Bergen, Essex, Hudson, Middlesex, Monmouth, Morris, Ocean, Passaic and Union counties, New Jersey and Kings and Richmond counties, New York. Eighteen of our offices are leased with remaining terms between one and fifteen years. At June 30, 2014, our net investment in property and equipment totaled $40.1 million. The following table sets forth certain information relating to our properties as of June 30, 2014. The net book values reported include our investment in land, building and/or leasehold improvements by property location.

 

Office Location

   Year
Opened
     Net Book Value as of
June 30, 2014

(In Thousands)
     Square
Footage
     Owned/
Leased
 

Executive Office:

           

120 Passaic Avenue

           

Fairfield, New Jersey

     2004       $ 10,203         53,000         Owned   

Main Office:

           

614 Kearny Avenue

           

Kearny, New Jersey

     1928         887         6,764         Owned   

Branches:

           

425 Route 9 & Ocean Gate Drive

           

Bayville, New Jersey

     1973         110         3,500         Leased   

417 Bloomfield Avenue

           

Caldwell, New Jersey

     1968         267         4,400         Owned   

20 Willow Street

           

East Rutherford, New Jersey

     1969         34         3,100         Owned   

534 Harrison Avenue

           

Harrison, New Jersey

     1995         611         3,000         Owned   

1353 Ringwood Avenue

           

Haskell, New Jersey

     1996         —           2,500         Leased   

718B Buckingham Drive

           

Lakewood, New Jersey

     2008         7         2,800         Leased   

630 North Main Street

           

Lanoka Harbor, New Jersey

     2005         1,911         3,200         Owned   

307 Stuyvesant Avenue

           

Lyndhurst, New Jersey

     1970         114         3,300         Owned   

270 Ryders Lane

           

Milltown, New Jersey

     1989         6         3,600         Leased   

339 Main Road

           

Montville, New Jersey

     1996         2         1,850         Leased   

119 Paris Avenue

           

Northvale, New Jersey

     1965         283         1,750         Owned   

 

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Office Location

   Year
Opened
     Net Book Value as of
June 30, 2014

(In Thousands)
     Square
Footage
     Owned/
Leased
 

80 Ridge Road

           

North Arlington, New Jersey

     1952         97         3,500         Owned   

510 State Highway 34

           

Old Bridge Township, New Jersey

     2002         842         2,400         Owned   

207 Old Tappan Road

           

Old Tappan, New Jersey

     1973         496         2,200         Owned   

267 Changebridge Road

           

Pine Brook, New Jersey

     1974         198         3,600         Owned   

917 Route 23 South

           

Pompton Plains, New Jersey

     2009         1,225         2,400         Leased   

653 Westwood Avenue

           

River Vale, New Jersey

     1965         645         1,600         Owned   

252 Park Avenue

           

Rutherford, New Jersey

     1974         1,456         1,984         Owned   

520 Main Street

           

Spotswood, New Jersey

     1979         210         2,400         Owned   

130 Mountain Avenue

           

Springfield, New Jersey

     1991         1,063         6,500         Owned   

827 Fischer Boulevard

           

Toms River, New Jersey

     1996         559         3,500         Owned   

2100 Hooper Avenue

           

Toms River, New Jersey

     2008         43         2,000         Leased   

487 Pleasant Valley Way

           

West Orange, New Jersey

     1971         125         3,000         Owned   

216 Main Street

           

West Orange, New Jersey

     1975         229         2,400         Owned   

250 Valley Boulevard

           

Wood-Ridge, New Jersey

     1957         1,432         9,500         Owned   

661 Wyckoff Avenue

           

Wyckoff, New Jersey

     2002         2,245         6,300         Owned   

Central Jersey Division Branch Offices:

           

Administrative Offices & Branch

           

1903 Highway 35

           

Oakhurst, New Jersey

     2008         407         15,200         Leased   

301 Main Street

           

Allenhurst, New Jersey

     2011         432         3,600         Leased   

611 Main Street

           

Belmar, New Jersey

     2002         19         3,200         Leased   

 

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Office Location

   Year
Opened
     Net Book Value as of
June 30, 2014

(In Thousands)
     Square
Footage
     Owned/
Leased
 

501 Main Street

           

