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, 2006
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- or -
[ ] Transition Report pursuant to section 13 OR 15(d) of the Securities
Exchange Act of 1934
For the transition period from ____________________ to ____________________
Commission Number: 0-51093
Kearny Financial Corp.
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(Exact name of Registrant as specified in its Charter)
United States 22-3803741
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(State or other jurisdiction of incorporation (IRS Employer
or organization) Identification No.)
120 Passaic Avenue, Fairfield, New Jersey 07004
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(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code: (973) 244-4500
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Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.10 per share
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(Title of Class)
Securities registered pursuant to Section 12(g) of the Act: None
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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 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. [X]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition
of "accelerated filer and large accelerated filer" in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [X]
Non-accelerated filer [ ]
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, 2005, (the
last day of the Registrant's most recently completed second fiscal
quarter) was $236.9 million.
As of September 8, 2006 there were issued and outstanding 72,667,600
shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Proxy Statement for the 2006 Annual Meeting of
Stockholders. (Part III)
PART I
Kearny Financial Corp. (the "Company" or the "Registrant") may from
time to time make written or oral "forward-looking statements," including
statements contained in the Company's filings with the Securities and Exchange
Commission (including this Annual Report on Form 10-K and the exhibits thereto),
in its reports to stockholders and in other communications by the Company, which
are made in good faith by the Company pursuant to the "safe harbor" provisions
of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements involve risks and uncertainties, such
as statements of the Company's plans, objectives, expectations, estimates and
intentions, that are subject to change based on various important factors (some
of which are beyond the Company's control). The following factors, among others,
could cause the Company's financial performance to differ materially from the
plans, objectives, expectations, estimates and intentions expressed in such
forward-looking statements: the strength of the United States economy in general
and the strength of the local economy in which the Company conducts operations;
the effects of, and changes in, trade, monetary and fiscal policies and laws,
including interest rate policies of the Board of Governors of the Federal
Reserve System, inflation, interest rates, market and monetary fluctuations; the
impact of changes in financial services laws and regulations (including laws
concerning taxes, banking, securities and insurance); changes in accounting
policies and practices, as may be adopted by regulatory agencies, the Financial
Accounting Standards Board or the Public Company Accounting Oversight Board;
technological changes; competition among financial services providers; and the
success of the Company at managing the risks involved in the foregoing and
managing its business.
The Company cautions that the foregoing list of important factors is
not exclusive. The Company does not undertake to update any forward-looking
statement, whether written or oral, that may be made from time to time by or on
behalf of the Company.
Item 1. Business
-----------------
General
The Company 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 (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, or 30% of its outstanding common stock. The remaining 70% of
the outstanding common stock, or 50,916,250 shares, are owned by Kearny MHC (the
"MHC"). 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 MHC and the Company are regulated by the Office
of Thrift Supervision.
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 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, and the Bank is regulated by the Office of Thrift Supervision and
the Federal Deposit Insurance Corporation.
2
Our primary business is attracting retail deposits from the general
public and using those deposits, together with funds generated from operations,
principal repayments on securities and loans and borrowed funds, for our
investing and lending activities. We invest in mortgage-backed securities, U.S.
government obligations, obligations of state and political subdivisions and
other securities. Our loan portfolio consists of one-to-four family residential
mortgage loans, multi-family and commercial mortgage loans, construction loans,
commercial business loans, home equity loans and lines of credit, and other
consumer loans. At June 30, 2006, mortgage-backed securities and investment
securities comprised 45.7% of our total assets while loans receivable, net,
comprised 35.0% of our total assets. At June 30, 2005 mortgage-backed securities
and investment securities were 59.9% and loans were 26.5% of our total assets,
and at June 30, 2004 these percentages were 64.5% and 26.1%, respectively. It is
our intention to continue to increase the balance of our loan portfolio relative
to the size of our securities portfolio.
Market Area. We operate from administrative headquarters in Fairfield,
New Jersey, and as of June 30, 2006 had 26 branch offices located in Bergen,
Hudson, Passaic, Morris, Middlesex, Essex, Union and Ocean Counties, New Jersey.
We also consider Monmouth County, New Jersey to be part of our market area. Our
lending is concentrated in these nine New Jersey counties, 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 primarily
conducted within our 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. As a result, our profitability could decrease.
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, and we
face competition for funds from investment products such as mutual funds,
short-term money funds and corporate and government securities. There are large
competitors operating throughout our total market area, including Bank of
America, Commerce Bank, Wachovia Bank and PNC Bank, and we also face strong
competition from other community-based financial institutions.
3
Lending Activities
General. We have traditionally focused on the origination of
one-to-four family loans, which comprise a significant majority of our total
loan portfolio. Our next largest category of lending is commercial real estate
which includes multi-family dwellings, mixed-use properties and other commercial
properties. We also offer consumer loans (primarily composed of home equity
loans and lines of credit), construction loans (to builders and developers as
well as individual homeowners) and commercial business loans, generally secured
by real estate.
At June 30,
----------------------------------------------------------------------------------------------------
2006 2005 2004 2003 2002
--------------------- ------------------ ------------------ -------------------- -------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
Type of Loans: (In thousands)
-------------
Real estate mortgage -
One-to-four family......... $465,822 65.80% $382,766 68.04% $358,241 70.22% $366,391 71.50% $458,969 77.24%
Real estate mortgage -
multi-family and
commercial.................. 107,111 15.13 96,685 17.18 83,426 16.35 71,099 13.88 59,418 10.00
Commercial business........... 3,208 0.45 2,930 0.52 5,161 1.01 2,353 0.46 6,704 1.13
Consumer:
Home equity loans.......... 93,639 13.23 54,199 9.63 37,381 7.33 37,315 7.28 36,750 6.19
Equity lines of credit..... 12,988 1.83 14,850 2.64 15,677 3.07 19,905 3.89 19,183 3.23
Passbook or certificate.... 2,884 0.41 2,831 0.50 2,746 0.54 2,895 0.56 3,044 0.51
Other...................... 247 0.03 264 0.05 336 0.07 1,273 0.25 1,111 0.18
Construction.................. 22,078 3.12 8,094 1.44 7,212 1.41 11,183 2.18 9,030 1.52
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans.............. 707,977 100.00% 562,619 100.00% 510,180 100.00% 512,414 100.00% 594,209 100.00%
-------- ====== -------- ====== -------- ====== -------- ====== -------- ======
Less:
Allowance for loan losses.. 5,451 5,416 5,144 5,180 5,170
Deferred loan (costs)
and fees, net........... (1,087) (815) (758) (1,927) (2,103)
-------- -------- -------- -------- --------
4,364 4,601 4,386 3,253 3,067
-------- -------- -------- -------- --------
Total loans, net......... $703,613 $558,018 $505,794 $509,161 $591,142
======== ======== ======== ======== ========
4
Loan Maturity Schedule. The following table sets forth the maturity of
our loan portfolio at June 30, 2006. Demand loans, loans having no stated
maturity, and overdrafts are shown as due in one year or less. Loans are stated
in the following tables at contractual maturity and actual maturities could
differ due to prepayments.
At June 30, 2006
-------------------------------------------------------------------------------------------------------
Real
estate
Real mortgage -
estate multi- Home
mortgage - family Home equity
one-to-four and Commercial equity lines of Passbook or
family commercial business loans credit certificate Other Construction Total
------ ---------- -------- ----- ------ ----------- ----- ------------ -----
(In thousands)
Amounts Due:
Within 1 Year .............. $ 155 $ 135 $ 3,175 $ 53 $ 58 $ 2,460 $ 126 $ 15,215 $ 21,377
-------- -------- -------- -------- -------- -------- -------- -------- --------
After 1 year:
1 to 3 years ............. 3,269 638 33 4,068 242 414 28 6,863 15,555
3 to 5 years ............. 12,015 2,491 - 7,248 47 - - - 21,801
5 to 10 years ............ 77,974 12,118 - 29,553 2,626 - - - 122,271
10 to 15 years ........... 129,230 35,252 - 37,326 9,057 10 93 - 210,968
Over 15 years ............ 243,179 56,477 - 15,391 958 - - - 316,005
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total due after one year ... 465,667 106,976 33 93,586 12,930 424 121 6,863 686,600
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total amount due ........... $465,822 $107,111 $ 3,208 $ 93,639 $ 12,988 $ 2,884 $ 247 $ 22,078 $707,977
======== ======== ======== ======== ======== ======== ======== ======== ========
5
The following table shows the dollar amount of loans as of June 30,
2006 that are due after June 30, 2007 according to rate type and loan category.
Floating or
Fixed Rates Adjustable Rates Total
----------- ---------------- -----
(In thousands)
Real estate mortgage -
one-to-four family ..................... $387,701 $ 77,966 $465,667
Real estate mortgage -
multi-family and commercial ............. 79,987 26,989 106,976
Commercial business ....................... 33 - 33
Consumer:
Home equity loans ...................... 93,586 - 93,586
Home equity lines of credit ............ 2,254 10,676 12,930
Passbook or certificate ................ - 424 424
Other .................................. 118 3 121
Construction ........................... - 6,863 6,863
-------- -------- --------
Total .............................. $563,679 $122,921 $686,600
======== ======== ========
One-to-Four Family Mortgage Loans. Our primary lending activity
consists of the origination of one-to-four family first mortgage loans, nearly
all of which are secured by property located within New Jersey.
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%. Our loan to value
limit on a non-owner occupied property is 75%. Loans in excess of $750,000 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 thirty years. Residential mortgage
loans on non-owner occupied properties have terms of up to fifteen years for
fixed rate loans and terms up to twenty years for adjustable rate loans. We also
offer ten-year balloon mortgages with a thirty-year amortization schedule on
owner occupied properties and a twenty year amortization schedule on non-owner
occupied properties.
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 thirty 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 thirty
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.
We offer a first time home buyer program for persons who have not
previously owned real estate and are purchasing a one-to-four family property in
Bergen, Passaic, Morris, Essex, Hudson, Middlesex, Monmouth, Ocean and Union
Counties, New Jersey for use as a primary residence. This program is also
available outside these areas only to persons who are existing deposit or loan
customers of Kearny Federal Savings Bank and/or members of their immediate
families. The financial incentives offered under this program are a one-quarter
of one percent rate reduction on all first mortgage loan types and the refund of
the application fee at closing.
The fixed rate mortgage loans that we originate generally meet the
secondary mortgage market standards of the Federal Home Loan Mortgage
Corporation. However, as our focus is on growing the size of
6
the loan portfolio, we generally do not sell loans in the secondary market and
do not currently anticipate that we will commence doing so in any large
capacity. There were no residential mortgage loan sales during the last three
fiscal years.
Substantially all of our residential mortgages include "due on sale"
clauses, which are provisions giving 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 residential loans are made by state certified or licensed independent
appraisers approved by the 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.
Multi-family and Commercial Real Estate Mortgage Loans. We also
originate mortgage loans on multi-family and commercial real estate properties,
including loans on apartment buildings, retail/service properties, and other
income-producing properties, such as mixed-use properties combining residential
and commercial space.
We generally require no less than a 30% down payment or equity position
for mortgage loans on multi-family and commercial real estate properties, and we
require personal guarantees on all such loans. Currently, these loans are made
with a maturity of up to 20 years. We also offer a five-year balloon loan with a
twenty- year amortization schedule. All of our multi-family and commercial real
estate mortgage loans are on properties within New Jersey.
Multi-family and commercial real estate mortgage loans generally are
considered to entail significantly greater risk than that which is involved with
one-to-four family real estate lending. The repayment of these loans typically
is dependent on the successful operations 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, multi-family and
commercial real estate mortgage loans generally carry larger balances to single
borrowers or related groups of borrowers than one-to-four family loans.
Multi-family and commercial real estate lending typically requires 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. These loans are normally secured by real estate,
and we require personal guarantees on all commercial 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 commercial term loans generally have terms of up to fifteen years
and are mostly fixed rate loans. Our commercial lines of credit have terms of up
to two years and are mostly adjustable rate loans. We also offer a one-year
interest only commercial line of credit with balloon payment.
Unlike single-family 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 typically are
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, have greater credit risk than residential mortgage
loans. In addition, commercial loans generally
7
carry larger balances to single borrowers or related groups of borrowers than
one-to-four family loans. Commercial lending requires substantially greater
evaluation and oversight efforts compared to residential or non-residential real
estate lending.
Home Equity Loans and Lines of Credit. Our home equity loans are fixed
rate loans for terms of generally up to twenty years. We also offer fixed and
adjustable rate home equity lines of credit with terms of up to fifteen years.
Collateral value is determined through an Automated Valuation Module (AVM),
specifically, the Freddie Mac's Home Valuation Explorer (HVE), or property value
analysis report (FHLMC Form 704) 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
primarily 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.
Other Consumer Loans. In addition to home equity loans and lines of
credit, our consumer loan portfolio includes savings and certificates of deposit
secured (passbook) loans and unsecured personal overdraft loans. We will
generally lend up to 90% of the account balance on a savings secured loan.
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 which 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. All of our construction lending is in New Jersey.
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
limited to one year with an interest rate tied to the prime rate 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 the 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, without a
contract in place. Financing is only provided for up to two houses at
8
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 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 all of the 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 of time.
Loans to One Borrower. Under federal law, savings institutions have,
subject to certain exemptions, lending limits to one borrower in an amount equal
to the greater of $500,000 or 15% of the institution's unimpaired capital and
surplus. Accordingly, as of June 30, 2006, our loans to one borrower limit was
approximately $55.3 million.
At June 30, 2006, our largest single borrower had an aggregate loan
balance of approximately $9.5 million, representing two mortgage loans secured
by commercial real estate. Our second largest single borrower had an aggregate
loan balance of approximately $9.3 million, representing two loans secured by
commercial real estate, one commercial line of credit secured by real estate and
one residential mortgage loan. Our third largest borrower had an aggregate loan
balance of approximately $9.2 million, representing one loan, a participation in
a construction loan secured by commercial real estate. At June 30, 2006, all of
these lending relationships were current and performing in accordance with the
terms of their loan agreements.
9
Loan Originations, Purchases, Sales, Solicitation and Processing. The
following table shows total loans originated, purchased and repaid during the
periods indicated.
For the Year Ended June 30,
-------------------------------------------
2006 2005 2004
------------ ----------- ------------
(In thousands)
Loan originations and purchases:
Loan originations:
Real estate mortgage - one-to-four family............ $118,371 $ 86,026 $ 69,550
Real estate mortgage - multi-family and commercial... 23,444 24,622 26,052
Commercial business.................................. 708 1,422 5,631
Construction......................................... 22,638 7,378 6,864
Consumer:
Home equity loans and lines of credit................ 66,456 39,598 31,656
Passbook or certificate.............................. 1,578 1,618 1,830
Other................................................ 412 324 266
-------- --------- ---------
Total loan originations................................ 233,607 160,988 141,849
-------- --------- ---------
Loan purchases:
Real estate mortgage - one-to-four family............ 24,434 1,515 14,262
Real estate mortgage - multi-family and commercial... - - 762
-------- --------- ---------
Total loan purchases................................... 24,434 1,515 15,024
-------- --------- ---------
Loan principal repayments.............................. (113,786) (111,740) (157,906)
-------- --------- ---------
Increase (decrease) due to other items................... 1,340 1,461 (2,334)
-------- --------- ---------
Net increase (decrease) in loan portfolio................ $145,595 $ 52,224 $ (3,367)
======== ========= =========
Our customary sources of loan applications include repeat customers,
referrals from realtors and other professionals and "walk-in" customers. Our
residential loan originations are largely advertising driven.
We primarily originate our own loans and retain them in our portfolio.
As part of our loan growth strategy, we generally do not sell loans in the
secondary market and do not currently anticipate that we will commence doing so
in any large capacity. There were no whole loan sales during the three years
ended June 30, 2006. Gross loan originations totaled $233.6 million for the year
ended June 30, 2006 and exceeded principal repayments by approximately $119.8
million.
In October 2005, the Bank entered into a loan purchase and servicing
agreement with Countrywide Home Loans Inc. located in Westlake Village,
California. The agreement with Countrywide calls for the purchase of loan pools
that contain mortgages on properties in our lending area. All loan pools
presented to the Bank must meet the Bank's underwriting requirements as outlined
in the purchase and servicing agreement. Countrywide services these mortgages.
During the year ended June 30, 2006, a total of $6.6 million of adjustable rate
loans and $12.6 million of fixed rate loans were purchased from Countrywide.
Purchase agreements have also been executed with a limited number of
smaller, local mortgage companies in an effort to maintain the Bank's loan
production pipeline. These agreements call for the purchase, on a flow basis, of
adjustable rate and/or 10 or 15 year fixed rate mortgage loans with servicing
released to the Bank. During the year ended June 30, 2006 a total of $2.4
million adjustable loans and $2.7 million of fixed rate loans were purchased
from these companies.
In addition to purchasing one-to-four family loans, we also
occasionally purchase participations in loans originated by other banks and also
through the Thrift Institutions Community Investment Corporation of New Jersey
("TICIC"). Our TICIC participations include multi-family and commercial real
estate properties.
10
The aggregate balance of TICIC participations at June 30, 2006 was $8.9 million
and the average balance on a single participation was approximately $256,000. At
June 30, 2006, we had a total of six non-TICIC participations with an aggregate
balance of $22.7 million, consisting of loans on commercial real estate
properties, including a medical center, a self-storage facility, a shopping
plaza, commercial buildings with a combination of retail and office space and a
construction loan to build townhouses.
Loan Approval Procedures and Authority. Senior management recommends
and the Board of Directors approves our lending policies and loan approval
limits. Our Senior Vice President and Chief Lending Officer may approve loans up
to $500,000. Loan department personnel of Kearny Federal Savings Bank serving in
the following positions may approve loans as follows: mortgage loan managers,
mortgage loans up to $250,000; consumer loan managers, consumer loans up to
$100,000; and consumer loan underwriters, consumer loans up to $50,000. 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 ratios. Our President and Chief Executive Officer,
Senior Vice President and Chief Financial Officer and Senior Vice President and
Treasurer each have authorization to countersign loans for amounts that exceed
$500,000 up to a limit of $750,000. Our Senior Vice President and Chief Lending
Officer must approve loans between $500,000 and $750,000 and one member of
senior management as outlined above. Non-conforming mortgage loans and loans
over $750,000 require the approval of the Board of Directors.
Asset Quality
Loan Delinquencies and Collection Procedures. The borrower is notified
by both mail and telephone when a loan is thirty days past due. If the
delinquency continues, subsequent efforts are made to contact the delinquent
borrower and additional collection notices and letters are sent. When a loan is
ninety days delinquent, it is our general practice to refer it to an attorney
for repossession or foreclosure. All reasonable attempts are made to collect
from borrowers prior to referral to an attorney for collection. 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 the lower of
the unpaid principal balance of the related loan or its fair market value less
estimated selling costs. The initial writedown of the property 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 occur. At June 30, 2006, we held real estate owned
totaling $109,000, consisting of one parcel of vacant land, currently under a
contract of sale.
Loans are reviewed on a regular basis and are placed on non-accrual
status when they are more than ninety days delinquent, with the exception of a
passbook loan, the outstanding balance of which is collected from the related
passbook account along with accrued interest and a penalty when the loan is 120
days delinquent. Loans may be placed on a non-accrual status at any time if, in
the opinion of management, the collection of additional interest is doubtful.
Interest accrued and unpaid at the time a loan is placed on non-accrual status
is charged against interest income. Subsequent payments are either applied to
the outstanding principal balance or recorded as interest income, depending on
the assessment of the ultimate collectibility of the loan. At June 30, 2006, we
had approximately $942,000 of loans that were held on a non-accrual basis.
11
Non-Performing Assets. The following table provides information
regarding the Bank's non-performing loans and other non-performing assets. As of
each of the dates indicated, we did not have any troubled debt restructurings.
At June 30, 2006, the allowance for loan losses totaled $5.5 million,
non-performing loans totaled $942,000, and the ratio of allowance for loan
losses to non-performing loans was 578.7%.
At June 30,
---------------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
(Dollars in thousands)
Loans accounted for on a non-accrual basis:
Real estate mortgage - one-to-four family... $ 329 $ 846 $ 771 $ 1,571 $ 1,152
Real estate mortgage - multi-family and
commercial............................... 592 1,004 1,414 621 897
Commercial business......................... - 31 39 - -
Consumer:
Home equity loans........................ 21 20 65 178 91
Home equity lines of credit.............. - 17 - - -
Other.................................... - 4 - - 21
Construction................................ - - - - -
-------- -------- -------- -------- --------
Total................................... 942 1,922 2,289 2,370 2,161
-------- -------- -------- -------- --------
Accruing loans which are contractually
past due 90 days or more:
Real estate mortgage - one-to-four family... - - - 423 427
Real estate mortgage - multi-family and
commercial............................... - - - - 168
Commercial business......................... - - - 23 23
Consumer:
Home equity loans and lines of credit.... - - - - 1
Passbook or certificate.................. - - 39 98 -
Other.................................... - - - 2 39
Construction................................ - - - - 469
-------- -------- -------- -------- --------
Total................................... - - 39 546 1,127
-------- -------- -------- -------- --------
Total non-performing loans.................... $ 942 $ 1,922 $ 2,328 $ 2,916 $ 3,288
======== ======== ======== ======== ========
Real estate owned............................. $ 109 $ 209 $ 209 $ 209 $ 209
======== ======== ======== ======== ========
Other non-performing assets................... $ - $ - $ - $ - $ -
======== ======== ======== ======== ========
Total non-performing assets................ $ 1,051 $ 2,131 $ 2,537 $ 3,125 $ 3,497
======== ======== ======== ======== ========
Total non-performing loans to total loans..... 0.13% 0.34% 0.46% 0.57% 0.55%
==== ==== ==== ==== ====
Total non-performing loans to total assets.... 0.05% 0.09% 0.12% 0.15% 0.17%
==== ==== ==== ==== ====
Total non-performing assets to total assets... 0.05% 0.10% 0.13% 0.16% 0.18%
==== ==== ==== ==== ====
During the year ended June 30, 2006, gross interest income of $81,000
would have been recorded on loans accounted for on a non-accrual basis if those
loans had been current, and $9,000 of interest on such loans was included in
income for the year ended June 30, 2006.
Classified Assets. Management, in compliance with Office of Thrift
Supervision guidelines, has instituted an internal loan review program, whereby
non-performing loans are classified as substandard, doubtful or loss. It is our
policy to review the loan portfolio, in accordance with regulatory
classification procedures, on at least a quarterly basis. When a loan is
classified as substandard or doubtful, management is required to evaluate the
loan for impairment. When management classifies a portion of a loan as loss, a
reserve equal to 100% of the loss amount is required to be established or the
loan is to be charged-off.
An asset is considered "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 substandard, with the added characteristic that the
weaknesses present make collection or liquidation in full highly questionable
and
12
improbable, on the basis of currently existing facts, conditions, and values.
Assets, or portions thereof, classified as "loss" are considered uncollectible
and of so little value that their continuance as assets without the
establishment of a specific loss reserve is not warranted. Assets which do not
currently expose the insured institution to a sufficient degree of risk to
warrant classification in one of the aforementioned categories but which have
credit deficiencies or potential weaknesses are required to be designated
"special mention" by management.
Management's classification of assets is reviewed by the Board on a
regular basis and by the regulatory agencies as part of their examination
process. An independent loan review firm performs a review of our residential
and commercial loan portfolios, and we downgrade our classifications to match
those of this reviewing firm if there is disagreement between our assessment and
the independent assessment. The following table discloses our classification of
assets and designation of certain loans as special mention as of June 30, 2006.
At June 30, 2006, all of the classified assets and special mention designated
assets were loans.