Bradley Beach, New Jersey

     2001         733         3,100         Owned   

700 Branch Avenue

           

Little Silver, New Jersey

     2001         —           2,500         Leased   

444 Ocean Boulevard North

           

Long Branch, New Jersey

     2004         —           1,500         Leased   

627 Second Avenue

           

Long Branch, New Jersey

     1998         606         3,200         Owned   

155 Main Street

           

Manasquan, New Jersey

     1998         —           3,000         Leased   

300 West Sylvania Avenue

           

Neptune City, New Jersey

     2000         210         3,000         Leased   

61 Main Street

           

Ocean Grove, New Jersey

     2002         2         2,800         Leased   

2201 Bridge Avenue

           

Point Pleasant, New Jersey

     2001         24         3,500         Leased   

700 Allaire Road

           

Spring Lake Heights, New Jersey

     1999         —           2,500         Leased   

2200 Highway 35

           

Wall Township, New Jersey

     1997         941         5,000         Owned   

Atlas Bank Division Branch Offices:

           

689 Fifth Avenue

           

Brooklyn, New York

     1923         811         4,900         Owned   

339 Sand Lane

           

Staten Island, New York

     2009         121         1,985         Leased   

 

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Item 3. Legal Proceedings

We are, from time to time, party to routine litigation, which arises in the normal course of business, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. At June 30, 2014, there were no lawsuits pending or known to be contemplated against us that would be expected to have a material effect on operations or income.

Item 4. Mine Safety Disclosures

Not applicable.

 

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

(a) Market Information. The Company’s common stock trades on The NASDAQ Global Select Market under the symbol “KRNY”. The table below shows the reported high and low prices of the common stock and dividends paid per public share for each quarter during the last two fiscal years.

 

     High      Low      Dividends
Paid
 

Fiscal Year 2014

        

Quarter ended June 30, 2014

   $ 15.55       $ 12.97       $ —     

Quarter ended March 31, 2014

   $ 15.49       $ 10.91       $ —     

Quarter ended December 31, 2013

   $ 11.99       $ 10.10       $ —     

Quarter ended September 30, 2013

   $ 11.05       $ 9.19       $ —     

Fiscal Year 2013

        

Quarter ended June 30, 2013

   $ 10.56       $ 9.50       $ —     

Quarter ended March 31, 2013

   $ 10.67       $ 9.63       $ —     

Quarter ended December 31, 2012

   $ 9.92       $ 8.66       $ —     

Quarter ended September 30, 2012

   $ 9.99       $ 9.40       $ —     

Declarations of dividends by the Board of Directors depend on a number of factors, including investment opportunities, growth objectives, financial condition, profitability, tax considerations, minimum capital requirements, regulatory limitations, stock market characteristics and general economic conditions. The timing, frequency and amount of dividends are determined by the Board.

The Company’s ability to pay dividends at its historic rates has been dependent on the ability of Kearny MHC to waive receipt of dividends. In accordance with applicable policies of the OTS, Kearny MHC waived receipt of all or substantially all of the dividends declared by the Company through the quarter ended March 31, 2012. Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Federal Reserve assumed jurisdiction over mutual holding company dividend waivers and imposed onerous new requirements on dividend waivers. Because the MHC was unable to obtain a waiver of these requirements, the Board of Directors elected to forego the declaration of a dividend in the fourth quarter of fiscal year 2012 and throughout fiscal 2013 and 2014. No assurances can be given as to the frequency or amount of future dividends, if any.

The Company’s ability to pay dividends may also depend on the receipt of dividends from the Bank, which is subject to a variety of limitations under federal banking regulations regarding the payment of dividends.

As of August 29, 2014 there were 3,291 registered holders of record of the Company’s common stock, plus approximately 2,026 beneficial (street name) owners.

(b) Use of Proceeds. Not applicable.

 

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(c) Issuer Purchases of Equity Securities. Set forth below is information regarding the Company’s stock repurchases during the fourth quarter of the fiscal year ended June 30, 2014.

 

     Issuer Purchases of Equity Securities  
     Total
Number

of Shares
(or Units)
purchased
     Average
Price Paid
Per Share
(or Unit)
     Total Number of
Shares (or Units)
Purchased as Part
of Publicly

Announced  Plans
or Programs *
     Maximum Number
(or Approximate
Dollar Value) of
Shares (or Units)
that May Yet be

Purchased Under the
Plans or Programs
 

April 1 – April 30, 2014

     —         $ —           —           708,040   

May 1 – May 31, 2014

     8,300         13.78         8,300         699,740   

June 1 – June 30, 2014

     —           —           —           699,740   
  

 

 

       

 

 

    

Total

     8,300       $ 13.78         8,300         699,740   
  

 

 

       

 

 

    

 

* On December 2, 2013, the Company announced the authorization of a stock repurchase program for up to 762,640 shares or 5% of shares outstanding.

Stock Performance Graph. The following stock performance graph compares the cumulative total shareholder return on the Company’s common stock with (a) the cumulative total shareholder return on stocks included in the NASDAQ Composite Index, (b) the cumulative total shareholder return on stocks included in the SNL Thrift $1 Billion - $5 Billion Index and (c) the cumulative total shareholder return on stocks included in the SNL Thrift MHC Index, in each case assuming an investment of $100.00 as of June 30, 2009. The cumulative total returns for the indices and the Company are computed assuming the reinvestment of dividends that were paid during the period. It is assumed that the investment in the Company’s common stock was made at the initial public offering price of $10.00 per share.

 

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LOGO

 

Index

   6/30/09      6/30/10      6/30/11      6/30/12      6/30/13      6/30/14  

Kearny Financial Corp.

   $ 100       $ 82       $ 83       $ 90       $ 97       $ 140   

NASDAQ Composite

     100         116         154         165         195         255   

SNL Thrift $1 B - $5 B Index

     100         100         110         120         146         178   

SNL Thrift MHC Index

     100         109         102         103         132         176   

The NASDAQ Composite Index measures all NASDAQ domestic and international based common type stocks listed on The NASDAQ Stock Market. The SNL indices were prepared by SNL Financial LC, Charlottesville, Virginia. The SNL Thrift $1 Billion - $5 Billion Index includes all thrift institutions with total assets between $1.0 billion and $5.0 billion. The SNL Thrift MHC Index includes all publicly traded mutual holding companies.

There can be no assurance that the Company’s future stock performance will be the same or similar to the historical stock performance shown in the graph above. The Company neither makes nor endorses any predictions as to stock performance.

 

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Item 6. Selected Financial Data

The following financial information and other data in this section are derived from the Company’s audited consolidated financial statements and should be read together therewith.

 

     At June 30,  
     2014     2013     2012     2011     2010  
     (In Thousands)  

Balance Sheet Data:

          

Assets

   $ 3,510,009      $ 3,145,360      $ 2,937,006      $ 2,904,136      $ 2,339,813   

Net loans receivable

     1,729,084        1,349,975        1,274,119        1,256,584        1,005,152   

Mortgage-backed securities available for sale

     437,223        780,652        1,230,104        1,060,247        703,455   

Mortgage-backed securities held to maturity

     295,658        101,114        1,090        1,345        1,700   

Debt securities available for sale

     407,898        300,122        12,602        44,673        29,497   

Debt securities held to maturity

     216,414        210,015        34,662        106,467        255,000   

Cash and cash equivalents

     135,034        127,034        155,584        222,580        181,422   

Goodwill

     108,591        108,591        108,591        108,591        82,263   

Deposits

     2,479,941        2,370,508        2,171,797        2,149,353        1,623,562   

Borrowings

     512,257        287,695        249,777        247,642        210,000   

Total stockholders’ equity

     494,676        467,707        491,617        487,874        485,926   
     For the Years Ended June 30,  
     2014     2013     2012     2011     2010  
     (In Thousands, Except Percentage and Per Share Amounts)  

Summary of Operations:

          

Interest income

   $ 95,819      $ 88,258      $ 98,549      $ 100,376      $ 93,108   

Interest expense

     21,998        22,001        28,369        32,216        36,321   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     73,821        66,257        70,180        68,160        56,787   

Provision for loan losses

     3,381        4,464        5,750        4,628        2,616   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