June 30,
--------------------------------------------
2006 2005 2004
------------- ------------- -------------
(In thousands)
Special Mention..... $ 236 $ 3,161 $ 734
Substandard......... 1,448 2,343 6,264
Doubtful............ 2,001 1,936 1,149
Loss................ - 6 -
--------- --------- --------
Total............. $ 3,685 $ 7,446 $ 8,147
========= ========= ========
At June 30, 2006, none of the loans classified as "special mention",
approximately $350,000 classified as "substandard" and approximately $592,000
classified as "doubtful" are included under non-performing assets, as shown in
the table on Page 12.
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 allowance is
maintained through provisions for loan losses that are charged to income in the
period they are established. We charge losses on loans against the allowance for
loan losses when we believe the collection of loan principal is unlikely.
Recoveries on loans previously charged-off are added back to the allowance.
Management, in determining the allowance for loan losses, considers the
losses inherent in the loan portfolio and changes in the nature and volume of
our loan activities, along with general economic and real estate market
conditions. We utilize a two-tier approach: (1) identification of impaired loans
and establishment of specific loss allowances on such loans; and (2)
establishment of general valuation allowances on the remainder of our loan
portfolio by type of loan.
A loan evaluated for impairment 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. All
loans identified as impaired are evaluated independently. We do not aggregate
such loans for evaluation purposes. Payments received on impaired loans are
applied first to interest receivable and then to principal.
We maintain a loan review system, which allows for a periodic review of
our loan portfolio and the early identification of potential impaired loans.
Such system takes into consideration, among other things, delinquency status,
size of loan, type of collateral and financial condition of the borrower. Large
groups of smaller balance homogeneous loans, such as residential real estate and
home equity and consumer loans are
13
evaluated in the aggregate using historical loss factors and current economic
conditions. Large balance and/or more complex loans, such as multi-family and
commercial real estate loans, are evaluated individually for impairment.
Specific loan loss allowances are established for identified loans
based on a review of such information and/or appraisals of the underlying
collateral. General loan loss allowances are based upon a combination of factors
including, but not limited to, actual loan loss experience, composition of the
loan portfolio, current economic conditions and management's judgment.
The estimation of the allowance for loan losses is inherently
subjective as it requires estimates and assumptions that are susceptible to
significant revisions as more information becomes available or as future events
change. Future additions to the allowance for loan losses may be necessary if
economic and other conditions in the future differ substantially from the
current operating environment. In addition, the Office of Thrift Supervision, as
an integral part of its examination process, periodically reviews our loan and
foreclosed real estate portfolios and the related allowance for loan losses and
valuation allowance for foreclosed real estate. The Office of Thrift Supervision
may require the allowance for loan losses or the valuation allowance for
foreclosed real estate to be increased based on its review of information
available at the time of the examination, which would negatively affect our
earnings.
The following table sets forth information with respect to the
allowance for loan losses at the dates indicated.
For the Year Ended June 30,
------------------------------------------------------------------
2006 2005 2004 2003 2002
--------- --------- --------- --------- ---------
Allowance balance (at beginning of period)............. $ 5,416 $ 5,144 $ 5,180 $ 5,170 $ 5,167
--------- --------- --------- --------- ---------
Provision for loan losses.............................. 72 68 - - 3
--------- --------- --------- --------- ---------
Charge-offs:
Real estate mortgage - one-to-four family............ - - 12 - -
Commercial business.................................. 30 5 24 - -
Other................................................ 12 4 - - -
--------- --------- --------- --------- ---------
Total charge-offs................................ 42 9 36 - -
--------- --------- --------- --------- ---------
Recoveries:
Real estate mortgage - one-to-four family........... - 213 - 10 -
Commercial business.................................. 5 - - - -
--------- --------- --------- --------- ---------
Total recoveries................................. 5 213 - 10 -
--------- --------- --------- --------- ---------
Net (charge-offs) recoveries........................... (37) 204 (36) 10 -
--------- --------- --------- --------- ---------
Allowance balance (at end of period)................... $ 5,451 $ 5,416 $ 5,144 $ 5,180 $ 5,170
========= ========= ========= ========= =========
Total loans outstanding................................ $ 707,977 $ 562,619 $ 510,180 $ 512,414 $ 594,209
========= ========= ========= ========= =========
Average loans outstanding.............................. $ 628,245 $ 517,746 $ 499,510 $ 546,521 $ 603,131
========= ========= ========= ========= =========
Allowance for loan losses as a percent
of total loans outstanding.......................... 0.77% 0.96% 1.01% 1.01% 0.87%
====== ====== ====== ====== ======
Net loans charged off as a percent
of average loans outstanding........................ 0.01% 0.00% 0.01% 0.00% 0.00%
====== ====== ====== ====== ======
Allowance for loan losses to non-performing loans...... 578.66% 281.79% 220.96% 177.64% 157.24%
====== ====== ====== ====== ======
14
Allocation of Allowance for Loan Losses. The following table sets forth
the allocation of the allowance for loan losses by loan category and the percent
of loans in each category to total loans receivable, net, at the dates
indicated. The portion of the loan loss allowance allocated to each loan
category does not represent the total available for future losses which may
occur within the loan category since the total loan loss allowance is a
valuation reserve applicable to the entire loan portfolio.
At June 30,
-------------------------------------------------------------------------------------------------------
2006 2005 2004 2003 2002
---------------- ----------------- ------------------ ----------------- ------------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ------- ------ --------- ------ --------- ------ --------- ------ ---------
(Dollars in thousands)
At end of period
allocated to:
Real estate mortgage -
one-to-four family.... $1,582 65.80% $1,514 68.04% $1,422 70.22% $1,980 71.50% $2,966 77.24%
Real estate mortgage -
multi-family and
commercial............. 3,133 15.13 3,368 17.18 3,358 16.35 2,198 13.88 1,184 10.00
Commercial business....... 34 0.45 50 0.52 57 1.01 59 0.46 70 1.13
Consumer:
Home equity loans....... 286 13.23 182 9.63 131 7.33 214 7.28 188 6.19
Home equity lines 1.83
of credit............ 39 47 2.64 52 3.07 218 3.89 261 3.23
Passbook or certificate. - 0.41 - 0.50 - 0.54 - 0.56 - 0.51
Other................... 27 0.03 120 0.05 4 0.07 10 0.25 17 0.18
Construction.............. 350 3.12 135 1.44 120 1.41 501 2.18 484 1.52
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
Total allowance...... $5,451 100.00% $5,416 100.00% $5,144 100.00% $5,180 100.00% $5,170 100.00%
====== ====== ====== ====== ====== ====== ====== ====== ====== ======
15
Securities Portfolio
General. Our deposits have traditionally exceeded our loan
originations, and we have invested these deposits primarily in mortgage-backed
securities and investment securities. Our mortgage-backed securities and
investment securities comprised 45.7% of our total assets at June 30, 2006. We
intend to increase the balance of our loan portfolio relative to the size of our
securities portfolio, however, such a change will take time and in the near
future, our assets will continue to be primarily in 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,
marketability and performance objectives. Our President and Chief Executive
Officer, Senior Vice President and Chief Financial Officer and Senior Vice
President and Treasurer are designated by the Board of Directors as the officers
responsible for securities investment transactions and all transactions require
the approval of at least two of these designated officers. The Interest Rate
Risk Management Committee, currently composed of Directors Hopkins, Regan,
Aanensen, Mazza and Parow, with our Senior Vice President and Chief Financial
Officer participating as a management liaison, is responsible for the
administration of the securities portfolio. This committee meets quarterly to
review the securities portfolio. The results of the committee's quarterly review
are reported to the full Board, which makes adjustments to the investment policy
and strategies as it considers necessary and appropriate.
All of our securities carry market risk insofar as increases in market
rates of interest may cause a decrease in their market value. Investments in
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 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.
Federally chartered savings banks have the authority to invest in
various types of liquid assets. The investments authorized under the investment
policy approved by our Board of Directors include U.S. government and government
agency obligations, municipal securities (consisting of bank qualified municipal
bond obligations of state and local governments) and mortgage-backed securities
of various U.S. government agencies or government-sponsored entities. 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.
Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," requires 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.
Statement No. 115 allows 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 a
separate component of equity.
16
At June 30, 2006, our mortgage-backed securities portfolio included
securities issued by the Government National Mortgage Association, the Federal
Home Loan Mortgage Corporation and the Federal National Mortgage Association,
and our investment securities portfolio included U.S. government obligations and
obligations of states and political subdivisions.
In the fiscal year ended June 30, 2005, we sold 120,000 shares of
Freddie Mac common stock, representing 48% of our investment in Freddie Mac
common stock at that time, which resulted in a pre-tax gain of $7.6 million.
During the year ended June 30, 2006, we sold the rest of our Freddie Mac
investment, 131,088 shares, and sold $249.1 million of government agency notes
with an average yield of 3.22%. This sale included our entire portfolio of
government agency notes. The loss on the sale of the government agency notes
partially offset the gain on the remainder of our Freddie Mac shares and mutual
fund shares issued by Dryden Government Income Fund, Inc. The net pre-tax gain
on the fiscal 2006 securities sales was approximately $1.0 million. We have now
sold all of our Freddie Mac stock and at June 30, 2006, we had no government
agency notes remaining in our securities portfolio.
At June 30, 2006, we also held the following securities: mutual fund
shares issued by AMF Adjustable Mortgage Rate Fund with an aggregate carrying
value of $7.4 million; and trust preferred securities with an aggregate carrying
value of $10.9 million. Currently, our policy does not permit new investments in
corporate equity securities beyond what we currently hold, and we do not invest
in mortgage-related securities of private corporate issuers, only those issued
by U.S. government agencies or government-sponsored entities.
At June 30, 2006, our securities portfolio contained mortgage-backed
securities issued by the Federal Home Loan Mortgage Corporation with an
aggregate book value in excess of 10% of our equity. The aggregate book value at
June 30, 2006 of mortgage-backed securities in our portfolio issued by the
Federal National Mortgage Association also exceeded 10% of our equity. The
aggregate book value and aggregate market value for mortgage-backed securities
issued by the Federal Home Loan Mortgage Corporation that we held at June 30,
2006 totaled $264.7 million and $256.0 million, respectively. The aggregate book
value and aggregate market value for mortgage-backed securities issued by the
Federal National Mortgage Association that we held at June 30, 2006 totaled
$382.9 million and $371.6 million, respectively. At June 30, 2006, management
classified all mortgage-backed securities issued by the Federal Home Loan
Mortgage Corporation and the Federal National Mortgage Association as held to
maturity. Other than mortgage-backed securities issued by the U.S. government or
its agencies, at June 30, 2006 we did not hold securities of any other issuer
having an aggregate book value in excess of 10% of our equity.
We do not currently participate in hedging programs, interest rate
caps, floors or swaps, or other activities involving the use of off-balance
sheet derivative financial instruments. Further, we do not purchase securities,
which are not rated investment grade.
Actual maturities of the securities held by us may differ from
contractual maturities because issuers may have the right to call or prepay
obligations with or without prepayment penalties. At June 30, 2006, the
aggregate book value and aggregate market value of callable securities in our
portfolio totaled $138.4 million and $136.2 million, respectively.
17
Mortgage-backed Securities. We only invest in mortgage-backed
securities issued by U.S. government agencies or government-sponsored entities,
such as Government National Mortgage Association, the Federal Home Loan Mortgage
Corporation and the Federal National Mortgage Association. Mortgage-backed
securities are pass-through securities typically issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a specific range and have varying
maturities. The life of a mortgage-backed security thus approximates the life of
the underlying mortgages. Mortgage originators use intermediaries (generally
government agencies and government-sponsored enterprises, but also a variety of
private corporate issuers) to pool and repackage the participation interests in
the form of securities, with investors such as us receiving the principal and
interest payments on the mortgages. The characteristics of the underlying pool
of mortgages, i.e., fixed-rate or adjustable-rate, as well as prepayment risk,
are passed on to the certificate holder. Mortgage-backed securities are
generally referred to as mortgage participation certificates or pass-through
certificates.
We do not currently invest in mortgage-backed securities of private
issuers or collateralized mortgage obligations. 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 their payment guarantees or credit
enhancements, which offer nominal credit risk to the security holder.
The following table sets forth the carrying value of our securities
portfolio at the dates indicated.
At June 30,
-----------------------------------------------------------------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(In thousands)
Securities Available for Sale:
-----------------------------
Mutual funds............................... $ 7,424 $ 14,140 $ 13,899 $ 14,196 $ 13,682
Common stock............................... - 8,551 15,894 12,748 15,367
Trust preferred securities due
after ten years........................ 10,922 10,900 11,771 10,896 10,630
----------- ----------- ----------- ----------- ----------
Total securities available for sale.. 18,346 33,591 41,564 37,840 39,679
----------- ----------- ----------- ----------- ----------
Investment Securities Held to Maturity:
--------------------------------------
U.S. government obligations................ 8,736 265,469 274,401 169,968 60,225
Obligations of states and political
subdivisions........................... 200,312 204,629 161,469 117,353 79,221
----------- ----------- ----------- ----------- ----------
Total investment securities
held to maturity................ 209,048 470,098 435,870 287,321 139,446
----------- ----------- ----------- ----------- ----------
Mortgage-Backed Securities Held to Maturity:
-------------------------------------------
Government National Mortgage
Association............................. 42,323 63,399 94,499 150,699 178,220
Federal Home Loan Mortgage
Corporation............................. 264,747 305,059 314,221 197,962 302,246
Federal National Mortgage Association...... 382,892 389,663 362,633 331,061 454,552
Collateralized mortgage obligations
issued by U.S. government agencies..... - - - 1,894 33,494
Other...................................... - - - 3 4
----------- ----------- ----------- ----------- ----------
Total mortgage-backed securities
held to maturity................. 689,962 758,121 771,353 681,619 968,516
----------- ----------- ----------- ----------- ----------
Total..................................... $ 917,356 $ 1,261,810 $ 1,248,787 $ 1,006,780 $1,147,641
=========== =========== =========== =========== ==========
18
The following table sets forth certain information regarding the
carrying values, weighted average yields and maturities of our securities
portfolio at June 30, 2006. This table shows contractual maturities and does not
reflect repricing or the effect of prepayments. Actual maturities may differ.
At June 30, 2006
-----------------------------------------------------------------------------------------------------
One Year One to Five to More than Total
or Less Five Years Ten Years Ten Years Investment Securities
---------------- ----------------- ----------------- ------------------- ---------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Market
Value Yield Value Yield Value Yield Value Yield Value Yield Value
----- ----- ----- ----- ----- ----- ----- ----- ----- ----- -----
(Dollars in thousands)
Mutual funds................... $ 7,424 4.60% $ - -% $ - -% $ - -% $ 7,424 4.60% $ 7,424
Common stock................... - - - - - - - - - - -
Trust preferred securities
due after ten years......... - - - - - - 10,922 6.55 10,922 6.55 10,922
U.S. government obligations.... - - - - 963 8.30 7,773 5.30 8,736 5.63 8,786
Obligations of states and
political subdivisions...... 4,339 3.64 17,194 3.22 120,775 3.80 58,004 3.92 200,312 3.78 195,661
Government National
Mortgage Association........ 87 7.54 461 8.97 482 11.08 41,293 5.49 42,323 5.60 42,646
Federal Home Loan
Mortgage Corporation........ 5 8.71 1,876 4.25 1,115 3.79 261,751 4.75 264,747 4.74 256,036
Federal National Mortgage
Association................. - - 6,076 5.55 10,687 5.58 366,129 4.82 382,892 4.85 371,647
------- ------- -------- -------- -------- --------
Total........................ $11,855 4.27% $25,607 3.95% $134,022 4.00% $745,872 4.79% $917,356 4.64% $893,122
======= ======= ======== ======== ======== ========
19
Sources of Funds
General. Deposits are our major 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 maturity and call of
investment 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. Borrowings (principally from the
Federal Home Loan Bank) are also used to supplement the amount of funds for
lending and investment.
Deposits. Our current deposit products include checking and savings
accounts, certificates of deposit accounts ranging in terms from thirty days to
five years, and individual retirement accounts. Deposit account terms vary,
primarily as to the required minimum balance amount, the amount of time that the
funds must remain on deposit and the applicable interest rate.
Deposits are obtained primarily from within New Jersey. Traditional
methods of advertising are used to attract new customers and deposits, including
radio, print media, direct mail and inserts included with customer statements.
We do not utilize the services of deposit brokers. Premiums or incentives for
opening accounts are sometimes offered. We periodically select particular
certificate of deposit maturities for promotion, with terms of five, nine and 13
months being the most popular. We may also offer a twenty-five basis point
premium on certificate accounts with a term of at least one year to certificate
of deposit account holders that have $200,000 or more on deposit with Kearny
Federal Savings Bank. We also offer the opportunity one time during the term of
the certificate to "bump up" the rate paid on all 17-month and 29-month
certificates of deposit from the rate set on such certificate to the current
rate being offering by Kearny Federal Savings Bank on certificates of that
particular maturity.
The determination of interest rates 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 advances from the Federal Home Loan
Bank. Interest rates are reviewed by senior management on a weekly basis and
rates are set generally with the intent to be in the top five to ten percent of
the competition.
A large percentage of our deposits are in certificates of deposit,
which represented 61.2% of total deposits at June 30, 2006. Our liquidity could
be reduced if a significant amount of certificates of deposit maturing within a
short period of time were not renewed. 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, 2006, $206.0 million, or 23.3%, of our
certificates of deposit were "jumbo" certificates of $100,000 or more. Deposit
inflows are significantly influenced by general interest rates and money market
conditions. The inflow of jumbo certificates of deposit and the retention of
such deposits upon maturity are particularly sensitive to general interest rates
and money market conditions, making jumbo certificates of deposit traditionally
a more volatile source of funding than core deposits. In order to retain jumbo
certificates of deposit, 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.
20
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 Year Ended June 30,
---------------------------------------------------------------------------------------------------
2006 2005 2004
------------------------------- ------------------------------ --------------------------------
Weighted Weighted Weighted
Percent Average Percent Average Percent Average
of Total Nominal of Total Nominal of Total Nominal
Amount Deposits Rate Amount Deposits Rate Amount Deposits Rate
------ -------- ---- ------ -------- ---- ------ -------- ----
(Dollars in thousands)
Non-interest-bearing demand..... $ 56,517 3.82% 0.00% $ 55,112 3.52% 0.00% $ 49,797 3.17% 0.00%
Interest-bearing demand......... 103,397 7.00 0.90 105,503 6.73 0.71 109,830 6.99 0.80
Savings and club................ 429,019 29.03 1.18 533,131 34.01 1.02 448,509 28.55 1.23
Certificates of deposit......... 888,810 60.15 3.27 873,907 55.74 2.33 963,089 61.29 2.25
---------- ----- ---------- ------ ---------- ------
Total deposits............... $1,477,743 100.00% 2.37% $1,567,653 100.00% 1.69% $1,571,225 100.00% 1.79%
========== ====== ========== ====== ========== ======
21
The following table sets forth certificates of deposit classified by
interest rate as of the dates indicated.
At June 30,
-----------------------------------------------
2006 2005 2004
-------------- -------------- --------------
(In thousands)
Interest Rate
0.00-1.99%................ $ 24,638 $ 189,266 $ 582,665
2.00-2.99%................ 46,588 343,916 173,505
3.00-3.99%................ 496,755 349,320 100,138
4.00-4.99%................ 162,070 32,750 25,956
5.00-5.99%................ 153,047 7,223 11,957
6.00-6.99%................ - 641 2,716
7.00-7.99%................ - - 82
----------- ----------- -----------
Total................... $ 883,098 $ 923,116 $ 897,019
=========== ============ ===========
The following table sets forth the amount and maturities of
certificates of deposit at June 30, 2006.
Amount Due
-------------------------------------------------------------------------------------------------
Within After
Interest Rate 1 year 1-2 years 2-3 years 3-4 years 4-5 years 5 years Total
------------- ------ --------- --------- --------- --------- ------- -----
(In thousands)
0.00-1.99%........... $ 24,637 $ 1 $ - $ - $ - $ - $ 24,638
2.00-2.99%........... 46,314 270 4 - - - 46,588
3.00-3.99%........... 403,661 72,588 18,781 1,724 - 1 496,755
4.00-4.99%........... 101,368 35,941 1,696 16,151 6,826 88 162,070
5.00-5.99%........... 82,238 70,809 - - - - 153,047
6.00-6.99%........... - - - - - - -
7.00-7.99%........... - - - - - - -
---------- --------- -------- --------- --------- -------- ---------
Total.............. $ 658,218 $ 179,609 $ 20,481 $ 17,875 $ 6,826 $ 89 $ 883,098
========== ========= ======== ========= ========= ======== =========
The following table shows the amount of certificates of deposit of
$100,000 or more by time remaining until maturity as of the dates indicated.
At June 30, 2006
----------------
(In thousands)
Maturity Period
Within three months................................ $ 44,553
Three through six months........................... 31,125
Six through twelve months.......................... 73,269
Over twelve months................................. 57,008
----------
$ 205,955
Borrowings. To supplement our deposits as a source of funds for lending
or investment, we borrow funds in the form of advances from the Federal Home
Loan Bank. We make use of Federal Home Loan Bank advances as part of our
interest rate risk management, primarily to extend the duration of funding to
match the longer-term fixed rate loans held in the loan portfolio as part of our
growth strategy.
Advances from the Federal Home Loan Bank are typically secured by the
Federal Home Loan Bank stock we own and a portion of our residential mortgage
loans and may be secured by other assets, mainly securities, which are
obligations of or guaranteed by the U.S. government. Additional information
regarding our Federal Home Loan Bank advances is included under Note 12 to
consolidated financial statements.
22
Short-term Federal Home Loan Bank advances generally have original
maturities of less than one year. The details of these short-term advances are
presented below for the dates and periods indicated.
At or For the
Year Ended June 30,
------------------------------------
2006 2005 2004
---- ---- ----
(Dollars in thousands)
Federal Home Loan Bank Advances:
Average balance outstanding.................. $ 3,958 $17,805 $ 1,151
Maximum amount outstanding at any
month-end during the period............... 28,000 20,000 30,000
Balance outstanding at end of period......... - - 30,000
Weighted average interest rate during
the period................................ 4.48% 2.24% 1.43%
Weighted average interest rate at end
of period................................. -% -% 1.43%
At June 30, 2006, long-term Federal Home Loan Bank advances totaled
$61.1 million. Advances consist of fixed-rate advances that will mature within
one to seven years. The advances are collateralized by Federal Home Loan Bank
stock and certain first mortgage loans and mortgage-backed securities. These
advances had a weighted average interest rate of 5.46% at June 30, 2006. Unused
overnight lines of credit at the Federal Home Loan Bank at June 30, 2006 were
$200.0 million.
As of June 30, 2006, long-term advances mature as follows:
Twelve Months Ending June 30, (In thousands)
-----------------------------
2007................................... $ 5,618
2008................................... 37,487
2009................................... 8,000
2010................................... -
2011................................... 10,000
Thereafter............................. -
----------
Total........................... $ 61,105
==========
Subsidiary Activity
Kearny Financial Corp. has two wholly owned subsidiaries: Kearny
Federal Savings Bank and Kearny Financial Securities, Inc. Kearny Financial
Securities, Inc., was organized in April 2005 under Delaware law as a Delaware
investment company primarily to hold investment and mortgage-backed securities.
Kearny Financial Securities, Inc. is currently inactive.
Kearny Federal Savings Bank has two wholly owned subsidiaries: KFS
Financial Services, Inc. and Kearny Federal Investment Corp. KFS Financial
Services, Inc. was incorporated as a New Jersey corporation in 1994 under the
name of South Bergen Financial Services, Inc., was acquired in Kearny's merger
with South Bergen Savings Bank in 1999 and was renamed KFS Financial Services,
Inc. in 2000. It is a service corporation subsidiary organized for the purpose
of selling insurance products, including annuities, to bank customers and the
general public through a third party networking arrangement. KFS Financial
Services, Inc. is not a licensed insurance agency, and it may only offer
insurance products through an agreement with a licensed insurance agency. KFS
Financial Services, Inc. has entered into an agreement with Savings Bank Life
Insurance of Massachusetts, a licensed insurance agency, through which it offers
insurance products.