     70,440        61,793        64,430        63,532        54,171   

Non-interest income, excluding asset gains, losses and write downs

     6,967        6,179        4,767        3,640        2,413   

Non-interest income (loss) from asset gains, losses and write downs

     1,156        10,209        (2,622     1,207        291   

Debt extinguishment expenses

     —          8,688        —          —          —     

Other non-interest expenses

     64,158        60,737        58,721        56,242        45,100   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     14,405        8,756        7,854        12,137        11,775   

Provisions for income taxes

     4,217        2,250        2,776        4,286        4,963   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 10,188      $ 6,506      $ 5,078      $ 7,851      $ 6,812   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Share and Per Share Data:

          

Net income per share:

          

Basic

   $ 0.16      $ 0.10      $ 0.08      $ 0.12      $ 0.10   

Diluted

     0.16        0.10        0.08        0.12        0.10   

Weighted average number of common shares outstanding:

          

Basic

     65,796        66,152        66,495        67,118        67,920   

Diluted

     65,836        66,152        66,495        67,118        67,920   

Cash dividends per share (1)

   $ —        $ —        $ 0.15      $ 0.20      $ 0.20   

Dividend payout ratio (2)

     —       —       54.60     41.00     53.70

 

(1) Excludes dividends waived by Kearny MHC.
(2) Represents cash dividends paid divided by net income.

 

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     At or For the Years Ended June 30,  
     2014     2013     2012     2011     2010  

Performance Ratios:

          

Return on average assets (net income divided by average total assets)

     0.31     0.22     0.17     0.29     0.31

Return on average equity (net income divided by average equity)

     2.17        1.33        1.04        1.63        1.42   

Net interest rate spread

     2.32        2.34        2.46        2.56        2.45   

Net interest margin

     2.44        2.50        2.65        2.80        2.83   

Average interest-earning assets to average interest-bearing liabilities

     116.81        118.83        117.90        117.38        120.88   

Efficiency ratio (non-interest expense divided by the sum of net interest income and non-interest income)

     78.30        84.00        81.19        77.04        75.81   

Non-interest expense to average assets

     1.96        2.38        2.02        2.10        2.04   

Asset Quality Ratios:

          

Non-performing loans to total loans

     1.45        2.27        2.61        2.76        2.13   

Non-performing assets to total assets

     0.77        1.05        1.27        1.46        0.93   

Net charge-offs to average loans outstanding

     0.12        0.28        0.59        0.12        0.05   

Allowance for loan losses to total loans

     0.71        0.80        0.79        0.93        0.84   

Allowance for loan losses to non-performing loans

     48.96        35.24        30.20        33.65        39.70   

Capital Ratios:

          

Average equity to average assets

     14.29        16.70        16.75        17.94        21.66   

Equity to assets at period end

     14.09        14.87        16.74        16.80        20.77   

Tangible equity to tangible assets at year end(1)

     11.32        11.93        12.87        13.11        17.36   

 

(1) Tangible equity equals total stockholders’ equity reduced by goodwill, core deposit intangible assets, disallowed servicing assets and accumulated other comprehensive (loss) income.

 

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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, and is intended to enhance your understanding of our financial condition and results of operations. You should read the information in this section in conjunction with the business and financial information regarding Kearny Financial Corp and the consolidated financial statements and notes thereto contained in this Annual Report on Form 10-K.

Overview

Financial Condition. Total assets increased $364.6 million to $3.51 billion at June 30, 2014 from $3.15 billion at June 30, 2013. The increase was funded largely through growth in deposits and borrowings. The net growth in deposits was reflected in both non-interest bearing and interest-bearing deposits with the growth in the latter comprised of increases in savings accounts and certificates of deposit that were partially offset by a decline in interest-bearing checking. The growth in liabilities funded a net increase in earning assets reflecting growth in loans, non-mortgage-backed securities and other interest-earning assets that were partially offset by a decline in the balances of mortgage-backed securities.

We executed a series of balance sheet restructuring and wholesale growth transactions during the latter half of fiscal 2013 that resulted in both growth and diversification within the securities portfolio. Notwithstanding the near term effect of these transactions on the composition and allocation of our earning assets during fiscal 2013, it remains the long-term goal of our business plan to reallocate our 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.