23
Kearny Federal Investment Corp. was organized in June 2004 under New
Jersey law as a New Jersey investment company primarily to hold investment
securities. At June 30, 2006, it held assets totaling $563.2 million.
Personnel
As of June 30, 2006, we had 268 full-time employees and 19 part-time
employees. The employees are not represented by a collective bargaining unit. We
believe our relationship with our employees is good.
Regulation
The Bank and the Company 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 the Bank and the Company. 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 mutual holding companies, could have a material
adverse impact on the Company, the Bank, and their operations. The adoption of
regulations or the enactment of laws that restrict the operations of the Bank
and/or the Company or impose burdensome requirements upon one or both of them
could reduce their profitability and could impair the value of the Bank's
franchise, resulting in negative effects on the trading price of the Company's
common stock.
Regulation of the Bank
General. As a federally chartered, Federal Deposit Insurance
Corporation-insured savings bank, the Bank is subject to extensive regulation by
the Office of Thrift Supervision and the Federal Deposit Insurance Corporation.
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 System. A federal savings bank's relationship
with its depositors and borrowers is regulated by both state and federal law,
especially in such matters as the ownership of savings accounts and the form and
content of the bank's mortgage documents.
The Bank must file reports with the Office of Thrift Supervision
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 Office of Thrift Supervision
regularly examines the Bank and prepares reports to the Bank's Board of
Directors on deficiencies, if any, found in its operations. The Office of Thrift
Supervision has substantial discretion to impose enforcement action on an
institution that fails to comply with applicable regulatory requirements,
particularly with respect to its capital requirements. In addition, the Federal
Deposit Insurance Corporation has the authority to recommend to the Director of
the Office of Thrift Supervision that enforcement action be taken with respect
to a particular federally chartered
24
savings bank and, if action is not taken by the Director, the Federal Deposit
Insurance Corporation has authority to take such action under certain
circumstances.
Insurance of Deposit Accounts. Deposit accounts in Kearny Federal
Savings Bank are insured by the Deposit Insurance Fund of the Federal Deposit
Insurance Corporation, generally up to a maximum of $100,000 for standard
accounts and $250,000 for individual retirement accounts. The Federal Deposit
Insurance Corporation maintains a risk-based deposit insurance assessment system
by which institutions are assigned to one of three categories based on their
capitalization and one of three subcategories based on examination ratings and
other supervisory information. An institution's assessment rate depends upon the
categories to which it is assigned. Assessment rates for Savings Association
Insurance Fund member institutions are determined semi-annually by the Federal
Deposit Insurance Corporation and currently range from zero basis points of
assessable deposits for the healthiest institutions to 27 basis points of
assessable deposits for the riskiest. The assessment rate for Kearny Federal
Savings Bank is currently 0%.
In addition to assessments for deposit insurance, all Federal Deposit
Insurance Corporation-insured institutions are required to pay assessments to
the Federal Deposit Insurance Corporation to fund payments on bonds issued in
the late 1980s by a federal agency to recapitalize the predecessor to the
Savings Association Insurance Fund. These assessments will continue until the
Financing Corporation bonds mature in 2017.
The Federal Deposit Insurance Corporation may terminate an
institution's deposit insurance upon a finding that the 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 Federal Deposit Insurance Corporation or the Office of
Thrift Supervision.
Federal Deposit Insurance Reform. As a result of the Federal Deposit
Insurance Reform Act of 2005, the Bank Insurance Fund and the Savings
Association Insurance Fund have been merged into a new combined fund, called the
Deposit Insurance Fund. The Federal Deposit Insurance Reform Act also (i)
increases deposit insurance coverage for retirement accounts to $250,000, (ii)
indexes the current $100,000 insurance coverage limit for standard accounts and
the new $250,000 limit for retirement accounts to reflect inflation (with
adjustments for inflation every five years, commencing January 1, 2011), (iii)
requires the Federal Deposit Insurance Corporation to assess annual deposit
insurance premiums on all banks and savings institutions, (iv) gives a one-time
insurance assessment credit totaling $4.7 billion to banks and savings
institutions in existence on December 31, 1996 that can be used to offset
premiums otherwise due, (v) imposes a cap on the level of the Deposit Insurance
Fund and provide for dividends or rebates when the fund grows beyond a specified
threshold, (vi) adopts a historical basis concept for distributing the
aforementioned one-time credit and dividends (with each institution's historical
basis to be determined by a formula that looks back to the institution's
assessment base in 1996 and adds premiums paid since that time) and (vii)
authorizes revisions to the current risk-based system for assessing premiums,
including replacing the current fixed reserve ratio requirement of 1.25% with a
range of between 1.15% and 1.5% of insured deposits.
The merger of the two deposit insurance funds required by the Federal
Deposit Insurance Reform Act was effective as of March 31, 2006. The Federal
Deposit Insurance Corporation is required to adopt final rules for the rest of
the provisions no later than 270 days after enactment. Such regulations will
result in the imposition of deposit insurance assessments on all members of the
Deposit Insurance Fund, including Kearny Federal Savings Bank, and such
assessments could have an adverse effect on operating expenses and results of
operations. Management cannot predict, however, the rate of any such insurance
assessments or the effect of the assessments on operations.
Regulatory Capital Requirements. Office of Thrift Supervision capital
regulations require savings institutions to meet three minimum capital
standards: (1) tangible capital equal to 1.5% of total adjusted assets,
25
(2) "Tier 1" or "core" capital equal to at least 4% (3% if the institution has
received the highest possible rating on its most recent examination) of total
adjusted assets, and (3) risk-based capital equal to 8% of total risk-weighted
assets. For information on the Bank's compliance with these regulatory capital
standards, see Note 14 to consolidated financial statements. In assessing an
institution's capital adequacy, the Office of Thrift Supervision takes into
consideration not only these numeric factors but also qualitative factors as
well, and has the authority to establish higher capital requirements for
individual institutions where necessary.
In addition, the Office of Thrift Supervision may require that a
savings institution that has a risk-based capital ratio of less than 8%, a ratio
of Tier 1 capital to risk-weighted assets of less than 4% or a ratio of Tier 1
capital to total adjusted assets of less than 4% (3% if the institution has
received the highest rating on its most recent examination) take certain action
to increase its capital ratios. If the savings institution's capital is
significantly below the minimum required levels of capital or if it is
unsuccessful in increasing its capital ratios, the Office of Thrift Supervision
may restrict its activities.
For purposes of the Office of Thrift Supervision capital regulations,
tangible capital is defined as core capital less all intangible assets except
for certain mortgage servicing rights. Tier 1 or core capital is defined as
common stockholders' equity, non-cumulative perpetual preferred stock and
related surplus, minority interests in the equity accounts of consolidated
subsidiaries, and certain non-withdrawable accounts and pledged deposits of
mutual savings banks. The Bank does not have any non-withdrawable accounts or
pledged deposits. Tier 1 and core capital are reduced by an institution's
intangible assets, with limited exceptions for certain mortgage and non-mortgage
servicing rights and purchased credit card relationships. Both core and tangible
capital are further reduced by an amount equal to the savings institution's debt
and equity investments in "non-includable" subsidiaries engaged in activities
not permissible for national banks other than subsidiaries engaged in activities
undertaken as agent for customers or in mortgage banking activities and
subsidiary depository institutions or their holding companies.
The risk-based capital standard for savings institutions requires the
maintenance of total capital of 8% of risk-weighted assets. Total capital equals
the sum of core and supplementary capital. The components of supplementary
capital include, among other items, cumulative perpetual preferred stock,
perpetual subordinated debt, mandatory convertible subordinated debt,
intermediate-term preferred stock, the portion of the allowance for loan losses
not designated for specific loan losses and up to 45% of unrealized gains on
equity securities. The portion of the allowance for loan and lease losses
includable in supplementary capital is limited to a maximum of 1.25% of
risk-weighted assets. Overall, supplementary capital is limited to 100% of core
capital. For purposes of determining total capital, a savings institution's
assets are reduced by the amount of capital instruments held by other depository
institutions pursuant to reciprocal arrangements and by the amount of the
institution's equity investments (other than those deducted from core and
tangible capital) and its high loan-to-value ratio land loans and
non-residential construction loans.
A savings institution's risk-based capital requirement is measured
against risk-weighted assets, which equal the sum of each on-balance-sheet asset
and the credit-equivalent amount of each off-balance-sheet item after being
multiplied by an assigned risk weight. These risk weights range from 0% for cash
to 100% for delinquent loans, property acquired through foreclosure, commercial
loans, and certain other assets.
The Federal Deposit Insurance Corporation Improvement Act, or FDICIA,
requires that the Office of Thrift Supervision and other federal banking
agencies revise their risk-based capital standards, with appropriate transition
rules, to ensure that they take into account interest rate risk, or IRR,
concentration of risk and the risks of non-traditional activities. The Office of
Thrift Supervision adopted regulations, effective January 1, 1994, that set
forth the methodology for calculating an IRR component to be incorporated into
the Office of Thrift Supervision risk-based capital regulations. On May 10,
2002, the Office of Thrift Supervision adopted an amendment to its capital
regulations which eliminated the IRR component of the risk-based capital
requirement. Pursuant to the amendment, the Office of Thrift Supervision will
continue to monitor the IRR of
26
individual institutions through the Office of Thrift Supervision requirements
for IRR management, the ability of the Office of Thrift Supervision to impose
individual minimum capital requirements on institutions that exhibit a high
degree of IRR, and the requirements of Thrift Bulletin 13a, which provides
guidance on the management of IRR and the responsibility of boards of directors
in that area.
The Office of Thrift Supervision continues to monitor the IRR of
individual institutions through analysis of the change in net portfolio value,
or NPV. NPV is defined as the net present value of the expected future cash
flows of an entity's assets and liabilities and, therefore, hypothetically
represents the value of an institution's net worth. The Office of Thrift
Supervision has also used this NPV analysis as part of its evaluation of certain
applications or notices submitted by thrift institutions. The Office of Thrift
Supervision, through its general oversight of the safety and soundness of
savings associations, retains the right to impose minimum capital requirements
on individual institutions to the extent the institution is not in compliance
with certain written guidelines established by the Office of Thrift Supervision
regarding NPV analysis.
Dividend and Other Capital Distribution Limitations. The Office of
Thrift Supervision imposes 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 the Bank, must file an application or a notice with the
Office of Thrift Supervision at least thirty days before making a capital
distribution, such as paying a dividend to the Company. A savings institution
must file an application for prior approval of a capital distribution if: (i) it
is not eligible for expedited treatment under the applications processing rules
of the Office of Thrift Supervision; (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 Office of Thrift Supervision or applicable regulations.
The Office of Thrift Supervision 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 or
agreement.
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. To qualify as a
qualified thrift lender, a savings institution must either (i) be deemed a
"domestic building and loan association" under 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 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 on a monthly basis in at least nine out of
every twelve months.
A savings bank that fails the qualified thrift lender test and does not
convert to a bank charter generally will 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. In addition, if the institution does
27
not requalify under the qualified thrift lender test within three years after
failing the test, the institution would be prohibited from engaging in any
activity not permissible for a national bank and would have to repay any
outstanding advances from the Federal Home Loan Bank as promptly as possible.
Community Reinvestment Act. Under the Community Reinvestment Act, every
insured depository institution, including the 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 Community Reinvestment Act 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 Community Reinvestment
Act requires the Office of Thrift Supervision to assess the depository
institution's record of meeting the credit needs of its community and to take
such record into account in its evaluation of certain applications by such
institution, such as a merger or the establishment of a branch office by the
Bank. An unsatisfactory Community Reinvestment Act examination rating may be
used by the Office of Thrift Supervision as the basis for the denial of an
application. The Bank received a satisfactory Community Reinvestment Act rating
in its most recent Community Reinvestment Act examination by the Office of
Thrift Supervision.
Federal Home Loan Bank System. The Bank is a member of the Federal Home
Loan Bank of New York, which is one of twelve regional Federal Home Loan Banks.
Each Federal Home Loan Bank 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 Federal Home Loan Bank System. It makes loans to members
pursuant to policies and procedures established by the board of directors of the
Federal Home Loan Bank.
As a member, the Bank is required to purchase and maintain stock in the
Federal Home Loan Bank of New York in an amount equal to the greater of 1% of
our aggregate unpaid residential mortgage loans, home purchase contracts or
similar obligations at the beginning of each year or 5% of our outstanding
Federal Home Loan Bank advances. The Federal Home Loan Bank imposes various
limitations on advances such as limiting the amount of certain types of real
estate related collateral to 30% of a member's capital and limiting total
advances to a member.
The Federal Home Loan Banks are required to provide funds for the
resolution of troubled savings institutions and to contribute to affordable
housing programs through direct loans or interest subsidies on advances targeted
for community investment and low- and moderate-income housing projects. These
contributions have adversely affected the level of Federal Home Loan Bank
dividends paid and could continue to do so in the future. In addition, these
requirements could result in the Federal Home Loan Banks imposing a higher rate
of interest on advances to their members.
Federal Reserve System. The Federal Reserve System requires all
depository institutions to maintain non-interest-bearing reserves at specified
levels against their checking accounts and non-personal certificate accounts.
Savings institutions have authority to borrow from the Federal Reserve
System "discount window," but Federal Reserve System policy generally requires
savings institutions to exhaust all other sources before borrowing from the
Federal Reserve System.
The USA Patriot Act. The Bank is subject to Office of Thrift
Supervision regulations implementing the Uniting and Strengthening America by
Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of
2001, or the USA Patriot Act. The USA Patriot Act gives the federal government
powers to address terrorist threats through enhanced domestic security measures,
expanded surveillance powers, increased information sharing and broadened
anti-money laundering requirements. By way of amendments to
28
the Bank Secrecy Act, Title III of the USA Patriot Act takes measures intended
to encourage information sharing among bank regulatory agencies and law
enforcement bodies. Further, certain provisions of Title III impose affirmative
obligations on a broad range of financial institutions, including banks,
thrifts, brokers, dealers, credit unions, money transfer agents and parties
registered under the Commodity Exchange Act.
Among other requirements, Title III of the USA Patriot Act and the
related regulations of the Office of Thrift Supervision impose the following
requirements with respect to financial institutions:
o Establishment of anti-money laundering programs that include, at
minimum: (i) internal policies, procedures, and controls; (ii)
specific designation of an anti-money laundering compliance
officer; (iii) ongoing employee training programs; and (iv) an
independent audit function to test the anti-money laundering
program.
o Establishment of a program specifying procedures for obtaining
identifying information from customers seeking to open new
accounts, including verifying the identity of customers within a
reasonable period of time.
o Establishment of appropriate, specific, and, where necessary,
enhanced due diligence policies, procedures, and controls
designed to detect and report money laundering.
o Prohibitions on establishing, maintaining, administering or
managing correspondent accounts for foreign shell banks (foreign
banks that do not have a physical presence in any country), and
compliance with certain record keeping obligations with respect
to correspondent accounts of foreign banks.
Bank regulators are directed to consider a holding company's
effectiveness in combating money laundering when ruling on Federal Reserve Act
and Bank Merger Act applications.
Regulation of the Company
General. The Company is a savings and loan holding company within the
meaning of Section 10 of the Home Owners' Loan Act. It is required to file
reports with the Office of Thrift Supervision and is subject to regulation and
examination by the Office of Thrift Supervision. The Company must also obtain
regulatory approval from the Office of Thrift Supervision before engaging in
certain transactions, such as mergers with or acquisitions of other financial
institutions. In addition, the Office of Thrift Supervision has enforcement
authority over the Company and any non-savings institution subsidiaries. This
permits the Office of Thrift Supervision to restrict or prohibit activities that
it determines to be a serious risk to the Bank. This regulation is intended
primarily for the protection of the depositors and not for the benefit of
stockholders of the Company.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 implemented
various legislative reforms addressing, among other matters, corporate
governance, auditing and accounting. As directed by Section 302(a) of
Sarbanes-Oxley Act and the implementing rules of the Securities and Exchange
Commission, the Company's Chief Executive Officer and Chief Financial Officer
each are required to certify that the quarterly and annual reports do not
contain any untrue statement of a material fact. The rules have several
requirements, including having these officers certify that: they are responsible
for establishing, maintaining and regularly evaluating the effectiveness of the
Company's internal controls; they have made certain disclosures to the Company's
auditors and the audit committee of the Board of Directors about internal
controls; and they have included information in the quarterly and annual reports
about their evaluation and whether there have been significant changes in the
internal controls or in other factors that could significantly affect internal
controls. The Company is subject to other additional reporting and audit
requirements as a result of the Sarbanes-Oxley Act.
29
Activities Restrictions. As a savings and loan holding company and as a
subsidiary holding company of a mutual holding company, the Company is subject
to statutory and regulatory restrictions on its business activities. The
non-banking activities of the Company and its non-savings institution
subsidiaries are restricted to certain activities specified by Office of Thrift
Supervision 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 the 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, the Company must file with the Office
of Thrift Supervision 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.
Mergers and Acquisitions. The Company must obtain approval from the
Office of Thrift Supervision 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 Federal Deposit Insurance Corporation. In evaluating an
application for the Company to acquire control of a savings institution, the
Office of Thrift Supervision would consider the financial and managerial
resources and future prospects of the Company 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.
Waivers of Dividends by Kearny MHC (the "MHC"). Office of Thrift
Supervision regulations require the MHC to notify the Office of Thrift
Supervision of any proposed waiver of its receipt of dividends from the Company.
The Office of Thrift Supervision reviews dividend waiver notices on a
case-by-case basis, and, in general, does not object to any such waiver if: (i)
the mutual holding company's board of directors determines that such waiver is
consistent with such directors' fiduciary duties to the mutual holding company's
members and (ii) the waiver would not be detrimental to the safe and sound
operations of the subsidiary savings association.
Conversion of the MHC to Stock Form. Office of Thrift Supervision
regulations permit the MHC to convert from the mutual form of organization to
the capital stock form of organization, commonly referred to as a second step
conversion. In a second step conversion a new holding company would be formed as
the successor to the Company, the MHC's corporate existence would end, and
certain depositors of the Bank would receive the right to subscribe for shares
of the new holding company. In a second step conversion, each share of common
stock held by stockholders other than the MHC would be automatically converted
into a number of shares of common stock of the new holding company determined
pursuant to an exchange ratio that ensures that the Company's stockholders own
the same percentage of common stock in the new holding company as they owned in
the Company immediately prior to the second step conversion. Under Office of
Thrift Supervision regulations, the Company's stockholders would not be diluted
because of any dividends waived by the MHC (and waived dividends would not be
considered in determining an appropriate exchange ratio), in the event the MHC
converts to stock form. The total number of shares held by the Company's
stockholders after a second step conversion also would be increased by any
purchases by the Company's stockholders in the stock offering of the new holding
company conducted as part of the second step conversion.
Acquisition of Control. Under the federal Change in Bank Control Act, a
notice must be submitted to the Office of Thrift Supervision if any person
(including a company), or group acting in concert, seeks to acquire "control" of
a savings and loan holding company or savings association. An acquisition of
"control"
30
can occur upon the acquisition of 10% or more of the voting stock of a savings
and loan holding company or savings institution or as otherwise defined by the
Office of Thrift Supervision. Under the Change in Bank Control Act, the Office
of Thrift Supervision 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 would then be subject to
regulation as a savings and loan holding company.
Item 1A. Risk Factors
---------------------
An increase in interest rates may have an adverse effect on our earnings.
Our earnings largely depend on our net interest income, measured as the
difference between:
o the interest income we earn on our interest-earning assets, such
as loans and securities; and
o the interest expense we pay on our interest-bearing liabilities,
such as deposits and amounts we borrow.
Generally, the rates we earn on our assets remain fixed for a
contractual period. We, like many community banks have liabilities that
generally have shorter contractual maturities than our interest-earning assets
or no contractual maturities, such as savings and money market deposits. This
imbalance can create significant earnings volatility, because market interest
rates change over time. In addition, short-term and long-term interest rates do
not necessarily change at the same time or at the same rate.
In a period of rising interest rates, the interest income earned on our
assets may not increase as rapidly as the interest paid on our liabilities. We
are vulnerable to volatility in our earnings resulting from an increase in
interest rates because the majority of our interest-earning assets are
relatively long-term, fixed rate assets. In an increasing rate environment, we
can expect our cost of funds to increase more rapidly than the yields earned on
our loan portfolio and securities portfolio because our primary source of funds
is deposits with generally shorter maturities than the maturities on our loans
and investment securities. The result may be a narrowing of our net interest
spread and a decrease in our earnings.
In a period of falling interest rates, prepayments of loans and
mortgage-backed securities generally increase as borrowers refinance their debt
in order to reduce their borrowing cost. This causes prepayment risk, because in
a falling interest rate environment we cannot reinvest prepayments at rates
comparable to the rates earned on the prepaid loans or securities. A falling
interest rate environment results in a decrease in rates we pay on deposits and
borrowings, but the decrease in the cost of our funds may not be as great as the
decrease in the yields on our mortgage-backed securities and loan portfolio. The
result may be a narrowing of our net interest spread and decrease in our
earnings.
We face further exposure to interest rate risk due to the large portion
of our total deposits that are certificates of deposit, particularly "jumbo"
certificates of $100,000 or more. Interest rates and money market conditions
significantly influence deposit inflows, but the presence of jumbo certificates
of deposit and retention of such deposits upon maturity, make them a more
volatile source of funding than core deposits. In order to retain jumbo
certificates, we may pay a premium rate, resulting in an increase in our cost of
funds. If we are unwilling or unable to pay a premium rate, to the extent that
such funds do not remain on deposit, borrowings may replace them, which could
increase our cost of funds, narrow our net interest spread and decrease our
earnings.
31
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. 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 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 a downturn in
economic conditions within the state could adversely affect our profitability.
A substantial majority of our loans are to individuals and businesses
in New Jersey. A decline in the economy of the state could have an adverse
impact on our earnings. We have a significant amount of real estate mortgages,
such that a decrease 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.
Due to our minority stock offering, our return on equity compares unfavorably to
other companies. This could negatively influence the price of our stock.
The net proceeds from our initial public offering in February 2005
substantially increased our equity capital. We expect to take time to invest
this capital prudently. As a result, our return on equity, which is the ratio of
earnings divided by average equity capital is lower than that of many similar
companies. To the extent that the stock market values a company based in part on
its return on equity, our low return on equity relative to our peer group could
negatively affect the trading price of our common stock.
The costs of our stock compensation plans are a significant expense and funding
of the plans may dilute shareholders' ownership interest in Kearny Financial
Corp.
Effective upon completion of the Company's initial public offering, the
Bank established an Employee Stock Ownership Plan ("ESOP"). We currently
recognize compensation expense for the ESOP, as shares are committed for release
to the participants' accounts each month based on the monthly average market
price of the shares. We currently recognize additional annual employee
compensation and benefit expenses and directors' compensation expense stemming
from stock options granted and restricted stock awarded to directors and
officers under the 2005 Stock Compensation and Incentive Plan. We expense the
fair value of all options over their vesting periods and the fair value of
restricted shares over the requisite service periods, in both cases five years.
These additional expenses adversely affect our profitability and stockholders'
equity.
The Company utilized open market purchases of common stock to fund
restricted stock awards; however, funding of stock options granted will come
either through open market purchases or from the issuance of authorized but
un-issued shares. Existing shareholders will experience a dilution in ownership
interest in the event the Company uses newly issued shares rather than open
market purchases to fund stock options.
Shareholders own a minority of Kearny Financial Corp.'s common stock and are not
able to exercise voting control over most matters put to a vote of stockholders.
Kearny MHC owns a majority of Kearny Financial Corp.'s common stock.
The Board of Directors of Kearny MHC is also the Board of Directors of Kearny
Financial Corp. and is able to exercise voting control
32
over most matters put to a vote of shareholders. For example, Kearny MHC may
exercise its voting control to prevent a sale or merger transaction in which
stockholders could receive a premium for their shares, to elect directors or to
approve employee benefit plans.
Provisions in our charter and by-laws limit the rights of stockholders, may
deter potential takeovers and may reduce the trading price of our stock.
Provisions in our charter and by-laws make it difficult and expensive
to pursue a change in control or takeover attempt that our Board of Directors
opposes. As a result, you may not have an opportunity to participate in such a
transaction, and the trading price of our stock may not rise to the level of
other institutions that are more vulnerable to hostile takeovers. Such
provisions include:
o the election of directors to staggered three-year terms;
o provisions restricting the calling of special meetings of
stockholders;
o the absence of cumulative voting by stockholders in elections of
directors; and
o advance notice requirements for stockholder nominations and new
business.
The Office of Thrift Supervision's policy on remutualization transactions could
prohibit acquisition of Kearny Financial Corp., which may adversely affect our
stock price.
Office of Thrift Supervision ("OTS") regulations permit the acquisition
of a mutual holding company by a mutual institution in a remutualization
transaction. Current OTS policy, however, views remutualization transactions as
raising significant issues concerning disparate treatment of minority
stockholders and mutual members of the target entity and raising issues
concerning the effect on the mutual members of the acquiring entity. The OTS may
give these issues special scrutiny and reject applications providing for the
remutualization of a mutual holding company unless the applicant can clearly
demonstrate that there is no cause for OTS's concerns in the particular case.
Should the OTS prohibit or otherwise restrict these transactions in the future,
our stock price may be adversely affected.
Item 1B. Unresolved Staff Comments
-----------------------------------
Not applicable.
Item 2. Properties
--------------------
At June 30, 2006, our net investment in property and equipment totaled
$35.9 million.
Item 3. Legal Proceedings
--------------------------
The Bank, from time to time, is a 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. There were no lawsuits pending or known to be
contemplated against the Company or the Bank at June 30, 2006 that would be
expected to have a material effect on operations or income.
Item 4. Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
None.
33
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
--------------------------------------------------------------------------------
Issuer Purchases of Equity Securities
-------------------------------------
Upon completion of the Company's first-step minority stock offering in
February 2005, the Company's common stock commenced trading on the Nasdaq
National Market under the symbol "KRNY." The table below shows the reported high
and low closing prices of the common stock during the periods indicated. The
quotations reflect inter-dealer prices, without retail mark-up, mark-down, or
commission, and may not represent actual transactions.
High Low Dividends
---- --- ---------
2005
----
Quarter ended March 31(1)......... $11.95 $11.08 -
Quarter ended June 30............. 11.95 10.10 -
2006
----
Quarter ended September 30........ $12.74 $11.50 $0.04
Quarter ended December 31......... 12.79 10.97 $0.05
Quarter ended March 31............ 13.89 12.20 $0.05
Quarter ended June 30............. 14.98 13.58 $0.05
---------------
(1) Closing of the minority stock offering February 23, 2005. Trading commenced
February 24, 2005.
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 is determined by the
Board.
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
the regulations of the Office of Thrift Supervision on the payment of dividends.
As of September 8, 2006, there were approximately 9,019 holders of
record of the Company's common stock, including persons who hold stock in
"street" name through various brokerage firms.
34
Set forth below is information regarding the Company's stock
repurchases during the fourth quarter of the fiscal year ended June 30, 2006.
The Company's purchases of its common stock to fund restricted stock awards are
not considered repurchases for purposes of the following table as such shares
remain outstanding and are held by the 2005 Stock Compensation and Incentive
Plan.
ISSUER PURCHASES OF EQUITY SECURITIES
-------------------------------------------------------------------------------------------------------------------------
(a) (b) (c) (d)
Total Total
Number of Number of Shares Maximum Number
Shares Average (or Units) Purchased (or Approximate Dollar Value)
(or Units) Price Paid as Part of Publicly of Shares (or Units) that May
Purchased per Share Announced Plans or Yet Be Purchased Under the
Period (or Unit) Programs Plans or Programs
--------------------------------- -------------- ------------- ------------------------ ---------------------------------
Quarter ended June 30, 2006 - 0 - $0 - 0 - 0
--------------------------------- -------------- ------------- ------------------------ ---------------------------------
Total - 0 - $0 - 0 - 0
--------------------------------- -------------- ------------- ------------------------ ---------------------------------
35
Item 6. Selected Financial Data
--------------------------------
The following financial information and other data in this section is
derived from the Company's audited consolidated financial statements and should
be read together therewith. The Company acquired Pulaski Bancorp, Inc. in
October 2002 and West Essex Bancorp, Inc. in July 2003.
At June 30,
-----------------------------------------------------------------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(In thousands)
Balance Sheet Data:
Assets.................................. $2,007,525 $2,107,005 $1,936,518 $1,996,482 $1,905,638
Loans receivable, net................... 703,613 558,018 505,794 509,161 591,142
Mortgage-backed securities
held to maturity...................... 689,962 758,121 771,353 681,619 968,516
Securities available for sale........... 18,346 33,591 41,564 37,840 39,679
Investment securities held to maturity.. 209,048 470,098 435,870 287,321 139,446
Cash and cash equivalents............... 230,279 139,865 39,488 325,657 97,030
Goodwill................................ 82,263 82,263 82,263 31,746 15,600
Deposits................................ 1,443,738 1,528,777 1,537,510 1,613,684 1,479,729
Federal Home Loan Bank advances......... 61,105 61,687 94,234 75,749 112,080
Total stockholders' equity.............. 490,886 505,482 293,505 295,669 302,454
For the Year Ended June 30,
---------------------------------------------------------------
2006 2005 2004 2003 2002
-------- --------- --------- --------- ---------
(In thousands, except per share amounts)
Summary of Operations:
Interest income....................... $ 89,323 $ 82,441 $ 78,654 $ 96,492 $ 106,162
Interest expense...................... 38,645 30,422 32,100 44,695 54,443
-------- --------- --------- --------- ---------
Net interest income................... 50,678 52,019 46,554 51,797 51,719
Provision for loan losses............. 72 68 - - 3
-------- --------- --------- --------- ---------
Net interest income after provision
for loan losses..................... 50,606 51,951 46,554 51,797 51,716
Non-interest income, excluding gain on
sale of available for sale securities 2,302 1,798 1,560 1,847 1,765
Non-interest income from gain on sale
of available for sale securities... 1,023 7,705 - - -
Merger related expenses............... - - 592 14,921 619
Non-interest expense, excluding
merger related expenses............. 42,046 34,862 28,880 29,431 28,446
-------- --------- --------- --------- ---------
Income before income taxes............ 11,885 26,592 18,642 9,292 24,416
Provisions for income taxes........... 2,277 7,694 5,745 5,237 7,926
-------- --------- --------- --------- ---------
Net income............................ $ 9,608 $ 18,898 $ 12,897 $ 4,055 $ 16,490
======== ========= ========= ========= =========
Net income per share - basic.......... $ 0.14 $ 0.33 $ 0.25 $ 0.08 $ 0.32
Net income per share - diluted........ $ 0.14 $ 0.33 $ 0.25 $ 0.08 $ 0.32
Weighted average number of common
shares outstanding - basic........ 70,904 57,963 50,916 50,916 50,916
Weighted average number of common
shares outstanding - diluted...... 71,100 57,963 50,916 50,916 50,916
Per Share Data:
Cash dividends per share (1)........ $ 0.19 $ - $ - $ 0.02 $ 0.02
Dividend payout ratio (2)........... 49.30% 0.00% 0.00% 24.32% 7.63%
36
At or For the Year Ended June 30,
-------------------------------------------------------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
Performance Ratios:
Return on average assets
(net income divided by
average total assets)............... 0.47% 0.94% 0.67% 0.21% 0.91%
Return on average equity
(net income divided by
average equity)...................... 1.91 5.40 4.52 1.38 5.55
Net interest rate spread............... 2.10 2.51 2.37 2.36 2.35
Net interest margin on average
interest-earnings assets............. 2.67 2.79 2.59 2.75 2.95
Average interest-earning
assets to average
interest-bearing liabilities......... 127.80 116.93 112.46 116.54 119.58
Efficiency ratio (Non-interest
expense divided by the sum
of net interest income and
non-interest income)................. 77.96 56.67 61.25 82.68 54.34
Efficiency ratio (net of gain on
sale of available for
sale securities)..................... 79.36 64.78 61.25 82.68 54.34
Non-interest expense to
average assets....................... 2.04 1.73 1.52 2.26 1.60
Asset Quality Ratios:(3)
Non-performing loans to total loans.... 0.13 0.34 0.46 0.57 0.55
Non-performing assets to total assets.. 0.05 0.10 0.13 0.16 0.18
Net charge-offs to average
loans outstanding..................... 0.01 0.00 0.01 0.00 0.00
Allowance for loan losses to
total loans.......................... 0.77 0.96 1.01 1.01 0.87
Allowance for loan losses to
non-performing loans................. 578.66 281.79 220.96 177.64 157.24
Capital Ratios:
Average equity to average
assets (average equity divided
by average total assets)............. 24.43 17.36 14.73 14.97 16.38
Equity to assets at period end......... 24.45 23.99 15.16 14.81 15.87
Tangible equity to tangible
assets at period end................. 21.19 20.66 11.29 13.31 15.02
Number of Offices:
Offices (including offices
acquired in mergers).............. 26 25 25 25 24
----------------
(1) Cash dividends paid per share represents the aggregate of dividends paid by
Kearny Financial Corp., West Essex Bancorp, Inc., and Pulaski Bancorp, Inc.
to the minority stockholders of West Essex Bancorp, Inc. and Pulaski
Bancorp, Inc. divided by the outstanding shares of Kearny Financial Corp.
common stock.
(2) Represents cash dividends declared per share divided by net income per
common share.
(3) Asset quality ratios are period end ratios.
37
Item 7. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations
-------------
General
This discussion and analysis reflects Kearny Financial Corp.'s
consolidated financial statements and other relevant statistical data. We
include it to enhance your understanding of our financial condition and results
of operations. You should read the information in this section in conjunction
with Kearny Financial Corp.'s consolidated financial statements and notes
thereto contained in this Annual Report on Form 10-K, and the other statistical
data provided herein.
Overview
Financial Condition and Results of Operations. Kearny Financial Corp.'s
results of operations depend primarily on its net interest income. Net interest
income is the difference between the interest income we earn on our
interest-earning assets and the interest we pay on our interest-bearing
liabilities. It is a function of the average balances of loans and investments
versus deposits and borrowed funds outstanding in any one period and the yields
earned on those loans and investments and the cost of those deposits and
borrowed funds.
Our interest-earning assets consist primarily of mortgage-backed
securities and investment securities, including available for sale and held to
maturity, which comprised 45.7% of total assets at June 30, 2006 while loans
receivable, net, comprised 35.0% of total assets. This was a change from 59.9%
and 26.5%, respectively, at June 30, 2005. The most significant change in our
interest-earning assets between June 30, 2005 and June 30, 2006 was a $145.6
million, or 26.1%, increase in loans receivable, net. During the year ended June
30, 2006, management stressed growth of the loan portfolio as a key goal.
Investment securities held to maturity decreased $261.1 million and
mortgage-backed securities held to maturity decreased $68.1 million. We
continued to invest proceeds from our initial public offering in mortgage loans.
Demand for mortgages contributed to the decrease in mortgage-backed securities,
as we used principal and interest payments to fund loan originations,
supplemented by the proceeds from a restructuring of the investment portfolio in
February 2006. Cash flows from mortgage-backed securities repayments also funded
deposit outflows. The decrease in investment securities resulted from the
restructuring of the investment portfolio.
Our interest-bearing liabilities consist primarily of retail deposits
and borrowings from the Federal Home Loan Bank of New York. At June 30, 2006,
our total deposits were $1.44 billion, compared to $1.53 billion at June 30,
2005, and our Federal Home Loan Bank of New York borrowings were $61.1 million
compared to $61.7 million a year earlier. The primary factor for the decrease in
deposits was a runoff of certificates of deposit and to some degree, core
deposits, due to a competitive market for deposits. The challenge for management
during the year ended June 30, 2006 was to balance the rate of attrition against
a significant increase in the cost of funds. A flat Treasury yield curve
throughout the year further exacerbated a difficult operating environment. The
nominal decrease in Federal Home Loan Bank advances resulted from a repayment of
principal on borrowings featuring a monthly amortization schedule.
Our net interest income decreased by 2.5%, to $50.7 million for the
year ended June 30, 2006 from $52.0 million for the year ended June 30, 2005.
The net interest rate spread decreased to 2.10% for the year ended June 30, 2006
from 2.51% for 2005 as the average cost of interest-bearing liabilities climbed
69 basis points to 2.60% while the average yield on interest-earning assets
improved 28 basis points to 4.70%. Total interest income increased 8.4% due to a
2.2% increase in the average balance of interest-earning assets and 28 basis
point increase in the average yield thereof, while total interest expense
increased 27.0%, primarily due to a 69 basis point increase in the average cost
of interest-bearing liabilities. Net interest income received a boost from the
reinvestment of proceeds from the restructuring of the investment portfolio into
cash equivalents earning market short-term interest rates.
38
Our results of operations also depend on our provision for loan losses,
non-interest income and non-interest expense. Non-interest income includes
service fees and charges, including income generated by the Bank's retail branch
network and operations, and income from bank owned life insurance. Non-interest
expense includes salaries and employee benefits, occupancy expenses and other
general and administrative expenses. Non-interest expense increased $7.1
million, or 20.3%, to $42.0 million for the year ended June 30, 2006, compared
to $34.9 million for the year ended June 30, 2005. The increase was due
primarily to increases in salaries and employee benefits, directors'
compensation expense, and to a lesser degree, occupancy expenses and
miscellaneous expenses. The increase in salaries and benefits and directors'
compensation expense resulted primarily from stock compensation plans commencing
during the quarter ended December 31, 2005.
Net income for the year ended June 30, 2006 was $9.6 million, a
decrease of $9.3 million, or 49.2%, from $18.9 million for the year ended June
30, 2005. The decrease in net income resulted primarily from lower net interest
income and higher non-interest expense. There was an increase in non-interest
income from service fees and charges and miscellaneous sources and a substantial
decrease in the contribution from net gain on sale of securities. In the year
ended June 30, 2006, the pre-tax gain on sale of securities contributed $1.0
million to income, compared to $7.7 million during the year ended June 30, 2005.
Total assets decreased $99.5 million, or 4.7%, to $2.01 billion at June
30, 2006 from $2.11 billion at June 30, 2005. Cash and cash equivalents
increased $90.4 million year-over-year, due to the reinvestment of proceeds from
the restructuring of the investment portfolio into cash equivalents. Cash and
cash equivalents provided funding for both loan originations and deposit
outflows. A $15.3 million, or 45.5%, reduction in securities available for sale,
to $18.3 million at June 30, 2006 from $33.6 million at June 30, 2005, was the
result of the sale of Freddie Mac common stock and a closed-end mutual fund.
Investment securities held to maturity decreased $261.1 million, or 55.5%, to
$209.0 million at June 30, 2006 from $470.1 million at June 30, 2005, due
primarily to the restructuring of the portfolio. Mortgage-backed securities held
to maturity decreased $68.1 million, or 9.0%, to $690.0 million from $758.1
million year-over-year, utilizing the cash flows from monthly principal and
interest payments to fund loan originations and deposit outflows.
Stockholders' equity decreased $14.6 million, or 2.9%, to $490.9
million at June 30, 2006, from $505.5 million at June 30, 2005. The decrease
primarily reflects the effect of unearned shares held by the 2005 Stock
Compensation and Incentive Plan and unallocated shares held by the employee
stock ownership plan totaling $13.9 million in aggregate. Cash dividends
declared of $4.7 million and a decrease of $5.6 million in accumulated other
comprehensive income resulting from the sale of available for sale securities
also contributed to the decrease in stockholders' equity, partially offset by
net income for the year of $9.6 million.
Business Strategy. Our current business strategy is to seek to grow and
improve our profitability by:
o increasing the volume of our loan originations and the size of
our loan portfolio relative to our securities portfolio;
o increasing the origination of multi-family and commercial real
estate loans, construction loans and commercial business loans;
o building our core banking business through internal growth and de
novo branching, as well as actively considering expansion
opportunities such as the acquisition of branches and other
financial institutions;
o developing a sales culture by training and encouraging our branch
personnel to promote our existing products and services to our
customers; and
39
o maintaining high asset quality.
Our deposits have traditionally exceeded our loan originations, and we
have invested these deposits primarily in mortgage-backed securities and
investment securities. Following our acquisition of South Bergen Savings Bank in
1999, we began focusing on growing the size of our loan portfolio. Prior to that
time, we focused our efforts on obtaining deposits from the communities in which
we operated our five branch offices in Bergen and Hudson counties and investing
those funds in mortgage-backed and other securities. A primary focus of our
current business strategy is to increase our volume of loan originations and the
size of our loan portfolio. There can be no assurance, however, that we will be
successful in this effort.
In an effort to develop our commercial business, we utilize several
experienced business development officers who focus on commercial loan
originations, and we expect to offer Internet banking and cash management
services to our commercial customers during the quarter ended December 31, 2006.
Our residential loan originations have traditionally been largely advertising
driven, but we also utilize regional loan originators who specialize in
residential mortgage loan originations and work throughout our retail branch
network, meeting with prospective loan customers wherever it is most convenient
for them.
Critical Accounting Policies
Our accounting policies are integral to understanding the results
reported. We describe them in detail in Note 1 to consolidated financial
statements beginning on Page F-8 of this document. In preparing the consolidated
financial statements, management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as of the dates of
the consolidated statements of financial condition and revenues and expenses for
the periods then ended. Actual results could differ significantly from those
estimates. Material estimates that are particularly susceptible to significant
changes relate to the determination of the allowance for loan losses, the
assessment of prepayment risks associated with mortgage-backed securities, the
evaluation of securities impairment and the impairment testing of goodwill.
Allowance for Loan Losses. The allowance for loan losses represents our
best estimate of losses known and inherent in our loan portfolio that are both
probable and reasonable to estimate. In determining the amount of the allowance
for loan losses, we consider the losses inherent in our loan portfolio and
changes in the nature and volume of our loan activities, along with general
economic and real estate market conditions. We use a two-tier approach: (1)
identification of impaired loans and establishment of specific loss allowances
on such loans; and (2) establishment of general valuation allowances on the
remainder of our loan portfolio. We maintain a loan review system, which allows
for a periodic review of our loan portfolio and the early identification of
potential impaired loans. Our system takes into consideration, among other
things, delinquency status, size of loans, and type of collateral and financial
condition of the borrowers. We establish specific loan loss allowances for
identified loans based on a review of such information and/or appraisals of the
underlying collateral. We base general loan loss allowances upon a combination
of factors including, but not limited to, actual loan loss experience,
composition of the loan portfolio, current economic conditions and management's
judgment.
Although we establish specific and general loan loss allowances in
accordance with management's best estimate, actual losses are dependent upon
future events and, as such, further provisions for loan losses may be necessary
in order to increase the level of the allowance for loan losses. For example,
our evaluation of the allowance includes consideration of current economic
conditions, and a change in economic conditions could reduce the ability of our
borrowers to make timely repayments of their loans. This could result in
increased delinquencies and increased non-performing loans, and thus a need to
make increased provisions to the allowance for loan losses, which would be a
charge to income during the period the provision is made, resulting in a
reduction to our earnings. A change in economic conditions could also adversely
affect the value of the properties collateralizing our real estate loans,
resulting in increased charge-offs against the allowance
40
and reduced recoveries, and thus a need to make increased provisions to the
allowance for loan losses. Furthermore, a change in the composition of our loan
portfolio or growth of our loan portfolio could result in the need for
additional provisions.
Prepayment Risks Associated with Mortgage-backed Securities. At June
30, 2006 and June 30, 2005, net premiums of approximately $2.5 million and $3.6
million, respectively, were included in the carrying amounts of our
mortgage-backed securities. We amortize the premium included in the carrying
amount over the average life of the security using the level-yield method. The
mortgage-backed securities we hold in our portfolio are subject to prepayment
risk because changes in interest rates can affect the expected life of these
mortgage-backed securities. We must estimate the level of prepayments in order
to estimate the average life of mortgage-backed securities.
We evaluate the estimated average life of mortgage-backed securities on
a monthly basis and adjust the amortization speed to reflect any change in the
average life. Amortizing the premium faster results in a reduction of the yield
on the securities, whereas slowing the amortization increases the yield. A
reduction in the yield decreases our interest income on mortgage-backed
securities, while an increase in the yield increases our interest income on
mortgage-backed securities.
The assessment of the prepayment risks related to mortgage-backed
securities is highly dependent upon the prediction of trends in market interest
rates. A reduction in interest rates generally results in increased prepayments
of mortgage-backed securities, as borrowers refinance their debt in order to
reduce their borrowing cost. Correspondingly, an increase in interest rates
should result in decreased prepayments and fewer re-financings. Because changes
in interest rates can affect the average life of mortgage-backed securities,
this makes the estimation of the prepayment risk difficult. We address this
difficulty by adjusting the amortization speed monthly to reflect the current
average life.
Impairment Testing of Goodwill. We record goodwill, representing the
excess of amounts paid over the fair value of net assets of the institutions
acquired in purchase transactions, at its fair value at the date of acquisition.
Through June 30, 2002, we amortized goodwill using the straight-line method over
15 years. Effective July 1, 2002, we adopted the Financial Accounting Standards
Board's Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets."
Goodwill is tested and deemed impaired when the carrying value of goodwill
exceeds its implied fair value. At June 30, 2006, we reported goodwill of $82.3
million. The value of the goodwill can change in the future. We expect the value
of the goodwill to decrease if there was a significant decrease in the franchise
value of Kearny Federal Savings Bank. If an impairment loss is determined in the
future, we will reflect the loss as an expense for the period in which the
impairment was determined, leading to a reduction of our net income for that
period by the amount of the impairment loss.
Other-than-Temporary Impairment of Securities. We evaluate on a
quarterly basis whether any securities are other-than-temporarily impaired. In
making this determination, we consider the extent and duration of the
impairment, the nature and financial health of the issuer, and our ability and
intent to hold securities for a period sufficient to allow for any anticipated
recovery in market value. Other considerations include a review of the credit
quality of the issuer and the existence of a guarantee or insurance, if
applicable to the security. If a security is determined to be
other-than-temporarily impaired, we will record an impairment loss as a charge
to income for the period in which the impairment loss was determined to exist,
resulting in a reduction to our earnings for that period.
As of June 30, 2006, we concluded that any unrealized losses in the
securities available for sale, mortgage-backed securities held to maturity and
investment securities held to maturity portfolios were temporary in nature due
to market interest rates and not the underlying credit quality of the issuers of
the securities. Additionally, we have the intent and ability to hold these
investments for the time necessary to
41
recover the amortized cost. Future events that would materially change this
conclusion and require a charge to operations for an impairment loss include a
change in the credit quality of the issuers.
Effective June 30, 2004, we adopted Emerging Issues Task Force ("EITF")
Issuance No. 03-1, "The Meaning of Other than Temporary Impairment and Its
Application to Certain Investments," which requires quantitative and qualitative
disclosures for investment securities that are impaired at the balance sheet
date, but for which other-than-temporary impairment has not been recognized.
Adoption of EITF 03-01 has not changed our policies for determining whether any
securities are other-than-temporarily impaired.