During fiscal 2014, loans receivable increased by $380.6 million to $1.74 billion, or 53.7% of earning assets, at June 30, 2014 from $1.36 billion or 47.1% of earning assets at June 30, 2013. For those same comparative periods, total securities decreased by $43.2 million to $1.36 billion, or 41.8% of earnings assets, at June 30, 2014 from $1.40 billion, or 48.4% of earning assets, at June 30, 2013.

Our 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. During fiscal 2014, commercial loans grew by $313.5 million, or 42.5%, to $1.05 billion, or 60.3% of total loans, from $737.5 million, or 54.2% of total loans, at June 30, 2013. For those same comparative periods, one- to four-family mortgage loans, including first mortgages and home equity loans and lines of credit, increased by $72.2 million to $680.2 million, or 39.0% of total loans, from $608.1 million, or 44.7% of total loans.

The reported growth in loans for fiscal 2014 included loans with fair values totaling $78.7 million acquired in conjunction with the acquisition of Atlas Bank on June 30, 2014. The loans acquired from Atlas Bank primarily included one- to four-family and commercial mortgage loans totaling $72.8 million and $5.7 million, respectively, plus aggregate net deferred loan origination costs totaling $194,000 as of that date. Included in the loans acquired from Atlas Bank were four impaired residential mortgage loans whose aggregate carrying values at the time of acquisition totaled $742,000. We recognized no expectation for future credit losses in the valuation of the four impaired loans acquired from Atlas Bank.

We continued to diversify the composition and allocation of our securities portfolio during fiscal 2014. Non-mortgage-backed securities, including U.S. agency debentures, corporate bonds, single-issuer

 

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trust preferred securities, collateralized loan obligations, municipal obligations, and asset-backed securities increased to $624.3 million, or 46.0% of securities, at June 30, 2014 from $510.1 million, or 36.7% of securities, at June 30, 2013. For those same comparative periods, the balance of mortgage-backed securities, comprised primarily of U.S. government and agency pass-through securities and collateralized mortgage obligations, decreased by $148.9 million to $732.9 million, or 54.0% of securities, from $881.8 million, or 63.3% of securities.

The changes in the securities portfolio for fiscal 2014 included the addition of securities with fair values totaling $26.9 million acquired in conjunction with the acquisition of Atlas Bank on June 30, 2014. The securities acquired from Atlas Bank included mortgage-backed securities, including pass-through securities and collateralized mortgage obligations, with fair values totaling $23.9 million as well as one corporate bond with a fair value of $3.0 million at June 30, 2014. All securities acquired from Atlas Bank were determined to be high-quality, investment grade securities with no “other-than-temporary” impairment.

For the year ended June 30, 2014, our total deposits increased by $109.4 million to $2.48 billion from $2.37 billion at June 30, 2013. As noted above, the growth in deposits was partly reflected in the growth of non-interest-bearing deposits which increased by $33.1 million during fiscal 2014. The remaining deposit growth was reflected in interest-bearing deposits which increased by $76.3 million to $2.26 billion at June 30, 2014. For the year ended June 30, 2014, within interest-bearing deposits, the balance of savings accounts and certificates of deposit increased by $51.9 million and $55.8 million, respectively. This growth was partially offset by a $31.3 million decline in the balance of interest-bearing checking accounts.

A portion of the net growth in deposits reflected balances with fair values totaling $86.1 million assumed in conjunction with the acquisition of Atlas Bank on June 30, 2014. Deposit balances assumed from Atlas Bank included non-interest-bearing and interest-bearing accounts totaling $14.6 million and $71.5 million, respectively. In addition to the deposits assumed from Atlas Bank, a portion of the net growth in deposit balances from period to period reflected changes in the balances of “non-retail” deposits acquired through various wholesale channels.

The balance of borrowings increased by $224.6 million to $512.3 million at June 30, 2014 from $287.7 million at June 30, 2013. The increase in borrowings largely reflected utilization of additional FHLB term advances to fund a portion of the loan growth reported during fiscal 2014. Interest rate derivatives were used to effectively extend duration of these borrowings for interest rate risk management purposes. The increase also reflected borrowings with fair values totaling $18.7 million assumed in conjunction with the Atlas Bank acquisition as well as a $12.0 million increase in overnight borrowings drawn for short-term liquidity management purposes.