Comparison of Financial Condition at June 30, 2006 and June 30, 2005
Our total assets decreased by $99.5 million, or 4.7%, to $2.01 billion
at June 30, 2006 from $2.11 billion at June 30, 2005, primarily due to decreases
in securities available for sale, investment securities held to maturity and
mortgage-backed securities held to maturity, partially offset by increases in
cash and cash equivalents and loans receivable, net.
Cash and cash equivalents increased $90.4 million, or 64.6%, to $230.3
million at June 30, 2006, from $139.9 million at June 30, 2005. Proceeds from
the Company's restructuring of its investment portfolio executed in February
2006 provided the growth in cash and cash equivalents. Management reinvested the
proceeds from the restructuring in cash and cash equivalents at market
short-term interest rates, with expectations of maintaining liquidity, to the
extent funds are not used for loan originations, at an elevated level as long as
the Treasury yield curve remains flat.
The carrying value of securities available for sale decreased $15.3
million, or 45.5%, to $18.3 million at June 30, 2006, from $33.6 million at June
30, 2005. As was the case during the year ended June 30, 2005, concern about the
future of government-sponsored enterprises triggered the sale during the year
ended June 30, 2006 of the Company's remaining shares of Freddie Mac common
stock. In June 2005, we sold 130,000 shares, which produced a gain of $7.6
million, before taxes. In February 2006, we sold 131,088 shares, which resulted
in a gain of $8.8 million, before taxes. We also sold all of our shares of a
closed-end mutual fund in August 2005, which resulted in a gain of $86,000,
before taxes. We acquired the Dryden Government Income Fund in the merger with
South Bergen Savings Bank in March 1999.
Investment securities held to maturity decreased $261.1 million, or
55.5%, to $209.0 million at June 30, 2006, from $470.1 million at June 30, 2005.
The decrease resulted almost exclusively from the sale of the Bank's entire
portfolio of government agency notes, totaling $249.1 million, in February 2006.
The transaction resulted in a loss of $7.8 million, before taxes. The weighted
average yield of the portfolio was 3.22%. Management reinvested the proceeds in
cash and cash equivalents at market short-term interest rates. The Bank's
portfolio of tax-exempt municipal bonds decreased $4.3 million, or 2.1%, to
$200.3 million at June 30, 2006, from $204.6 million at June 30, 2005. Cash flow
from matured government agency notes and tax-exempt municipal bonds partially
funded deposit outflows.
Mortgage-backed securities held to maturity decreased $68.1 million, or
9.0%, to $690 million at June 30, 2006, from $758.1 million at June 30, 2005.
Management utilized the cash flows from monthly principal and interest payments
and matured mortgage-backed securities to fund loan originations and deposit
outflows. In an attempt to provide some protection against interest-rate risk,
during the year ended June 30, 2006, management purchased $111.7 million of
mortgage-backed securities with most of the pools containing adjustable rate
mortgages. As of June 30, 2006, $331.4 million, or 48.0% of the mortgage-backed
securities are variable rate compared to $337.2 million, or 44.5% at June 30,
2005.
Loans receivable, net, increased $145.6 million, or 26.1%, to $703.6
million at June 30, 2006, from $558.0 million at June 30, 2005. During the year
ended June 30, 2006, management stressed growth of the
42
loan portfolio as a key goal. One-to-four family real estate mortgages increased
$83.0 million, or 21.7%, to $465.8 million at June 30, 2006, from $382.8 million
at June 30, 2005. Multi-family and commercial real estate mortgages increased
$10.4 million, or 10.8%, to $107.1 million at June 30, 2006, from $96.7 million
at June 30, 2005. Our strategy particularly emphasizes growth in this segment of
the loan portfolio. Commercial business lines of credit increased $278,000, or
9.6%, to $3.2 million at June 30, 2006, from $2.9 million at June 30, 2005.
Consumer lending, primarily home equity loans and home equity lines of credit
increased $37.6 million, or 52.1%, to $109.7 million at June 30, 2006, from
$72.1 million at June 30, 2005. Construction loans increased $14.0 million, or
172.8%, to $22.1 million at June 30, 2006, from $8.1 million at June 30, 2005.
To supplement our own loan originations, management entered into agreements to
purchase mortgages from several mortgage companies. During the year ended June
30, 2006, we purchased $24.4 million from these sources.
Premises and equipment increased $964,000, or 2.8%, to $35.9 million at
June 30, 2006, from $35.0 million at June 30, 2005. The increase resulted
primarily from the cost associated with completing the construction of a de novo
branch in Lacey Township, New Jersey, which opened in October 2005. The increase
also includes the cost of renovations of retail branches located in Old Tappan
and Northvale, New Jersey, which management expects to complete in September and
October 2006, respectively.
Bank owned life insurance ("BOLI") increased $10.6 million, or 265.0%,
to $14.6 million at June 30, 2006, from $4.0 million at June 30, 2005. During
the year, the Company purchased BOLI policies totaling $10.2 million.
Total deposits decreased by $85.1 million, or 5.6%, to $1.44 billion at
June 30, 2006, from $1.53 billion at June 30, 2005. Non-interest-bearing demand
deposits increased $5.0 million, or 8.9%, to $61.1 million at June 30, 2006,
from $56.1 million at June 30, 2005. Year-over-year, interest-bearing demand
accounts increased $22.8 million, or 23.0%, to $122.1 million from $99.3
million. In the quarter ended March 31, 2006, the Bank introduced several
products designed to retain and attract core deposits, including Star Banking
and a tiered money market account, which contributed to the growth in
interest-bearing demand deposits. Savings and club accounts decreased $72.8
million, or 16.2%, to $377.4 million at June 30, 2006, from $450.2 million at
June 30, 2005. Fierce competition for core deposits within our marketplace
contributed to the decrease in savings and club accounts as well as transfers to
our own interest-bearing demand accounts. Certificates of deposit decreased
$40.0 million, or 4.3%, to $883.1 million at June 30, 2006, from $923.1 million
at June 30, 2005. Management marketed special certificate of deposit maturities,
typically with terms of five, nine and 13 months and promotional interest rates,
to retain and attract new deposits. The challenge for management during the year
ended June 30, 2006 was to balance the rate of attrition for all deposit
categories against a significant increase in the cost of funds.
Federal Home Bank of New York advances decreased $582,000, or 0.9%, to
$61.1 million at June 30, 2006, from $61.7 million at June 30, 2005. The
advances retired during the year were on a monthly repayment schedule. Twice
during the year, for short periods, management utilized an overnight line of
credit with the Federal Home Loan Bank of New York to meet liquidity needs.
Stockholders' equity decreased $14.6 million, or 2.9%, to $490.9
million at June 30, 2006, from $505.5 million at June 30, 2005. The decrease
primarily reflects the effect of unearned shares held by the 2005 Stock
Compensation and Incentive Plan and unallocated shares held by the employee
stock ownership plan totaling $13.9 million in aggregate. Cash dividends
declared of $4.7 million and a decrease of $5.6 million in accumulated other
comprehensive income resulting from the sale of available for sale securities
also contributed to the decrease in stockholders' equity, partially offset by
net income for the year of $9.6 million. During the year ended June 30, 2006,
$1.5 million in employee stock ownership plan ("ESOP") shares were released.
Paid in capital decreased $18.9 million during the year due to the purchase of
the Company's common stock in the open market to fund the restricted stock plan.
This reduction of equity was partially
43
offset by the vesting of $2.0 million in restricted stock shares, a $1.2 million
adjustment to equity for expensing stock options and $412,000 attributed to the
excess of market over cost of ESOP shares released. Management recorded the
purchase of stock to fund the restricted stock plan as a reduction of paid in
capital in accordance with SFAS No. 123R. The decrease in accumulated other
comprehensive income resulted from a reduction in the carrying value, net of
taxes, of the Company's securities available for sale portfolio due to the sales
of Freddie Mac common stock and a closed-end mutual fund, nominally offset by an
increase in the carrying value, net of taxes, of the securities remaining in the
portfolio.
Comparison of Operating Results for the Years Ended June 30, 2006 and June 30,
2005
General. Net income for the year ended June 30, 2006 was $9.6 million,
a decrease of $9.3 million, or 49.2%, from $18.9 million for the year ended June
30, 2005. The decrease in net income resulted primarily from lower net interest
income and higher non-interest expenses. There was an increase in non-interest
income from service fees and charges and miscellaneous sources and a substantial
decrease in the contribution from gain on sale of securities. An increase in
interest income did not offset an increase in interest expense resulting in
lower net interest income. The increase in non-interest expenses was due
primarily to increases in salaries and employee benefits, directors'
compensation expense, and to a lesser degree, occupancy expenses and
miscellaneous expenses.
Net Interest Income. Net interest income decreased by $1.3 million, or
2.5%, to $50.7 million for the year ended June 30, 2006, from $52.0 million for
the year ended June 30, 2005. Our net interest rate spread decreased 41 basis
points to 2.10% for the year ended June 30, 2006, from 2.51% for 2005. Our net
interest margin decreased 12 basis points to 2.67% for the year ended June 30,
2006, compared with 2.79% for the year ended June 30, 2005. Despite a 28 basis
point improvement in the average yield on interest-earning assets, increasing
from 4.42% for the year ended June 30, 2005 to 4.70% for the year ended June 30,
2006, the net interest rate spread decreased due to a 69 basis point increase in
the average cost of interest-bearing liabilities to 2.60% compared to 1.91%,
year-over-year. An increase in the average yield on interest-earning assets, a
$36.5 million increase in average interest-earnings assets and $106.9 million
decrease in average interest-bearing liabilities, was more than offset by the
increase in the cost of average interest-bearing liabilities resulting in a
decrease in the net interest margin, year-over-year. The ratio of average
interest-earning assets to average interest-bearing liabilities increased to
127.8% for the year ended June 30, 2006, compared to 116.9% for the year ended
June 30, 2005. Average interest-earning assets increased 2.0%, to $1.90 billion
for the year ended June 30, 2006, from $1.86 billion for the year ended June 30,
2005. Average interest-bearing liabilities decreased 6.7%, to $1.49 billion for
the year ended June 30, 2006, from $1.59 billion for the year ended June 30,
2005.
Interest Income. Total interest income increased $6.9 million, or 8.4%,
to $89.3 million for the year ended June 30, 2006, from $82.4 million for the
year ended June 30, 2005. The improvement in interest income resulted from both
an increase in the yield on average interest-earning assets as well as an
increase in the average balance of interest-earning assets. The average yield on
average interest-earning assets increased 28 basis points to 4.70% from 4.42%,
while average interest-earning assets increased $36.5 million, or 2.0%, to $1.90
billion from $1.86 billion.
Interest income on loans receivable increased $6.0 million, or 20.5%,
to $35.3 million for the year ended June 30, 2006, from $29.3 million for the
year ended June 30, 2005. The increase resulted from an increase in the average
balance of loans receivable, net, partially offset by a reduction in the average
yield on loans. The average balance of loans receivable, net, increased $110.5
million, or 21.3%, to $628.2 million for the year ended June 30, 2006, from
$517.7 million for the year ended June 30, 2005. The average yield on loans
decreased four basis points, to 5.62% for the year ended June 30, 2006, compared
to 5.66% for 2005. The lower yield reflects generally lower interest rates on
originations compared to principal repayments on seasoned higher yielding
mortgages; however, the decline in average yields year-over-year began to slow.
The average yield for the year ended June 30, 2005 was 5.66% compared to 5.79%
for 2004.
44
Interest income on mortgage-backed securities held to maturity
decreased $483,000, or 1.4%, to $33.5 million for the year ended June 30, 2006,
compared to $34.0 million for the year ended June 30, 2005. The decrease in
interest income on mortgage-backed securities resulted from a decrease in the
average balance outstanding rather than average yield, which was unchanged at
4.59% for the years ended June 30, 2006 and 2005. The average balance of
mortgage-backed securities decreased $11.4 million, or 1.5%, to $729.0 million
for the year ended June 30, 2006, from $740.4 million for the year ended June
30, 2005. The decrease in the average balance resulted from the utilization of
cash flows from monthly principal and interest payments to fund loan
originations and deposit outflows rather than reinvestment in the portfolio.
Following a decline in average yield between the prior two years, due to
principal repayments received on seasoned higher yielding securities reinvested
in a lower interest rate environment, the average yield stabilized during the
year ended June 30, 2006. The average yield for the year ended June 30, 2005 was
4.59% compared to 4.76% for 2004. Most pools purchased during the year contained
adjustable rate mortgages, thus sacrificing higher yields on fixed rate
mortgages for interest rate risk protection in the future.
Interest income on investment securities available for sale and held to
maturity, both taxable and tax-exempt, decreased $2.3 million, or 13.9%, to
$14.2 million for the year ended June 30, 2006, from $16.5 million for the year
ended June 30, 2005. The decrease resulted from a decrease of $95.6 million, or
19.5%, in the average balance of investment securities to $394.6 million for the
year ended June 30, 2006, from $490.2 million for the year ended June 30, 2005,
partially offset by an increase in the average yield year-over-year. The average
yield for the year ended June 30, 2006 was 3.60%, compared to 3.37% for the year
ended June 30 2005. The decrease in the average balance resulted almost
exclusively from the sale of the Bank's entire portfolio of government agency
notes, totaling $249.1 million, in February 2006. Management attributes the
increase in the average yield in part to this sale since the weighted average
yield on these notes was 3.22%. Interest income on tax-exempt investment
securities increased $730,000, or 10.6%, to $7.6 million for the year ended June
30, 2006, from $6.9 million for the year ended June 30, 2005. The increase
resulted from an increase in the average balance partially offset by a decrease
in the average yield. The average balance increased by $21.5 million, or 11.9%,
to $202.0 million for the year ended June 30, 2006, from $180.5 million for the
year ended June 30, 2005, while the average yield decreased to 3.78% for the
year ended June 30, 2006, from 3.82% in 2005. The actual balance at June 30,
2006 of $200.3 million, compared to $204.6 million at June 30, 2005 reflects
management's decision to de-emphasize tax-exempt securities, due to lower
pre-tax income and lower interest rates on new issues. Interest income on
taxable investment securities decreased $3.0 million, or 31.3%, to $6.6 million
for the year ended June 30, 2006, from $9.6 million for the year ended June 30,
2005, resulting from a decrease in average balance partially offset by an
increase in average yield. The average balance decreased $117.1 million, or
37.8%, to $192.6 million for the year ended June 30, 2006, from $309.7 million
for the year ended June 30, 2005. The average yield increased to 3.40% for the
year ended June 30, 2006, from 3.11% for 2005. The sale of the entire government
agency notes portfolio substantially contributed to both the decrease in average
balance and increase in average yield.
Interest income on other interest-earning assets increased $3.7
million, or 142.3%, to $6.3 million for the year ended June 30, 2006, from $2.6
million for the year ended June 30, 2005. The composition of interest income on
other interest-earning assets during the year ended June 30, 2006 included
interest received from deposits at other banks, specifically the Federal Home
Loan Bank of New York and Bank of America, and dividends paid on Federal Home
Loan Bank of New York capital stock. The increase in interest income resulted
from an increase in average yield and average balance. The average yield
increased to 4.28% for the year ended June 30, 2006, from 2.30% for 2005 while
the average balance increased $33.0 million, or 28.7%, to $147.9 million for the
year ended June 30, 2006, from $114.9 million for the year ended June 30, 2005.
Management reinvested the proceeds from the investment portfolio restructuring
in cash and cash equivalents to take advantage of market short-term interest
rates.
Interest Expense. Total interest expense increased $8.2 million, or
27.0%, to $38.6 million for the year ended June 30, 2006, from $30.4 million for
year ended June 30, 2005. The increase resulted from an
45
increase in the average cost of interest-bearing liabilities, partially offset
by a decrease in the average balance of interest-bearing liabilities. The
average cost increased 69 basis points to 2.60% in the year ended June 30, 2006,
from 1.91% for 2005. The average balance of interest-bearing liabilities
declined $106.9 million, or 6.7%, to $1.49 billion during the year ended June
30, 2006, as compared to $1.59 billion during the year ended June 30, 2005.
Management increased rates to match the competition's rate offerings in the face
of rising short-term interest rates in an effort to stem the outflow of deposits
triggered by the competitive market for deposits.
Interest expense on deposits increased $8.6 million, or 32.5%, to $35.1
million for the year ended June 30, 2006, from $26.5 million for the year ended
June 30, 2005. The average cost of interest-bearing deposits increased to 2.47%
for the year ended June 30, 2006, from 1.75% in 2005. The average cost of
certificates of deposit increased to 3.27% from 2.33%, while the average cost of
savings and club accounts increased to 1.18% from 1.02% and the average cost of
interest-bearing demand accounts increased to 0.90% from 0.71%. Management found
it necessary to market special certificate of deposit maturities with
promotional interest rates, typically with terms of five, nine and 13 months, to
retain and attract new deposits. The average balance of interest-bearing
deposits decreased $91.3 million, or 6.0%, to $1.42 billion for the year ended
June 30, 2006, from $1.51 billion for the prior year. Average certificates of
deposit increased to $888.8 million from $873.9 million, average savings and
club accounts decreased to $429.0 million from $533.1 million and average
interest-bearing demand deposits decreased to $103.4 million from $105.5
million. The Bank introduced several products designed to retain and attract
core deposits, including Star Banking and a tiered money market account. The
challenge for management during the year ended June 30, 2006 was to balance the
rate of attrition for all deposit categories against a significant increase in
the cost of funds.
Interest expense on Federal Home Loan Bank advances decreased $314,000,
or 8.1%, to $3.6 million for the year ended June 30, 2006, from $3.9 million for
the year ended June 30, 2005. The decrease in interest expense resulted from a
decrease in the average balance of advances outstanding partially offset by an
increase in the average cost of advances. The average balance of advances
outstanding decreased $15.7 million, or 19.4%, to $65.3 million for the year
ended June 30, 2006 compared to $81.0 million for the year ended June 30, 2005.
The average cost of borrowings increased to 5.47% from 4.80%, year-over-year.
The decrease in the average balance resulted from short-term advances obtained
and subsequently paid off during the year ended June 30, 2005, to fund the
purchase of securities. The same situation did not occur during the year ended
June 30, 2006. The average cost of borrowed money increased during the year
ended June 30, 2006, due to management's utilization of an overnight line of
credit with the Federal Home Loan Bank of New York to meet liquidity needs.
Overnight borrowings were particularly expensive due to the high cost of
short-term interest rates relative to rates on longer-term advances.
Provision for Loan Losses. We charge provisions for loan losses to
operations at a level required to reflect credit losses in the loan portfolio
that are both probable and reasonable to estimate. Management, in determining
the allowance for loan losses, considers the losses inherent in the loan
portfolio and changes in the nature and volume of our loan activities, along
with the general economic and real estate market conditions. We utilize a
two-tier approach: (1) identification of impaired loans and establishment of
specific loss allowances on such loans; and (2) establishment of general
valuation allowances on the remainder of our loan portfolio. We establish a
specific loan loss allowance for an impaired loan based on delinquency status,
size of loan, type of collateral and/or appraisal of the underlying collateral
and financial condition of the borrower. Management bases general loan loss
allowances upon a combination of factors including, but not limited to, actual
loan loss experience, composition of the loan portfolio, current economic
conditions and management's judgment.
There was a $72,000 provision for loan losses recorded for the year
ended June 30, 2006 compared to a $68,000 provision for loan losses recorded for
the year ended June 30, 2005. During the year ended June 30, 2006, total loans
increased to $708.0 million at June 30, 2006, from $562.6 million at June 30,
2005.
46
Non-performing loans were $942,000, or 0.13%, of total loans at June 30, 2006,
as compared to $1.9 million, or 0.34%, of total loans at June 30, 2005. The
allowance for loan losses as a percentage of total loans outstanding was 0.77%
at June 30, 2006, compared to 0.96% at June 30, 2005, reflecting balances of
$5.5 million and $5.4 million, respectively. The ratio of the allowance for loan
losses to non-performing loans increased to 578.7% at June 30, 2006, from 281.8%
at June 30, 2005. The increase in the ratio is a result of a $980,000 decrease
in non-performing loans from approximately $1.9 million at June 30, 2005, to
$942,000 at June 30, 2006.
Management assesses the allowance for loan losses monthly. While
management uses available information to recognize losses on loans, additional
loan loss provisions in the future may be necessary based on changes in economic
conditions. In addition, regulatory agencies, as an integral part of their
examination process, periodically review the allowance for loan losses and may
require us to recognize additional provisions based on their judgment of
information available to them at the time of their examination.
Non-interest Income. Non-interest income attributed to fees, service
charges and miscellaneous income and excluding gains on the sale of securities
increased $504,000, or 28.0%, to $2.3 million for the year ended June 30, 2006,
from $1.8 million for the year ended June 30, 2005. Fees and service charges
increased $68,000 year-over-year, primarily due to an increase in prepayment
charges on loans and a nominal increase in fee income attributed to the Bank's
retail branch network, partially offset by lower other loan fees. Miscellaneous
income increased $436,000 primarily due to an increase in the cash surrender
value of bank owned life insurance and other fees from operations. At June 30,
2006, we had a $14.6 million investment in bank owned life insurance, compared
to $4.0 million at June 30, 2005.
Non-interest income attributed to net gain on the sale of securities
was $1.0 million in the year ended June 30, 2006, resulting from the sale of
131,088 shares of Freddie Mac common stock, a closed-end mutual fund and the
Bank's entire portfolio of government agency notes. The three transactions
produced pre-tax gains of $8.8 million and $86,000 and a pre-tax loss of $7.8
million, respectively. Non-interest income attributed to gains on the sale of
securities was $7.7 million in the year ended June 30, 2005, resulting from the
sale of 120,000 shares of Freddie Mac common stock and a trust-preferred
security. Concern about the future of government-sponsored enterprises triggered
the sale of the Company's Freddie Mac common stock investment. The common stock,
trust-preferred security and closed-end mutual fund were part of the Company's
available for sale investment portfolio and the government agency notes were in
the Bank's held-to-maturity portfolio.
Non-interest Expense. Non-interest expense increased $7.1 million, or
20.3%, to $42.0 million for the year ended June 30, 2006, from $34.9 million for
the year ended June 30, 2005. The increase in non-interest expense resulted
primarily from increases in salaries and employee benefits, directors'
compensation expense, miscellaneous expense, equipment expense and to a lesser
degree, advertising expense and net occupancy expense of premises.
Salaries and employee benefits increased $4.3 million, or 20.7%, to
$25.1 million in the year ended June 30, 2006, from $20.8 million in the year
ended June 30, 2005. The compensation expense component increased $372,000, or
2.8%, to $13.4 million for the year ended June 30, 2006, from $13.1 million for
the year ended June 30, 2005. The increase resulted from normal salary increases
and hiring of additional employees to staff our newest retail branch opened in
Lacy Township, New Jersey during October 2005. Pension plan expense decreased
$699,000 to $2.6 million for the year ended June 30, 2006, compared to 2005.
Pension plan expense in the year ended June 30, 2005 included additional
contributions to compensate for lower than expected investment returns on plan
assets during prior periods. Benefits expense increased $905,000 to $3.8
million, year-over-year, resulting from higher health insurance premiums as well
as additional employees enrolled in the benefit plans. Employee stock ownership
plan ("ESOP") compensation expense increased $1.4 million to $1.9 million,
compared to 2005. ESOP compensation expense began
47
accruing immediately following the initial public offering completed in February
2005, therefore, there was only four months' expense recorded during the year
ended June 30, 2005. Stock compensation plan expense attributed to a stock
benefit plan approved at the 2005 Annual Meeting was $2.3 million. There was no
such expense recorded in 2005. Payroll tax expense increased $82,000 to $1.1
million compared to the previous year.
Net occupancy expense of premises increased $119,000, or 3.7%, to $3.3
million for the year ended June 30, 2006, from $3.2 million for the year ended
June 30, 2005. Decreases in rent expense, net, and lower property taxes
partially offset increases in repairs and maintenance expense, depreciation
expense and utilities expense. During the year ended June 30, 2006, the Bank
leased space at two locations vacated by management staff and administrative
operations upon their move to the Company's headquarters in late 2004. Another
tenant will move into Bank property in November 2006 and additional vacant space
is being prepared for lease. The rental income will partially offset the
occupancy expense of such premises in the future.
Equipment expense increased $470,000, or 11.8%, to $4.4 million for the
year ended June 30, 2006, from $4.0 million during the year ended June 30, 2005.
The largest increase was attributed to the data processing expense, which
increased $255,000 to $2.5 million, year-over-year. A significant part of the
increase resulted from additional security enhancements to the Bank's data
processing infrastructure.
Advertising expense increased $289,000, or 24.1%, to $1.5 million for
the year ended June 30, 2006, from $1.2 million for the year ended June 30,
2005. The increase in advertising expense resulted from a publicity campaign
connected to the grand opening of the Lacy Township branch, and media
advertising launching our Star Banking product and promoting special certificate
of deposit offerings. These were in addition to extensive campaigns to advertise
residential and commercial loan products and retail and commercial deposit
products.
Directors' compensation expense increased $1.2 million, or 135.4%, to
$2.1 million for the year ended June 30, 2006, from $886,000 for the year ended
June 30, 2005. Stock compensation plan expense attributed to a stock benefit
plan approved at the 2005 Annual Meeting was $1.1 million. There was no such
expense recorded in 2005. Directors' fees remained unchanged at $676,000 and
advisory board fees decreased $89,000 to $123,000, year-over-year. Other fees
including an incentive bonus plan were $225,000 for 2006.
Miscellaneous expense increased $744,000, or 20.1%, to $4.4 million for
the year ended June 30, 2006, from $3.7 million for the year ended June 30,
2005. Audit and accounting services expense and costs associated with being a
public company, including annual meeting expense produced the largest increases
in the miscellaneous expense category. Audit and accounting services expense
increased $184,000 to $535,000, compared to 2005. A significant part of that
increase, approximately $124,000, resulted from professional services rendered
to assist management in complying with Sarbanes-Oxley Section 404. The Company
recorded expense of approximately $10,000 in 2005 to begin the compliance effort
for Section 404. Annual meeting expense was $201,000 during the year ended June
30, 2006, which includes a provision for the estimated cost of the 2006 annual
meeting. There was no such expense recorded in 2005.
Provision for Income Taxes. The provision for income taxes decreased
$5.4 million, or 70.1%, to $2.3 million for the year ended June 30, 2006, from
$7.7 million for the year ended June 30, 2005. The decrease in income tax
expense resulted from a decrease in pre-tax income of $14.7 million, or 55.3%,
to $11.9 million in the year ended June 30, 2006, from $26.6 million for the
year ended June 30, 2005. The effective income tax rates were 19.2% for the year
ended June 30, 2006, as compared to 28.9% for the year ended June 30, 2005. Due
to the Bank's significant investment in tax-exempt municipal bonds, tax-exempt
interest reduced the Company's federal income expense by approximately $2.4
million during the year ended June 30, 2006, compared to a reduction of
approximately $2.2 million in the year ended June 30, 2005.
48
Comparison of Operating Results for the Years Ended June 30, 2005 and June 30,
2004
General. Net income for the year ended June 30, 2005 was $18.9 million,
an increase of $6.0 million, or 46.5%, from $12.9 million for 2004. The increase
in net income resulted from the gain on sale of available for sale securities
recorded in 2005. Without the gain on sale, net income for the year ended June
30, 2005 remained virtually unchanged from a year earlier, since an increase in
non-interest expense offset a comparable increase in net interest income.
Net Interest Income. Net interest income increased by $5.4 million, or
11.6%, to $52.0 million for the year ended June 30, 2005, from $46.6 million for
the year ended June 30, 2004. The net interest rate spread increased to 2.51%
for the year ended June 30, 2005, from 2.37% for 2004. The net interest margin
increased 20 basis points to 2.79% for the year ended June 30, 2005, compared
with 2.59% for the year ended June 30, 2004. The net interest rate spread
improved due to a four basis point increase in the average yield on
interest-earning assets complemented by a decrease of 10 basis points in the
average cost of interest-bearing liabilities. The increase in net interest
margin resulted from the improvement in the ratio of average interest-earning
assets to average interest-bearing liabilities, 116.93% for the year ended June
30, 2005, compared to 112.46% for the year ended June 30, 2004. Average
interest-earning assets increased $68.8 million, or 3.9%, to $1.86 billion for
the year ended June 30, 2005, from $1.79 billion for the year ended June 30,
2004. Average interest-bearing liabilities remained virtually unchanged,
decreasing by $2.3 million for the year ended June 30, 2005.
Interest Income. Total interest income increased $3.7 million, or 4.7%,
to $82.4 million for the year ended June 30, 2005, from $78.7 million for the
year ended June 30, 2004. The improvement in interest income resulted from both
the increase in the yield on average interest-earning assets as well as the
increase in average interest-earning assets. The average yield on average
interest-earning assets increased four basis points to 4.42% from 4.38%, while
average interest-earning assets increased $68.8 million, or 3.9%, to $1.86
billion from $1.79 billion.
Interest income on loans receivable increased $392,000, or 1.4%, to
$29.3 million for the year ended June 30, 2005, from $28.9 million for the year
ended June 30, 2004. The increase resulted from an increase in the average
balance of loans receivable, net, partially offset by a reduction in the average
yield on loans. The average balance of loans receivable, net, increased $18.2
million, or 3.6%, to $517.7 million for the year ended June 30, 2005, from
$499.5 million for the year ended June 30, 2004. The average yield on loans
decreased 13 basis points, to 5.66% for the year ended June 30, 2005, compared
to 5.79% for 2004. The increased average balance reflects an effort to improve
the ratio of loans to deposits. Net loans receivable increased $52.2 million, or
10.3%, to $558.0 million at June 30, 2005, from $505.8 million at June 30, 2004.
The lower yield reflects generally lower interest rates on originations and
downward rate adjustments on adjustable rate and floating rate loans.
Interest income on mortgage-backed securities held to maturity deceased
$26,000 and was $34.0 million for the year ended June 30, 2005, virtually
unchanged from 2004. Interest income on mortgage-backed securities did not
change as an increase in the average balance outstanding was offset by a
decrease in the average yield. The average balance of mortgage-backed securities
increased $27.0 million, or 3.8%, to $740.4 million for the year ended June 30,
2005, from $713.4 million for the year ended June 30, 2004. At the same time,
the average yield decreased 17 basis points to 4.59% for the year ended June 30,
2005, compared to 4.76% for 2004. The increase in average balance resulted from
the substitution of mortgage-backed securities for loans earlier in the year,
while management launched an advertising campaign designed to increase loan
originations. Mortgage-backed securities actually decreased $13.3 million, or
1.7%, to $758.1 million at June 30, 2005, from $771.4 million at June 30, 2004.
The decline in yield resulted from principal repayments received on older higher
yielding securities subsequently reinvested in a lower interest rate
environment. Additionally, most mortgage-backed securities purchased during the
year were adjustable rate, sacrificing
49
higher yields on fixed rate mortgages in the short-term for some interest rate
risk protection in the future.
Interest income on investment securities available for sale and held to
maturity, both taxable and tax-exempt, increased $2.1 million, or 14.6%, to
$16.5 million for the year ended June 30, 2005, from $14.4 million for the year
ended June 30, 2004. The increase resulted from an increase of $64.9 million, or
15.3%, in the average balance of investment securities to $490.2 million for the
year ended June 30, 2005, from $425.3 million for the year ended June 30, 2004.
A two basis point reduction in the average yield, declining to 3.37% for the
year ended June 30, 2005 from 3.39% for 2004, nominally offset the increase in
the average balance. Interest income on tax-exempt investment securities
increased $1.2 million, or 21.1%, to $6.9 million for the year ended June 30,
2005, from $5.7 million for the year ended June 30, 2004. The increase resulted
from an increase in the average balance partially offset by a decrease in the
average yield. The average balance increased by $38.9 million, or 27.5%, to
$180.5 million for the year ended June 30, 2005, from $141.6 million for the
year ended June 30, 2004, while the average yield decreased by 21 basis points,
to 3.82% for the year ended June 30, 2005, from 4.03% in 2004. Interest income
on taxable investment securities increased $908,000, or 10.4%, to $9.6 million
for the year ended June 30, 2005, from $8.7 million for the year ended June 30,
2004, resulting from increases in both average balance and average yield. The
average balance increased $26.0 million, or 9.2%, to $309.7 million for the year
ended June 30, 2005, from $283.7 million for the year ended June 30, 2004. The
average yield increased four basis points, to 3.11% for the year ended June 30,
2005, from 3.07% for 2004. There has been steady growth in both the tax-exempt
and taxable portfolios over the previous three years. Management gradually
shifted assets from those vulnerable to high prepayments such as mortgage-backed
securities, or with low yields, including cash and cash equivalents and
securities purchased under agreements to resell, into higher yielding
investments, particularly tax-exempt securities, which were offering higher tax
equivalent yields.
Interest income on other interest-earning assets increased $1.3
million, or 100.0%, to $2.6 million for the year ended June 30, 2005, from $1.3
million for the year ended June 30, 2004. There were no securities purchased
under agreements to resell during the year ended June 30, 2005, therefore, the
composition of interest income on other interest-earning assets for 2005
included only interest received from deposits at other banks, specifically the
Federal Home Loan Bank of New York, and dividends paid on Federal Home Loan Bank
of New York capital stock. The increase in interest income resulted from an
increase in average yield, partially offset by a decrease in the average
balance. The average yield increased 1.45%, to 2.30% for the year ended June 30,
2005, from 0.85% for 2004 while the average balance decreased $41.4 million, or
26.5%, to $114.9 million for the year ended June 30, 2005, from $156.3 million
for the year ended June 30, 2004. The investment of funds received from the
purchase of the Company's common stock, including over-subscriptions held during
the subscription period, contributed to the increase in interest income on other
interest-earning assets, particularly the ability to invest those funds during a
period of rising short-term interest rates.
Interest Expense. Total interest expense decreased $1.7 million, or
5.3%, to $30.4 million for the year ended June 30, 2005, from $32.1 million for
year ended June 30, 2004. The decrease resulted from a decrease in the average
cost of interest-bearing liabilities, with virtually no change in the average
balance of interest-bearing liabilities. The average cost decreased ten basis
points to 1.91% in the year ended June 30, 2005, from 2.01% for 2004. The
average balance of interest-bearing liabilities declined slightly to $1.59
billion during the year ended June 30, 2005, as compared to $1.60 billion during
the year ended June 30, 2004. Average cost decreased due to historically low
market interest rates prevailing during the period, though short-term rates
started climbing as the Federal Reserve raised the federal funds rate by 25
basis point increments.
Interest expense on deposits decreased $1.6 million, or 5.7%, to $26.5
million for the year ended June 30, 2005, from $28.1 million for the year ended
June 30, 2004. Interest expense included $491,000, paid on funds received during
the subscription period of the initial public offering completed in February
2005. The decrease resulted from a decrease in the average cost of
interest-bearing deposits and a slight decrease in the
50
average balance of interest-bearing deposits. The average cost of
interest-bearing deposits decreased ten basis points to 1.75% for the year ended
June 30, 2005, from 1.85% in 2004. The average cost of certificates of deposit
increased to 2.33% from 2.25%, while the average cost of savings and club
accounts decreased to 1.02% from 1.23% and the average cost of interest-bearing
demand accounts decreased to 0.71% from 0.80%. Management found it necessary to
begin raising certificate of deposit interest rates, reacting to rising
short-term interest rates during the second half of the year in order to reverse
earlier deposit outflows. The average balance of interest-bearing deposits
decreased $8.9 million to $1.51 billion for the year ended June 30, 2005, from
$1.52 billion for the prior year. The nominal decrease in the average balance
partially resulted from the temporary increase in deposits attributed to funds
received during the subscription period of the initial public offering completed
in February 2005 substantially offsetting an overall deposit outflow. Average
certificates of deposit declined to $873.9 million from $963.1 million, average
savings and club accounts increased to $533.1 million from $448.5 million and
average interest-bearing demand deposits decreased to $105.5 million from $109.8
million. The increase in average savings and club accounts reflects the
aforementioned temporary increase in deposits associated with the initial public
offering.
Interest expense on Federal Home Loan Bank advances decreased $128,000,
or 3.2%, to $3.9 million for the year ended June 30, 2005, from $4.0 million for
the year ended June 30, 2004. The decrease in interest expense resulted from a
decrease in the average cost of advances partially offset by an increase in the
average balance of advances. The average cost of advances fell 60 basis points
to 4.80% for the year ended June 30, 2005, from 5.40% for 2004, while the
average balance increased $6.7 million, or 9.0%, to $81.0 million for the year
ended June 30, 2005, from $74.3 million for the year ended June 30, 2004. The
increase in the average balance resulted from short-term advances obtained
earlier in the year to fund the purchase of securities, subsequently paid off
with proceeds from the initial stock offering completed in February 2005. The
relatively low interest rates associated with those advances contributed to
lowering the average cost of borrowed money.
Provision for Loan Losses. Provisions for loan losses are charged to
operations at a level required to reflect credit losses in the loan portfolio
that are both probable and reasonable to estimate. Management, in determining
the allowance for loan losses, considers the losses inherent in the loan
portfolio and changes in the nature and volume of our loan activities, along
with the general economic and real estate market conditions. We utilize a
two-tier approach: (1) identification of impaired loans and establishment of
specific loss allowances on such loans; and (2) establishment of general
valuation allowances on the remainder of our loan portfolio. A specific loan
loss allowance is established for an impaired loan based on delinquency status,
size of loan, type of collateral and/or appraisal of the underlying collateral
and financial condition of the borrower. General loan loss allowances are based
upon a combination of factors including, but not limited to, actual loan loss
experience, composition of the loan portfolio, current economic conditions and
management's judgment.
There was a $68,000 provision for loan losses recorded for the year
ended June 30, 2005, but no provision for loan losses in 2004. During the year
ended June 30, 2005, total loans increased to $562.6 million at June 30, 2005,
from $510.2 million at June 30, 2004. Non-performing loans were $1.9 million, or
0.34%, of total loans at June 30, 2005, as compared to $2.3 million, or 0.46%,
of total loans at June 30, 2004. The allowance for loan losses as a percentage
of gross loans outstanding was 0.96% at June 30, 2005, compared to 1.01% at June
30, 2004, reflecting balances of $5.4 million and $5.1 million, respectively.
The ratio of the allowance for loan losses to non-performing loans increased to
281.79% at June 30, 2005, from 220.96% at June 30, 2004. The increase is a
result of a $406,000 decrease in non-performing loans from $2.3 million at June
30, 2004, to $1.9 million at June 30, 2004.
Management assesses the allowance for loan losses monthly. While
management uses available information to recognize losses on loans, future loan
loss provisions may be necessary based on changes in economic conditions. In
addition, regulatory agencies, as an integral part of their examination process,
periodically review the allowance for loan losses and may require us to
recognize additional provisions based on their judgment of information available
to them at the time of their examination. The allowance for loan
51
losses as of June 30, 2005 was maintained at a level that represented
management's best estimate of losses in the loan portfolio to the extent they
were both probable and reasonably estimable.
Non-interest Income. Non-interest income attributed to fees, service
charges and miscellaneous income and excluding gains on the sale of securities
increased $238,000, or 14.9%, to $1.8 million for the year ended June 30, 2005,
from $1.6 million for the year ended June 30, 2004. The increase resulted
primarily from an increase in fee income from the Bank's retail branch network,
an increase in the cash value of bank owned life insurance and non-recurring
loan fee income. At June 30, 2005, we had a $4.0 million investment in bank
owned life insurance, compared to $3.8 million at June 30, 2004.
Non-interest income attributed to gains on the sale of securities was
$7.7 million in the year ended June 30, 2005, resulting from the sale of 120,000
shares of Freddie Mac common stock and a trust- preferred security with a
carrying value of $1.0 million. There were no sales of securities during 2004.
Concern about the future of government-sponsored enterprises triggered the sale
of approximately 48% of the Company's Freddie Mac common stock investment. Both
the common stock and trust-preferred security were part of the Company's
available for sale investment portfolio.
Non-interest Expense. Non-interest expense increased $5.4 million, or
18.3%, to $34.9 million for the year ended June 30, 2005, from $29.5 million for
the year ended June 30, 2004. The increase in non-interest expenses resulted
from increases in salaries and employee benefits, net occupancy expense of
premises and equipment, advertising and miscellaneous expenses. These increases
were offset by the absence of merger related expenses in 2005 as compared to
$592,000 of such expense during 2004.
Salaries and employee benefits increased $4.3 million, or 26.1%, to
$20.8 million in the year ended June 30, 2005, from $16.5 million in the year
ended June 30, 2004. The compensation component increased $1.4 million, or
12.5%, to $12.6 million for the year ended June 30, 2005, from $11.2 million for
the year ended June 30, 2004. The increase resulted from normal salary increases
plus additional employees, including several business development personnel and
mortgage solicitors hired during the year. Pension plan expense and employee
benefits expense increased $1.7 million and $574,000, respectively, for the year
ended June 30, 2005 compared to 2004. The increase in pension plan expense
resulted from lower than expected investment returns on plan assets and higher
contributions due to the incremental effect of normal salary increases. During
the period March through June 2005, we recorded $466,000 in employee stock
ownership plan ("ESOP") compensation expense. The ESOP commenced immediately
following the initial public offering completed in February 2005, therefore,
there was no such expense recorded in 2004.
Net occupancy expense of premises and equipment expense increased $1.1
million, or 18.3%, to $7.1 million for the year ended June 30, 2005, from $6.0
million for the year ended June 30, 2004. Net occupancy expense of premises and
equipment expense increased $640,000 and $478,000, respectively, for the year
ended June 30, 2005 compared to 2004. The increase in net occupancy expense of
premises reflects the impact of our new 53,000 square foot administrative
headquarters building in Fairfield, New Jersey. Management staff and
administrative operations began occupying the building in late September and
continued to move in until December 2004. Approximately nine months of operating
expenses and six months of depreciation expense is included in the year ended
June 30, 2005. The increase in equipment expense resulted from higher
depreciation expense and increased costs related to data processing, ATM support
and Internet banking, all of which are outsourced.
Advertising expense increased $315,000, or 36.6%, to $1.2 million for
the year ended June 30, 2005, from $861,000 for the year ended June 30, 2004.
The increase in advertising expense resulted from greater media advertising in
an attempt to increase loan originations, publicize the Bank's retail and
commercial products and refine the Bank's branding. Also, rather than relying
exclusively on the large circulation newspapers, management began focusing
specifically on the counties in which we operate, through advertisements in
smaller local newspapers.
52
All other elements of non-interest expenses increased $281,000, or
5.4%, to $5.8 million for the year ended June 30, 2005, from $5.5 million, net
of merger related expenses of $592,000 for the year ended June 30, 2004. Most of
the increase in miscellaneous expenses is due to the increased costs associated
with being a public company, such as periodic reporting, retention of a transfer
agent and professional fees. Professional fees consisting of legal expense and
audit and accounting services expense increased $43,000 and $161,000,
respectively, for the year ended June 30, 2005, compared to 2004.
Provision for Income Taxes. The provision for income taxes increased
$2.0 million, or 35.1%, to $7.7 million for the year ended June 30, 2005, from
$5.7 million for the year ended June 30, 2004. The increase in income tax
expense resulted from an increase in pre-tax income of $8.0 million, or 43.0%,
to $26.6 million in the year ended June 30, 2005, from $18.6 million for the
year ended June 30, 2004. The effective income tax rates were 28.9% for the year
ended June 30, 2005, as compared to 30.8% for the year ended June 30, 2004.
Management attributes the lower effective income tax rate to tax management
strategies, including investing in bank-qualified tax-exempt municipal bonds and
transferring investment securities held to maturity and mortgage-backed
securities held to maturity to a New Jersey investment subsidiary, Kearny
Federal Investment Corp., a wholly-owned subsidiary of the Bank, which commenced
operations in July 2004. Of particular significance, tax-exempt municipal bond
interest reduced the Company's federal income expense by approximately $2.2
million.
53
Average Balance Sheet. The following table sets forth certain
information relating to Kearny Financial Corp. at and for the periods indicated.
We derived the average yields and costs by dividing income or expense by the
average balance of assets or liabilities, respectively, for the periods
presented with daily balances used to derive average balances with the exception
of the year ended June 30, 2004. Management does not believe that the use of
weekly or monthly balances for the year ended June 30, 2004 caused any material
differences in the information presented.
For the Year Ended June 30,
At June 30, ----------------------------------------------------------------------------------
2006 2006 2005 2004
------------------ ---------------- ------------------- ---------------- ------------------------
Actual Average Average Average
Actual Yield/ Average Yield/ Average Yield/ Average Yield/
Balance Cost Balance Interest Cost Balance Interest Cost Balance Interest Cost
------- ---- ------- -------- ---- ------- -------- ---- ------- -------- ----
(Dollars in thousands)
Interest-earning assets:
Loans receivable,
net(1)................ $ 703,613 5.68% $ 628,245 $35,338 5.62% $ 517,746 $29,311 5.66% $ 499,510 $28,919 5.79%
Mortgage-backed
securities
held to maturity...... 689,962 4.85 728,960 33,471 4.59 740,417 33,954 4.59 713,422 33,980 4.76
Investment securities:(2)
Tax-exempt............ 200,312 3.78 202,042 7,634 3.78 180,513 6,904 3.82 141,630 5,702 4.03
Taxable............... 27,082 5.72 192,561 6,554 3.40 309,740 9,632 3.11 283,708 8,724 3.07
Securities purchased
under agreements
to resell............. - 0.00 - - 0.00 - - 0.00 95,385 982 1.03
Other interest-
earning assets(3)..... 213,122 5.13 147,949 6,326 4.28 114,916 2,640 2.30 60,885 347 0.57
---------- ---------- ------- ---------- ------- ---------- -------
Total interest-
earning assets....... 1,834,091 5.10 1,899,757 89,323 4.70 1,863,332 82,441 4.42 1,794,540 78,654 4.38
------- ------- -------
Non-interest-earning
assets................. 173,434 161,423 151,055 144,698
---------- ---------- ---------- ----------
Total assets........... $2,007,525 $2,061,180 $2,014,387 $1,939,238
========== ========== ========== ==========
Interest-bearing
liabilities:
Interest-bearing
demand................ $ 122,129 1.56 $ 103,397 931 0.90 $ 105,503 752 0.71 $ 109,830 882 0.80
Savings and club........ 377,431 1.15 429,019 5,064 1.18 533,131 5,422 1.02 448,509 5,508 1.23
Certificates of
deposit............... 883,098 3.83 888,809 29,074 3.27 873,907 20,358 2.33 963,089 21,692 2.25
Federal Home Loan Bank
advances.............. 61,105 5.46 65,333 3,576 5.47 80,990 3,890 4.80 74,340 4,018 5.40
---------- ---------- ------- ---------- --------- ---------- -------
Total interest-
bearing liabilities.. 1,443,763 3.01 1,486,558 38,645 2.60 1,593,531 30,422 1.91 1,595,768 32,100 2.01
------- ------- -------
Non-interest-bearing
liabilities............ 72,876 71,089 71,119 57,846
---------- ---------- ---------- ----------
Total liabilities....... 1,516,639 1,557,647 1,664,650 1,653,614
Stockholders' equity..... 490,886 503,533 349,737 285,624
---------- ---------- ---------- ----------
Total liabilities and
stockholders' equity.. $2,007,525 $2,061,180 $2,014,387 $1,939,238
========== ========== ========== ==========
Net interest income...... $50,678 $52,019 $46,554
======= ======= =======
Interest rate spread(4).. 2.09% 2.10% 2.51% 2.37%
==== ==== ==== ====
Net yield on interest-
earning assets(5)...... 2.67% 2.79% 2.59%
==== ==== ====
Ratio of average
interest-earning
assets to average
interest- bearing
liabilities............ 1.27x 1.28x 1.17x 1.12x
========== =========== ========== ===========
-----------------
(1) Non-accruing loans have been included in loans receivable, and the effect
of such inclusion was not material.