Stockholders’ equity increased by $27.0 million to $494.7 million at June 30, 2014 from $467.7 million at June 30, 2013. The increase in stockholders’ equity was partly attributable to our issuance of common stock valued at $15.5 million as consideration paid to Kearny MHC for the acquisition of Atlas Bank, net income of $10.2 million for the fiscal year ended June 30, 2014, a reduction of unearned ESOP shares relating to the offsets of benefit plan expenses during the year and a net decrease in the unrealized loss of our available for sale securities portfolios. These were partially offset by an increase in treasury stock resulting from our share repurchase activity that was partially offset by the issuance of shares for the exercise of stock options during fiscal 2014.

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

 

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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, 2014 was $10.2 million or $0.16 per diluted share; an increase of $3.7 million from $6.5 million or $0.10 per diluted share for the fiscal year ended June 30, 2013. The increase in net income reflected an increase in net interest income and declines in non-interest expense and the provision for loan losses that were partially offset by a decline in non-interest income. These factors contributed to an overall increase in pre-tax net income and the provision for income taxes.

Our net interest income increased $7.5 million to $73.8 million for the year ended June 30, 2014 from $66.3 million for the year ended June 30, 2013. The increase in net interest income reflected a $7.5 million increase in interest income to $95.8 million from $88.3 million. The increase in interest income primarily reflected an increase in the average balance of interest-earning assets that was partially offset by a decline in their average yield. For the year ended June 30, 2014, the average balance of interest-earning assets increased by $376.3 million to $3.03 billion compared to $2.65 billion for the year ended June 30, 2013. For those same comparative periods, the average yield on interest-earning assets decreased by 16 basis points to 3.17% from 3.33%.

Interest expense remained generally stable at $22.0 million for the year ended June 30, 2014 and 2013. The nominal decrease in interest expense between the two periods reflected an increase in the average balance of interest-bearing liabilities that was substantially offset by a decline in their average cost. For the year ended June 30, 2014 the average balance of interest-bearing liabilities increased by $360.8 million to $2.59 billion compared to $2.23 billion for the year ended June 30, 2013. For those same comparative periods, the average cost of interest-bearing liabilities decreased 14 basis points to 0.85% from 0.99%.

In total, the net interest rate spread decreased two basis points to 2.32% for fiscal 2014 from 2.34% for fiscal 2013 while the net interest margin decreased six basis points to 2.44% from 2.50% for those same comparative periods.

The provision for loan losses decreased $1.1 million to $3.4 million for fiscal 2014 from $4.5 million for fiscal 2013. 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 changes to certain environmental loss factors that were partially offset by decreases in historical loss factors.

Non-interest income decreased by $8.3 million to $8.1 million for fiscal 2014 from $16.4 million for fiscal 2013. The decrease in non-interest income primarily reflected a decline in gains on securities sold arising primarily from the comparatively higher levels recorded during fiscal 2013 in conjunction with the balance sheet restructuring transactions discussed earlier. The decrease also reflected a decline in the gain on sale of loans attributable to a decrease in SBA loan origination and sale volume during fiscal 2014. The decrease in non-interest income was partially offset by an increase in income attributable to our investment in bank-owned life insurance that was augmented by a decline on losses relating to write downs and sales of real estate owned. Other variances in non-interest income included decreases in loan-related and deposit-related fees and charges that were partially offset by an increase in other miscellaneous income primarily reflecting a gain on bargain purchase recorded in conjunction with the Atlas Bank acquisition.

 

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Non-interest expense decreased by $5.2 million to $64.2 million for the year ended June 30, 2014 from $69.4 million for the year ended June 30, 2013. The decrease in non-interest expense primarily reflected the absence of any debt extinguishment expenses recognized during fiscal 2013 in conjunction with the balance sheet restructuring transactions discussed earlier for which no such expenses were recorded during fiscal 2014. This decrease in expense was partially offset by the recognition of non-recurring expenses included in equipment and systems expense, and to a lesser extent other categories of non-interest expense associated with the conversion of the primary core processing systems to Fiserv, Inc. during fiscal 2014. We also recognized non-recurring merger-related expenses during fiscal 2014 in conjunction with the acquisition of Atlas Bank. Less noteworthy operating increases in other categories of non-interest expense were reported in salaries and employee benefits, premises occupancy, advertising and marketing, deposit insurance expense and other miscellaneous expense.