(2) Includes both available for sale and held to maturity securities.
(3) Includes interest-bearing deposits at other banks, federal funds purchased
and Federal Home Loan Bank of New York capital stock.
(4) Interest rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest-bearing
liabilities.
(5) Net yield on interest-earning assets represents net interest income as a
percentage of average interest-earning assets.
54
Rate/Volume Analysis. The following table reflects the sensitivity of
Kearny Financial Corp.'s interest income and interest expense to changes in
volume and in prevailing interest rates during the periods indicated. Each
category reflects the: (1) changes in volume (changes in volume multiplied by
old rate); (2) changes in rate (changes in rate multiplied by old volume); and
(3) net change. The net change attributable to the combined impact of volume and
rate has been allocated proportionally to the absolute dollar amounts of change
in each.
Year Ended June 30, Year Ended June 30,
------------------------------------ ------------------------------------
2006 vs. 2005 2005 vs. 2004
------------------------------------ ------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------------------ ------------------------------------
Volume Rate Net Volume Rate Net
----------- ------------ ----------- ------------ ------------ ----------
(In thousands)
Interest and dividend income:
Loans receivable..................................... $ 6,235 $ (208) $ 6,027 $ 1,047 $ (655) $ 392
Mortgage-backed securities held to maturity.......... (483) - (483) 1,234 (1,260) (26)
Investment securities:
Tax-exempt......................................... 804 (74) 730 1,510 (308) 1,202
Taxable............................................ (3,911) 833 (3,078) 795 113 908
Securities purchased under agreements to resell...... - - - (491) (491) (982)
Other interest-earning assets........................ 923 2,763 3,686 519 1,774 2,293
-------- -------- -------- -------- -------- --------
Total interest-earning assets....................... $ 3,568 $ 3,314 $ 6,882 $ 4,614 $ (827) $ 3,787
======== ======== ======== ======== ======== ========
Interest expense:
Interest-bearing demand.............................. $ (15) $ 194 $ 179 $ (34) $ (96) $ (130)
Savings and club..................................... (1,145) 787 (358) 944 (1,030) (86)
Certificates of deposit.............................. 353 8,363 8,716 (2,077) 743 (1,334)
Advances from Federal Home Loan Bank................. (813) 499 (314) 341 (469) (128)
--------- -------- --------- -------- -------- --------
Total interest-bearing liabilities................. $ (1,620) $ 9,843 $ 8,223 $ (826) $ (852) $ (1,678)
========= ======== ======== ======== ======== ========
Change in net interest income......................... $ 5,188 $ (6,529) $ (1,341) $ 5,440 $ 25 $ 5,465
======== ======== ======== ======== ======== ========
55
Liquidity and Commitments
Our liquidity, represented by cash and cash equivalents, is a product
of our operating, investing and financing activities. Our primary sources of
funds are deposits, amortization, prepayments and maturities of mortgage-backed
securities and outstanding loans, maturities of investment securities and funds
provided from operations. In addition, we invest excess funds in short-term
interest-earning assets such as overnight deposits or U.S. agency securities,
which provide liquidity to meet lending requirements. While scheduled payments
from the amortization of loans and mortgage-backed securities and maturing
investment securities and short-term investments are relatively predictable
sources of funds, general interest rates, economic conditions and competition
greatly influence deposit flows and prepayments on loans and mortgage-backed
securities.
The Bank is required to have enough investments that qualify as liquid
assets in order to maintain sufficient liquidity to ensure a safe operation.
Liquidity may increase or decrease depending upon the availability of funds and
comparative yields on investments in relation to the return on loans. We attempt
to maintain adequate but not excessive liquidity, and liquidity management is
both a daily and long-term function of business management.
We review cash flow projections regularly and update them in order to
maintain liquid assets at levels believed to meet the requirements of normal
operations, including loan commitments and potential deposit outflows from
maturing certificates of deposit and savings withdrawals. At June 30, 2006, the
Bank had outstanding commitments to originate loans of $44.4 million,
construction loans in process of $11.4 million and unused lines of credit of
$25.5 million.
Certificates of deposit increased during the quarter ended June 30,
2005, due to a promotional short-term rate offered by the Bank. Deposits,
primarily certificates of deposit, decreased in the quarters ended September 30,
2005 and December 31, 2005 as the Bank intentionally slowed increases in the
rates it pays on deposits relative to the pace of rising market interest rates.
Certificates of deposit continued to decrease, as well as core deposits, during
the quarter ended March 31, 2006. Management's goal to slow the increase in the
cost of funds was not sustainable. In the quarter ended March 31, 2006, the Bank
introduced several deposit products designed to build core deposits and adjusted
interest rates on certificates of deposit to stabilize their rate of attrition.
During the quarter ended June 30, 2006, management introduced promotional rates
for terms of five, nine and 13 months to retain and attract new certificates of
deposit. Certificates of deposit scheduled to mature in one year or less at June
30, 2006, totaled $658.2 million.
While deposits are the Bank's primary source of funds, the Bank also
generates cash through borrowings from the Federal Home Loan Bank of New York
(the "FHLB"). At June 30, 2006, advances from the FHLB amounted to $61.1
million. The Bank has the capacity to borrow additional funds from the FHLB,
through an overnight line of credit or by taking additional long-term or
short-term advances. Because of continued strong loan demand and continued
deposit outflows, the Bank began utilizing the FHLB overnight line of credit
during the quarter ended March 31, 2006. Management used proceeds from the
restructuring of the securities portfolio in February 2006 to repay the borrowed
money. No further borrowing occurred during the year ended June 30, 2006, due to
adequate liquidity.
As noted above, loan prepayments are greatly influenced by general
interest rates. At June 30, 2006, 79.6% of our loan portfolio consisted of fixed
rate loans with maturities of greater than one year. If a rising interest rate
environment were to occur, we would expect that the rate of prepayments on fixed
rate loans would decrease, thus decreasing the amount of funds coming from
prepayments and reducing our liquidity.
56
The following table discloses our contractual obligations and
commitments as of June 30, 2006.
Less Than After
Total 1 Year 1-3 Years 4-5 Years 5 Years
--------- --------- --------- --------- -------
(In thousands)
Operating lease obligations................ $ 1,728 $ 271 $ 443 $ 373 $ 641
Certificates of deposit.................... 883,098 658,218 200,090 24,701 89
Federal Home Loan Bank advances............ 61,105 5,618 45,487 10,000 -
-------- -------- -------- ------- --------
Total.................................. $945,931 $664,107 $246,020 $35,074 $ 730
======== ======== ======== ======= ========
Total
Amounts Less Than Over
Committed 1 Year 1-3 Years 4-5 Years 5 Years
--------- --------- --------- --------- -------
(In thousands)
Undisbursed funds from approved lines of
credit(1)............................... $25,556 $ 534 $ - $ - $25,022
Construction loans in process.............. 11,368 8,395 2,973 - -
Other commitments to extend credit(1)...... 44,424 44,424 - - -
------- ------- ------ ------- -------
Total.................................. $81,348 $53,353 $2,973 $ - $25,022
======= ======= ====== ======= =======
-------------------
(1) Represents amounts committed to customers.
Our material capital expenditure plans relate to renovations and
significant improvements to six branch offices, which includes the replacement
of one office location with a new building. We expect to complete such
renovations, improvements and construction by the end of calendar year 2007, and
we anticipate approximately $3.6 million in funds will be required for the plans
related to these six offices. Furthermore, in December of 2004, we acquired a
3.7 acre parcel of land in West Caldwell, New Jersey. We intend to construct a
branch office at this location and subdivide and lease to third parties the
portion of land not used for the branch building. Engineering studies continue
at this location, while we attempt to develop a plan acceptable to the
municipality.
The general business purpose of these expenditures is to maintain and
improve Kearny Federal Savings Bank's facilities. We anticipate that cash flows
from our normal operations will be a sufficient source of funds for these
expenditure plans.
Off-Balance Sheet Arrangements
We are a party to financial instruments with off-balance-sheet risk in
the normal course of our business of investing in loans and securities as well
as in the normal course of maintaining and improving Kearny Federal Savings
Bank's facilities. These financial instruments include significant purchase
commitments, such as commitments related to capital expenditure plans and
commitments to purchase investment securities or mortgage-backed securities, and
commitments to extend credit to meet the financing needs of our customers. At
June 30, 2006, we had no significant off-balance sheet commitments to purchase
securities. Our significant purchase commitments as of June 30, 2006 related to
capital expenditure plans consisted of anticipated post-June 30, 2006
expenditures of approximately $281,000 connection with the completion of
renovations of existing branches in Old Tappan and Northvale, New Jersey.
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Our exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for commitments to
extend credit is represented by the contractual notional amount of those
instruments. We use the same credit policies in making
57
commitments and conditional obligations as we do for on-balance-sheet
instruments. At June 30, 2006, the total approved loan origination commitments
outstanding amounted to $44.4 million and commitments to purchase participation
interests in loans totaled $0. At the same date, unused lines of credit were
$25.5 million and construction loans in process were $11.4 million. Since many
of the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. For
additional information regarding our outstanding lending commitments at June 30,
2006, see Note 16 to consolidated financial statements contained in this Annual
Report on Form 10-K.
Capital
Consistent with its goals to operate a sound and profitable financial
organization, Kearny Federal Savings Bank actively seeks to maintain a well
capitalized institution in accordance with regulatory standards. As of June 30,
2006, Kearny Federal Savings Bank exceeded all capital requirements of the
Office of Thrift Supervision. Kearny Federal Savings Bank's regulatory capital
ratios at June 30, 2006 were as follows: core capital 19.41%; Tier I risk-based
capital 48.19%; and total risk-based capital 48.90%. The regulatory capital
requirements to be considered well capitalized are 5.0%, 6.0% and 10.0%,
respectively. For additional information regarding regulatory capital at June
30, 2006, see Note 14 to consolidated financial statements contained in this
Annual Report on Form 10-K.
Impact of Inflation
The financial statements included in this document have been prepared
in accordance with accounting principles generally accepted in the United States
of America. These principles require the measurement of financial position and
operating results in terms of historical dollars, without considering changes in
the relative purchasing power of money over time due to inflation.
Our primary assets and liabilities are monetary in nature. As a result,
interest rates have a more significant impact on our performance than the
effects of general levels of inflation. Interest rates, however, do not
necessarily move in the same direction or with the same magnitude as the price
of goods and services, since such prices are affected by inflation. In a period
of rapidly rising interest rates, the liquidity and maturities of our assets and
liabilities are critical to the maintenance of acceptable performance levels.
The principal effect of inflation on earnings, as distinct from levels
of interest rates, is in the area of non-interest expense. Expense items such as
employee compensation, employee benefits and occupancy and equipment costs may
be subject to increases as a result of inflation. An additional effect of
inflation is the possible increase in the dollar value of the collateral
securing loans that we have made. We are unable to determine the extent, if any,
to which properties securing our loans have appreciated in dollar value due to
inflation.
Recent Accounting Pronouncements
Management believes that there were no significant recent accounting
pronouncements requiring disclosure at June 30, 2006.
58
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
-------------------------------------------------------------------
Management of Interest Rate Risk and Market Risk
Qualitative Analysis. Because the majority of our assets and
liabilities are sensitive to changes in interest rates, a significant form of
market risk for us is interest rate risk, or changes in interest rates.
Notwithstanding the unpredictability of future interest rates, management
expects that changes in interest rates may have a significant, adverse impact on
our net interest income.
Our ability to make a profit largely depends on our net interest
income, which could be negatively affected by changes in interest rates. Net
interest income is the difference between:
o the interest income we earn on our interest-earning assets, such
as loans and securities; and
o the interest expense we pay on our interest-bearing liabilities,
such as deposits and amounts we borrow.
The rates we earn on our assets are generally fixed for a contractual
period of time. We, like many savings institutions, have liabilities that
generally have shorter contractual maturities than our assets, such as
certificates of deposit, or have no stated maturity, such as savings and money
market deposits. This imbalance can create significant earnings volatility
because market interest rates change over time. In a period of rising interest
rates, the interest income earned on our assets, which consist primarily of
long-term, fixed-rate securities, may not increase as rapidly as the interest
paid on our liabilities.
We are vulnerable to volatility in our earnings as a result of an
increase in interest rates because the majority of our interest-earning assets
consist of long-term, fixed rate assets. At June 30, 2006, 82.1% of our loans
with contractual maturities of greater than one year had fixed rates of
interest, and 74.4% of our total loans had contractual maturities of ten or more
years. At June 30, 2006, we held $690.0 million of mortgage-backed securities,
representing 34.4% of our assets. We invest generally in fixed-rate securities
and 97.0% of our mortgage-backed securities at June 30, 2006 had contractual
maturities of greater than ten years. In an increasing rate environment, our
cost of funds is expected to increase more rapidly than the interest earned on
our loan portfolio and securities portfolio because our primary source of funds
is deposits with generally shorter maturities than the maturities on our loans
and investment securities. Having interest-bearing liabilities that reprice more
frequently than interest-earning assets will be detrimental during periods of
rising interest rates and could cause our net interest rate spread to shrink
because the increase in the rates we would earn on our securities and loan
portfolios may be less than the increase in the rates we would pay on deposits
and borrowings.
In a period of falling interest rates, prepayments of loans and
mortgage-backed securities generally will increase as borrowers refinance their
debt in order to reduce their borrowing cost. This causes reinvestment risk,
because in a falling rate environment we are generally not able to reinvest
prepayments at rates that are comparable to the rates we earned on the prepaid
loans or securities. A falling rate environment would result in a decrease in
rates we pay on deposits and borrowings, but the decrease in the cost of our
funds may not be as great as the decrease in the yields on our mortgage-backed
securities and loan portfolios. This could cause a narrowing of our net interest
rate spread and could cause a decrease in our earnings.
The Board of Directors has established an Interest Rate Risk Management
Committee, comprised of Directors Regan, Aanensen, Mazza and Parow, which is
responsible for monitoring interest rate risk. Our Chief Financial Officer also
participates in this committee as a management liaison. The committee meets
quarterly to address management of our assets and liabilities, including review
of our short term liquidity position; loan and deposit pricing and production
volumes and alternative funding sources; current
59
investments; average lives, durations and repricing frequencies of loans and
securities; and a variety of other asset and liability management topics. The
results of the committee's quarterly review are reported to the full Board,
which makes adjustments to our interest rate risk policy and strategies as it
considers necessary and appropriate.
Quantitative Analysis. The following table presents Kearny Federal
Savings Bank's net portfolio value as of June 30, 2006. The Office of Thrift
Supervision, based on information provided by Kearny Federal Savings Bank,
calculated the net portfolio values shown in this table.
At June 30, 2006
------------------------------------------------------------------
Net Portfolio Value
Net Portfolio Value as % of Present Value of Assets
------------------------ ----------------------------------------
Changes in Net Portfolio Basis Point
Rates(1) $ Amount $ Change % Change Value Ratio Change
-------- -------- -------- -------- ----------- ------
(Dollars in thousands)
+300 bp 274,160 -135,558 -33% 15.39% -581 bp
+200 bp 318,540 -91,178 -22% 17.40% -380 bp
+100 bp 364,082 -45,637 -11% 19.35% -185 bp
0 bp 409,718 21.20%
-100 bp 451,685 41,966 +10% 22.80% +160 bp
-200 bp 482,117 72,398 +18% 23.88% +268 bp
----------
(1) The-300bp scenario is not shown due to the low prevailing interest rate
environment.
This analysis also indicated that as of June 30, 2006 an immediate and
permanent 2.00% increase in interest rates would cause an approximately 6.41%
decrease in our net interest income.
Future interest rates or their effect on net portfolio value or net
interest income are not predictable. Computations of prospective effects of
hypothetical interest rate changes are based on numerous assumptions, including
relative levels of market interest rates, prepayments, and deposit run-offs, and
should not be relied upon as indicative of actual results. Certain shortcomings
are inherent in this type of computation. Although certain assets and
liabilities may have similar maturity or periods of repricing, they may react at
different times and in different degrees to changes in market interest rates.
The interest rate on certain types of assets and liabilities, such as demand
deposits and savings accounts, may fluctuate in advance of changes in market
interest rates, while rates on other types of assets and liabilities may lag
behind changes in market interest rates. Certain assets, such as adjustable rate
mortgages, generally have features which restrict changes in interest rates on a
short-term basis and over the life of the asset. In the event of a change in
interest rates, prepayments and early withdrawal levels could deviate
significantly from those assumed in making calculations set forth above.
Additionally, an increased credit risk may result as the ability of many
borrowers to service their debt may decrease in the event of an interest rate
increase.
Notwithstanding the discussion above, the quantitative interest rate
analysis presented above indicates that a rapid increase in interest rates would
adversely affect our net interest margin and earnings.
Item 8. Financial Statements and Supplementary Data
----------------------------------------------------
The Company's financial statements are contained in this Annual Report
on Form 10-K immediately following Item 15.
60
Item 9. Changes In and Disagreements With Accountants on Accounting and
--------------------------------------------------------------------------------
Financial Disclosure
--------------------
There were no disagreements or reportable events as described in Item
304 of Regulation S-K in connection with the merger of the Company's former
independent auditors, Radics & Co., LLC, into the Company's current independent
auditors, Beard Miller Company LLP.
Item 9A. Controls and Procedures
---------------------------------
(a) Disclosure Controls and Procedures
Based on their evaluation of the Company's disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934 (the "Exchange Act")), the Company's principal executive
officer and principal financial officer have concluded that as of the end of the
period covered by this Annual Report on Form 10-K such disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Company in reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in Securities and Exchange Commission rules and forms and is accumulated and
communicated to the Company's management, including the principal executive and
principal financial officer, as appropriate to allow timely decisions regarding
required disclosures.
(b) Internal Control over Financial Reporting
1. Management's Annual Report on Internal Control Over Financial
Reporting.
Management's report on the Company's internal control over financial
reporting appears in the Company's financial statements that are contained in
this Annual Report on Form 10-K immediately following Item 15. Such report is
incorporated herein by reference.
2. Attestation Report of Independent Public Accounting Firm.
The attestation report of Beard Miller Company LLP on management's
assessment of the Company's internal control over financial reporting appears in
the Company's financial statements that are contained in this Annual Report on
Form 10-K immediately following Item 15. Such report is incorporated herein by
reference.
3. Changes in Internal Control Over Financial Reporting.
During the last quarter of the year under report, there was no change
in the Company's internal control over financial reporting that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
Item 9B. Other Information
---------------------------
None.
61
PART III
Item 10. Directors and Executive Officers of the Registrant
------------------------------------------------------------
The information that appears under the headings "Section 16(a)
Beneficial Ownership Reporting Compliance" and "Information Regarding Directors
and Executive Officers" in the Registrant's definitive proxy statement for the
Registrant's 2006 Annual Meeting of Stockholders (the "Proxy Statement") is
incorporated herein by reference.
The Company has adopted a code of ethics that applies to its principal
executive officer, principal financial officer and principal accounting officer.
A copy of the code of ethics is available without charge upon request to the
Corporate Secretary, Kearny Financial Corp., 120 Passaic Avenue, Fairfield, New
Jersey 07004.
Item 11. Executive Compensation
--------------------------------
The information that appears under the headings "Board of Directors and
Executive Officer Compensation" and "Compensation Committee Report on Executive
Compensation" in the Proxy Statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
--------------------------------------------------------------------------------
Related Stockholder Matters
---------------------------
(a) Security Ownership of Certain Beneficial Owners. Information
required by this item is incorporated herein by reference to
the section captioned "Voting Securities and Principal
Holders Thereof" in the Proxy Statement.
(b) Security Ownership of Management. Information required by
this item is incorporated herein by reference to the section
captioned "Information Regarding Directors and Executive
Officers" in the Proxy Statement.
(c) Changes in Control. Management of the Company knows of no
arrangements, including any pledge by any person of
securities of the Company, the operation of which may at a
subsequent date result in a change in control of the
registrant.
(d) Securities Authorized for Issuance Under Equity Compensation
Plans. Set forth below is information as of June 30, 2006
with respect to compensation plans under which equity
securities of the Registrant are authorized for issuance.
62
Equity Compensation Plan Information
------------------------------------
(A) (B) (C)
Number of Securities
Number of Securities Remaining Available for
to be Issued Upon Weighted-average Future Issuance Under
Exercise of Exercise Price of Equity Compensation
Outstanding Options, Outstanding Options, Plans (Excluding Securities
Warrants and Rights Warrants and Rights Reflected in Column (A))
------------------- ------------------- ------------------------
Equity compensation plans
approved by shareholders:
2005 Stock Compensation
and Incentive Plan (1)............ 3,374,240 $ 12.34 277,856
Equity compensation plans not
approved by stockholders:
None............................... - - -
----------- -------- ----------
Total....................... 3,374,240 $ 12.34 277,856
=========== ======== ==========
-----------------
(1) In addition to 3,374,240 options outstanding under this plan as of June 30,
2006, restricted stock awards of 1,337,696 shares were outstanding under
this plan as of June 30, 2006. Such awards are earned at the rate of 20%
one year after the date of the grant and 20% annually thereafter. As of
June 30, 2006, there were 189,897 shares remaining available for restricted
share awards under this plan, and these shares are included under column
(C) as securities remaining available for future issuance under this plan
along with 87,959 options remaining available for award.
Item 13. Certain Relationships and Related Transactions
--------------------------------------------------------
The information that appears under the subheading "Certain
Relationships and Related Transactions" under the heading "Information Regarding
Directors and Executive Officers" in the Proxy Statement is incorporated herein
by reference.
Item 14. Principal Accountant Fees and Services
------------------------------------------------
The information relating to this item is incorporated herein by
reference to the information contained under the section captioned "Information
Regarding Independent Auditor" in the Proxy Statement.
PART IV
Item 15. Exhibits and Financial Statement Schedules
----------------------------------------------------
(1) The following financial statements and the independent auditors'
report appear in this Annual Report on Form 10-K immediately after this Item 15:
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition as of
June 30, 2006 and 2005
Consolidated Statements of Income For the Years Ended
June 30, 2006, 2005 and 2004
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended June 30, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the Years Ended
June 30, 2006, 2005 and 2004
Notes to Consolidated Financial Statements
63
(2) All schedules are omitted because they are not required or
applicable, or the required information is shown in the consolidated financial
statements or the notes thereto.
(3) The following exhibits are filed as part of this report:
3.1 Charter of Kearny Financial Corp.*
3.2 Bylaws of Kearny Financial Corp.*
4 Stock Certificate of Kearny Financial Corp*
10.1 Employment Agreement with John N. Hopkins*+
10.2 Employment Agreement with Allan Beardslee*+
10.3 Employment Agreement with Albert E. Gossweiler*+
10.4 Employment Agreement with Sharon Jones*+
10.5 Employment Agreement with William C. Ledgerwood*+
10.6 Employment Agreement with Erika Sacher Parisi*+
10.7 Employment Agreement with Patrick M. Joyce*+
10.8 Employment Agreement with Craig Montanaro**+
10.9 Directors Consultation and Retirement Plan*+
10.10 Benefit Equalization Plan*+
10.11 Benefit Equalization Plan for Employee Stock Ownership Plan*+
10.12 Stock Option Plan ***+
10.13 Restricted Stock Plan ***+
10.14 Kearny Federal Savings Bank Director Life Insurance Agreement****+
10.15 Kearny Federal Savings Bank Executive Life Insurance Agreement****+
11 Statement regarding computation of earnings per share
21 Subsidiaries of the Registrant (see "Item 1. Business - Subsidiary Activity" herein)
23 Consent of Beard Miller Company LLP
31 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
----------
* Incorporated by reference to the exhibits to the Registrant's Registration Statement on Form S-1
(File No. 333-118815).