The combined effects of these factors resulted in higher pre-tax net income and the provision for income taxes during fiscal 2014 compared with fiscal 2013. The increase in our effective income tax rate largely reflected the comparatively smaller portion of net income arising from tax favored sources, such as income from municipal obligations and bank-owned life insurance, during fiscal 2014 compared to fiscal 2013.

Recent Acquisition Activity. We completed the acquisition of Atlas Bank, a federal mutual savings bank headquartered in Brooklyn, New York, on June 30, 2014. As of June 30, 2014, Atlas Bank operated from its main retail banking office in Brooklyn and a branch in Staten Island, New York, and had assets with a fair value of $120.9 million and liabilities with fair values totaling $105.2 million. Atlas Bank had no stockholders, and therefore no merger consideration was paid to third parties. We issued 1,044,087 shares of Kearny-Federal common stock to Kearny MHC as consideration for the transaction. As the merger was completed on June 30, 2014, the transaction is reflected in the consolidated balance sheets and consolidated statements of operations at and for the relevant periods presented in this report.

Critical Accounting Policies

Our accounting policies are integral to understanding the results reported. We describe them in detail in Note 1 to our audited consolidated financial statements included as an exhibit to this document. In preparing the audited 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 evaluation of securities impairment and the impairment testing of goodwill.

Allowance for Loan Losses. The allowance for loan losses is a valuation account that reflects our estimation of the losses in our loan portfolio to the extent they are both probable and reasonable to estimate. The balance of the allowance is generally maintained through provisions for loan losses that are charged to income in the period that estimated losses on loans are identified by our loan review system. We charge losses on loans against the allowance as such losses are actually incurred. Recoveries on loans previously charged-off are added back to the allowance.

As described in greater detail in the notes to audited consolidated financial statements, our allowance for loan loss calculation methodology utilizes a “two-tier” loss measurement process that is performed quarterly. Through the first tier of the process, we identify the loans that must be reviewed individually for impairment. Such loans generally include our larger and/or more complex loans including commercial mortgage loans, as well as our one- to four-family mortgage loans, home equity loans and home equity lines of credit. A reviewed loan is deemed to be impaired when, based on current

 

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information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Once a loan is determined to be impaired, management measures the amount of the estimated impairment associated with that loan which is generally defined as the amount by which the carrying value of a loan exceeds its fair value. We establish valuation allowances for loan impairments in the fiscal period during which they are identified. Impairments on individually evaluated loans generally are charged off against the applicable valuation allowance when they are determined to be confirmed, expected losses.

The second tier of the loss measurement process involves estimating the probable and estimable losses on loans not otherwise individually reviewed for impairment. Such loans generally comprise large groups of smaller-balance homogeneous loans as well as the remaining non-impaired loans of those types noted above that are otherwise eligible for individual impairment evaluation.

Valuation allowances established through the second tier of the loss measurement process utilize historical and environmental loss factors to collectively estimate the level of probable losses within defined segments of our loan portfolio. To calculate the historical loss factors, our allowance for loan loss methodology generally utilizes a 24-month moving average of annual net charge-off rates (charge-offs net of recoveries) by loan segment, where available, to calculate the actual, historical loss experience. The outstanding principal balance of each loan segment is multiplied by the applicable historical loss factor to estimate the level of probable losses based upon our historical loss experience.

Environmental loss factors are based upon specific qualitative criteria representing key sources of risk within the loan portfolio. Such risk criteria includes the level of and trends in nonperforming loans; the effects of changes in credit policy; the experience, ability and depth of the lending function’s management and staff; national and local economic trends and conditions; credit risk concentrations; changes in local and regional real estate values; changes in the nature, volume and terms of loans; changes in the quality of loan review systems and resources and the effects of regulatory, legal and other external factors. The outstanding principal bal