** Incorporated by reference to the exhibit to the Registrant's Form 8-K filed on July 21, 2005.
(File No. 000-51093).
*** Incorporated by reference to the appendices to the Registrant's definitive proxy statement for the
2005 Annual Meeting filed on September 30, 2005 (File No. 000-51093).
**** Incorporated by reference to the exhibits to the Registrant's Form 8-K filed on August 18, 2005.
(File No. 000-51093).
+ Management or compensatory plan required to be filed as an exhibit.
64
September 1, 2006
Beard Miller Company LLP
55 US Highway 46 East
PO Box 676
Pine Brook, NJ 07058-0676
Management Report on Internal Control over Financial Reporting
--------------------------------------------------------------
The management of Kearny Financial Corp. and Subsidiaries (collectively the
"Company") is responsible for establishing and maintaining adequate internal
control over financial reporting. The Company's internal control system is a
process designed to provide reasonable assurance to the management and board of
directors regarding the preparation and fair presentation of published
consolidated financial statements.
Our internal control over financial reporting includes policies and procedures
that pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect transactions and dispositions of assets; provide
reasonable assurances that transactions are recorded as necessary to permit
preparation of consolidated financial statements in accordance with U.S.
generally accepted accounting principles, and that receipts and expenditures are
being made only in accordance with authorizations of management and the
directors of the Company; and provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use or disposition of the
Company's assets that could have a material effect on our consolidated financial
statements.
All internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to consolidated financial
statement preparation and presentation. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate due to changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.
The Company's management assessed the effectiveness of internal control over
financial reporting as of June 30, 2006. In making this assessment, we used the
criteria set forth by The Committee of Sponsoring Organizations of the Treadway
Commission in Internal Control-Integrated Framework. Based on our assessment, we
believe that, as of June 30, 2006, the Company's internal control over financial
reporting is effective based on those criteria.
Page 2
Beard Miller Company LLP
Management Report
September 1, 2006
The Company's independent registered public accounting firm that audited the
consolidated financial statements has issued an audit report on our assessment
of, and the effective operation of, the Company's internal control over
financial reporting as of June 30, 2006.
/s/John N. Hopkins
-------------------------------------
John N. Hopkins
President and Chief Executive Officer
/s/Albert E. Gossweiler
-------------------------------------
Albert E. Gossweiler
Senior Vice President and Chief Financial Officer
[BMC LOGO]
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Kearny Financial Corp.
We have audited management's assessment, included in the
accompanying Management Report on Internal Control Over Financial Reporting,
that Kearny Financial Corp. (the "Company") and Subsidiaries maintained
effective internal control over financial reporting as of June 30, 2006, based
on criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (the COSO
criteria). Management of the Company is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility
is to express an opinion on management's assessment and an opinion on the
effectiveness of the Company's internal control over financial reporting based
on our audit.
We conducted our audit in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained in
all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
To the Board of Directors and Stockholders 2.
Kearny Financial Corp.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that Kearny Financial Corp.
and Subsidiaries maintained effective internal control over financial reporting
as of June 30, 2006, is fairly stated, in all material respects, based on the
COSO criteria. Also, in our opinion, Kearny Financial Corp. and Subsidiaries
maintained, in all material respects, effective internal control over financial
reporting as of June 30, 2006, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated statements
of financial condition of the Company as of June 30, 2006 and 2005, and the
related consolidated statements of income, changes in stockholders' equity, and
cash flows of the Company for each of the years in the three-year period ended
June 30, 2006, and our report dated September 1, 2006, expressed an unqualified
opinion.
/s/Beard Miller Company, LLP
Beard Miller Company, LLP
Pine Brook, New Jersey
September 1, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Kearny Financial Corp.
Kearny, New Jersey
We have audited the accompanying consolidated statements of financial
condition of Kearny Financial Corp. (the "Company") and Subsidiaries as of June
30, 2006 and 2005, and the related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the years in the three-year
period ended June 30, 2006. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audits to obtain reasonable assurance about
whether the consolidated financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to in
the second preceding paragraph present fairly, in all material respects, the
consolidated financial position of Kearny Financial Corp. and Subsidiaries as of
June 30, 2006 and 2005, and the consolidated results of their operations and
cash flows for each of the years in the three-year period ended June 30, 2006,
in conformity with accounting principles generally accepted in the United States
of America.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of Kearny
Financial Corp.'s internal control over financial reporting as of June 30, 2006,
based on the criteria established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO), and our report dated September 1, 2006 expressed an unqualified opinion
on management's assessment of internal control over financial reporting and an
unqualified opinion on the effectiveness of the Company's internal control over
financial reporting.
/s/ Beard Miller Company LLP
Beard Miller Company LLP
Pine Brook, New Jersey
September 1, 2006
F-1
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30,
2006 2005
----------- -----------
(In Thousands, Except Share
and Per Share Data)
ASSETS
Cash and amounts due from depository institutions $ 22,563 $ 16,683
Interest-bearing deposits in other banks 207,716 123,182
----------- -----------
Cash and Cash Equivalents 230,279 139,865
Securities available for sale (amortized cost 2006 $18,550; 2005 $25,153) 18,346 33,591
Securities held to maturity (estimated fair value 2006 $204,447; 2005 $469,221) 209,048 470,098
Loans receivable, including net deferred loan costs 2006 $1,087; 2005 $815 709,064 563,434
Less allowance for loan losses (5,451) (5,416)
----------- -----------
Net Loans Receivable 703,613 558,018
Mortgage-backed securities held to maturity (estimated fair value 2006 $670,329;
2005 $762,730) 689,962 758,121
Premises and equipment 35,941 34,977
Federal Home Loan Bank of New York ("FHLB") stock 5,406 11,361
Interest receivable 8,836 10,430
Goodwill 82,263 82,263
Bank owned life insurance 14,628 3,981
Other assets 9,203 4,300
----------- -----------
Total Assets $ 2,007,525 $ 2,107,005
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing $ 61,080 $ 56,142
Interest-bearing 1,382,658 1,472,635
----------- -----------
Total Deposits 1,443,738 1,528,777
Advances from FHLB 61,105 61,687
Advance payments by borrowers for taxes 5,232 4,627
Other liabilities 6,564 6,432
----------- -----------
Total Liabilities 1,516,639 1,601,523
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock, $0.10 par value; 25,000,000 shares authorized; none issued and outstanding - -
Common stock, $0.10 par value; 75,000,000 shares authorized; 2006 72,737,500 shares and
2005 72,737,500 shares issued and outstanding 7,274 7,274
Paid-in capital 192,534 207,838
Retained earnings 306,728 301,857
Unearned Employee Stock Ownership Plan shares (15,517) (16,972)
Accumulated other comprehensive income (loss) (133) 5,485
----------- -----------
Total Stockholders' Equity 490,886 505,482
----------- -----------
Total Liabilities and Stockholders' Equity $ 2,007,525 $ 2,107,005
=========== ===========
See notes to consolidated financial statements.
--------------------------------------------------------------------------------
F-2
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
----------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30,
---------------------------
2006 2005 2004
------- ------- -------
(In Thousands, Except Per Share Data)
----------------------------------------------------------------------------------------------
INTEREST INCOME
Loans $35,338 $29,311 $28,919
Mortgage-backed securities 33,471 33,954 33,980
Securities:
Taxable 6,554 9,632 8,724
Tax-exempt 7,634 6,904 5,702
Other interest-earning assets 6,326 2,640 1,329
------- ------- -------
Total Interest Income 89,323 82,441 78,654
------- ------- -------
INTEREST EXPENSE
Deposits 35,069 26,532 28,082
Borrowings 3,576 3,890 4,018
------- ------- -------
Total Interest Expense 38,645 30,422 32,100
------- ------- -------
Net Interest Income 50,678 52,019 46,554
PROVISION FOR LOAN LOSSES 72 68 --
------- ------- -------
Net Interest Income after Provision for Loan Losses 50,606 51,951 46,554
------- ------- -------
NON-INTEREST INCOME
Fees and service charges 1,016 948 824
Gain on sale of securities 1,023 7,705 --
Miscellaneous 1,286 850 736
------- ------- -------
Total Non-Interest Income 3,325 9,503 1,560
------- ------- -------
NON-INTEREST EXPENSES
Salaries and employee benefits 25,145 20,790 16,522
Net occupancy expense of premises 3,282 3,163 2,523
Equipment 4,423 3,953 3,470
Advertising 1,465 1,176 861
Federal insurance premium 548 554 587
Amortization of intangible assets 636 636 636
Directors' compensation 2,099 886 827
Merger related expenses -- -- 592
Miscellaneous 4,448 3,704 3,454
------- ------- -------
Total Non-Interest Expenses 42,046 34,862 29,472
------- ------- -------
Income before Income Taxes 11,885 26,592 18,642
INCOME TAXES 2,277 7,694 5,745
------- ------- -------
Net Income $ 9,608 $18,898 $12,897
======= ======= =======
NET INCOME PER COMMON SHARE
Basic $ 0.14 $ 0.33 $ 0.25
======= ======= =======
Diluted $ 0.14 $ 0.33 $ 0.25
======= ======= =======
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
Basic 70,904 57,963 50,916
======= ======= =======
Diluted 71,100 57,963 50,916
======= ======= =======
See notes to consolidated financial statements.
--------------------------------------------------------------------------------
F-3
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended June 30, 2006, 2005, and 2004
Accumulated
Common Stock Unearned Other
--------------- Paid-In Retained Unearned Incentive Treasury Comprehensive
Shares Amount Capital Earnings ESOP Shares Plan Shares Stock Income (Loss) Total
------ ------ ------- -------- ----------- ----------- ----- ------------- -----
(In Thousands)
------------------------------------------------------------------------------------------------------------------------------------
BALANCE - JUNE 30, 2003 12 $ 1 $19,066 $273,970 $ (663) $(193) $(4,283) $ 7,771 $295,669
--------
Comprehensive income:
Net income - - - 12,897 - - - - 12,897
Unrealized gain on
securities
available for sale, net
of
deferred income tax
expense of $1,296 - - - - - - - 2,275 2,275
--------
Total Comprehensive Income 15,172
--------
Acquisition of West Essex
Bancorp, Inc. (2) - (18,567) (3,908) 663 193 4,283 - (17,336)
----- ----- -------- -------- -------- ---- ------- ------- --------
BALANCE - JUNE 30, 2004 10 1 499 282,959 - - - 10,046 293,505
--------
Comprehensive income:
Net income - - - 18,898 - - - - 18,898
Realized gain on securities
available for sale, net
of
income tax of $2,697 - - - - - - - (5,008) (5,008)
Unrealized gain on
securities
available for sale, net
of
deferred income tax
expense of $240 - - - - - - - 447 447
--------
Total Comprehensive Income 14,337
--------
Initial capitalization from
establishment of mutual
holding company (10) (1) 1 - - - - - -
Proceeds from common stock
offering 72,738 7,274 207,293 - - - - - 214,567
-----------------------------------------------------------------------------------------------------------------------------------
F-4
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended June 30, 2006, 2005, and 2004
Accumulated
Common Stock Unearned Other
--------------- Paid-In Retained Unearned Incentive Treasury Comprehensive
Shares Amount Capital Earnings ESOP Shares Plan Shares Stock Income (Loss) Total
------ ------ ------- -------- ----------- ----------- ----- ------------- -----
(In Thousands)
------------------------------------------------------------------------------------------------------------------------------------
Unearned ESOP shares (1,746 $
shares) - $ - - $ - $(17,457) $ - $ - $ - $(17,457)
ESOP shares committed to be
released (48 shares) - - 45 - 485 - - - 530
------- ------ ----------- -------- --------- ------ ------- -------- ---------
BALANCE - JUNE 30, 2005 72,738 7,274 207,838 301,857 (16,972) - - 5,485 505,482
---------
Comprehensive income:
Net income - - - 9,608 - - - - 9,608
Realized gain on securities
available for sale, net
of
income tax of $3,095 - - - - - - - (5,749) (5,749)
Unrealized gain on
securities
available for sale, net
of
deferred income tax
expense of $71 - - - - - - - 131 131
--------
Total Comprehensive Income 3,990
--------
Refund of common stock
offering expense - - 3 - - - - - 3
ESOP shares committed to be
released (144 shares) - - 412 - 1,455 - - - 1,867
Stock option transactions - - 1,211 - - - - - 1,211
Treasury stock purchases (178) - - - - - (2,268) - (2,268)
Treasury stock reissued to
restricted stock plan 178 - (2,268) - - - 2,268 - -
Restricted stock plan shares
purchased (1,194 shares) - - (16,673) - - - - - (16,673)
Restricted stock plan shares
earned (164 shares) - - 2,011 - - - - - 2,011
Cash dividends declared
($0.24/share) - - - (4,737) - - - - (4,737)
------- ------ ----------- -------- -------- ------ ------- ------- --------
BALANCE - JUNE 30, 2006 72,738 $7,274 $192,534 $306,728 $(15,517) $ - $ - $ (133) $490,886
======= ====== =========== ======== ======== ====== ======= ======= ========
See notes to consolidated financial statements.
--------------------------------------------------------------------------------
F-5
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30,
-----------------------------------
2006 2005 2004
--------- --------- ---------
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 9,608 $ 18,898 $ 12,897
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization of premises and equipment 1,898 1,549 1,314
Net amortization of premiums, discounts and loan fees
and costs 1,033 1,035 2,679
Deferred income taxes (9) 343 556
Amortization of intangible assets 636 636 636
Provision for loan losses 72 68 -
Realized gains on sale of securities available for sale (8,844) (7,705) -
Realized loss on sale of securities held to maturity 7,821 - -
(Increase) in cash surrender value of bank owned life
insurance (439) (145) (149)
ESOP stock option plan and restricted stock plan expenses 5,089 530 -
Realized loss on sale of real estate owned 35 - -
(Increase) decrease in interest receivable 1,594 (569) (1,381)
(Increase) decrease in other assets (2,964) 4,006 132
Increase (decrease) in interest payable 53 (57) (376)
Increase (decrease) in other liabilities (446) 1,045 (1,705)
--------- --------- ---------
Net Cash Provided by Operating Activities 15,137 19,634 14,603
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities available for sale (298) (202) (152)
Proceeds from sale of securities available for sale 15,750 8,866 -
Proceeds from sale of securities held to maturity 241,206 - -
Purchases of securities held to maturity (4,000) (54,387) (263,187)
Proceeds from calls and maturities of securities held to maturity 11,199 15,387 111,189
Proceeds from repayments of securities held to maturity 4,836 4,797 3,612
Purchase of loans (24,434) (1,515) (15,024)
Net (increase) decrease in loans receivable (121,373) (50,913) 16,922
Proceeds from sale of real estate owned 65 - -
Purchases of mortgage-backed securities held to maturity (111,670) (163,607) (425,124)
Principal repayments on mortgage-backed securities held to
maturity 178,918 175,911 334,016
Additions to premises and equipment (2,862) (9,877) (8,079)
Purchase of FHLB stock (3,322) - (592)
Redemption of FHLB stock 9,277 31 2,987
Purchase of bank owned life insurance (10,208) - -
--------- --------- ---------
Net Cash Provided by (Used in) Investing Activities 183,084 (75,509) (243,432)
--------- --------- ---------
See notes to consolidated financial statements
-----------------------------------------------------------------------------------------------------------
F-6
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
----------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30,
-----------------------------------
2006 2005 2004
--------- --------- ---------
(In Thousands)
CASH FLOWS FROM FINANCING ACTIVITIES
Net decrease in deposits $ (85,097) $ (8,714) $ (75,836)
Repayment of FHLB advances (582) (2,547) (11,515)
Net change in short-term borrowings from FHLB - (30,000) 30,000
Increase in advance payments by borrowers for taxes 605 403 11
Proceeds from issuance of common stock of Kearny
Financial Corp. - 197,110 -
Refund of common stock offering expense 3 - -
Dividends paid to minority stockholders of Kearny Financial Corp. (3,795) - -
Purchase of common stock of Kearny Financial Corp. for treasury (2,268) - -
Purchase of common stock of Kearny Financial Corp. for restricted
stock plan (16,673) - -
--------- --------- ---------
Net Cash Provided by (Used in) Financing Activities (107,807) 156,252 (57,340)
--------- --------- ---------
Net Increase (Decrease) in Cash and Cash Equivalents 90,414 100,377 (286,169)
CASH AND CASH EQUIVALENTS - BEGINNING 139,865 39,488 325,657
--------- --------- ---------
CASH AND CASH EQUIVALENTS - ENDING $ 230,279 $ 139,865 $ 39,488
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION Cash paid during the year
for:
Income taxes, net of refunds $ 6,154 $ 2,090 $ 5,956
========= ========= =========
Interest $ 38,592 $ 30,479 $ 32,476
========= ========= =========
SUPPLEMENTAL DISCLOSURES OF NON-CASH TRANSACTIONS
Cash dividend declared $ 942 $ - $ -
========= ========= =========
Minority interest in consolidated subsidiaries $ - $ - $ 17,336
========= ========= =========
Goodwill - West Essex acquisition $ - $ - $ 50,517
========= ========= =========
Deposit for acquisition of West Essex Bancorp, Inc. $ - $ - $ (67,853)
========= ========= =========
See notes to consolidated financial statements
----------------------------------------------------------------------------------------------------------------------
F-7
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidated Financial Statement Presentation
The consolidated financial statements include the accounts of the Company,
its wholly-owned subsidiaries, Kearny Federal Savings Bank (the "Bank") and
Kearny Financial Securities, Inc., and the Bank's wholly-owned
subsidiaries, KFS Financial Services, Inc. and Kearny Federal Investment
Corp., and have been prepared in conformity with accounting principles
generally accepted in the United States of America. All significant
intercompany accounts and transactions have been eliminated in
consolidation.
In preparing the consolidated financial statements, management is required
to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the dates of the consolidated statements of
financial condition and revenues and expenses for the periods then ended.
Actual results could differ significantly from those estimates. A material
estimate that is particularly susceptible to significant change relates to
the determination of the allowance for loan losses. Management believes
that the allowance for loan losses represents its best estimate of losses
known and inherent in the loan portfolio that are both probable and
reasonable to estimate. While management uses available information to
recognize losses on loans, future additions to the allowance for loan
losses may be necessary based on changes in economic conditions in the
market area.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan
losses. Such agencies may require the recognition of additions to the
allowance based on their judgments about information available to them at
the time of their examination.
Business of the Company and Subsidiaries
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 at its 26 locations in New Jersey and using these
deposits, together with other funds, to invest in securities and to make
loans collateralized by residential and commercial real estate and, to a
lesser extent, consumer loans. The Company's other subsidiary, Kearny
Financial Securities, Inc., was organized in April 2005 under Delaware law
as a Delaware Investment Company primarily to hold investment and
mortgage-backed securities. The Bank's subsidiary, Kearny Federal
Investment Corp. was organized in July 2004 under New Jersey law as a New
Jersey Investment Company primarily to hold investment and mortgage-backed
securities.
Cash and Cash Equivalents
Cash and cash equivalents include cash and amounts due from depository
institutions and interest-bearing deposits in other banks, all with
original maturities of three months or less.
--------------------------------------------------------------------------------
F-8
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Securities
Investments in debt securities that we have the positive intent and ability
to hold to maturity are classified as held-to-maturity securities and
reported at amortized cost. Debt and equity securities that are bought and
held principally for the purpose of selling them in the near term are
classified as trading securities and reported at fair value, with
unrealized holding gains and losses included in earnings. Debt and equity
securities not classified as trading securities or as held-to-maturity
securities are classified as available for sale securities and reported at
fair value, with unrealized holding gains or losses, net of deferred income
taxes, reported in the accumulated other comprehensive income component of
stockholders' equity.
Individual securities are considered impaired when fair value is less than
amortized cost. Management evaluates on a monthly basis whether any
securities are other-than-temporarily impaired. In making this
determination, we consider the extent and duration for the impairment, the
nature and financial health of the issuer, other factors relevant to
specific securities, and our ability and intent to hold securities for a
period of time sufficient to allow for any anticipated recovery in market
value. If a security is determined to be other-than-temporarily impaired,
an impairment loss is charged to operations.
Premiums and discounts on all securities are amortized/accreted to maturity
by use of the level-yield method. Gain or loss on sales of securities is
based on the specific identification method.
Concentration of Risk
Financial instruments which potentially subject the Company and its
subsidiaries to concentrations of credit risk consist of cash and cash
equivalents, investment and mortgage-backed securities and loans. Cash and
cash equivalents include amounts placed with highly rated financial
institutions. Investment securities include securities backed by the U.S.
Government and other highly rated instruments. The Bank's lending activity
is primarily concentrated in loans collateralized by real estate in the
State of New Jersey. As a result, credit risk is broadly dependent on the
real estate market and general economic conditions in the state.
Loans Receivable
Loans receivable are stated at unpaid principal balances plus net deferred
loan origination costs and discounts less the allowance for loan losses.
Loan origination fees and certain direct loan origination costs are
deferred and amortized, using the level-yield method, as an adjustment of
yield over the contractual lives of the related loans. Unearned discounts
are accreted by use of the level-yield method over the contractual lives of
the related loans.
Recognition of interest by the accrual method is generally discontinued
when interest or principal payments are ninety days or more in arrears on a
contractual basis, or when other factors indicate that the collection of
such amounts is doubtful. At the time a loan is placed on nonaccrual
status, an allowance for uncollected interest is recorded in the current
period for previously accrued and uncollected interest. Interest on such
loans, if appropriate, is recognized as income when payments are received.
A loan is returned to accrual status when interest or principal payments
are no longer ninety days or more in arrears on a contractual basis and
factors indicating doubtful collectibility no longer exist.
--------------------------------------------------------------------------------
F-9
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Allowance for Loan Losses
An allowance for loan losses is maintained at a level that represents
management's best estimate of losses known and inherent in the loan
portfolio that are both probable and reasonable to estimate. The allowance
is decreased by loan charge-offs, increased by subsequent recoveries of
loans previously charged off, and then adjusted, via either a charge or
credit to operations, to an amount determined by management to be
necessary. Loans or portions thereof, are charged off when, after
collection efforts are exhausted, they are determined to be uncollectible.
Management of the Bank, in determining the allowance for loan losses,
considers the losses inherent in its loan portfolio and changes in the
nature and volume inherent in its loan activities, along with the general
economic and real estate market conditions. The Bank utilizes a two tier
approach: (1) identification of impaired loans and establishment of
specific loss allowances on such loans; and (2) establishment of general
valuation allowances on the remainder of its loan portfolio. The Bank
maintains a loan review system which allows for a periodic review of its
loan portfolio and the early identification of potential impaired loans.
Such system takes into consideration, among other things, delinquency
status, size of loans, type of collateral and financial condition of the
borrowers. Specific loan loss allowances are established for identified
loans based on a review of such information and/or appraisals of the
underlying collateral. General loan losses are based upon a combination of
factors including, but not limited to, actual loan loss experience,
composition of the loan portfolio, current economic conditions and
management's judgment. Although management believes that specific and
general loan losses are 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.
A loan evaluated for impairment is deemed to be impaired when, based on
current information and events, it is probable that the Bank will be unable
to collect all amounts due according to the contractual terms of the loan
agreement. All loans identified as impaired are evaluated independently.
The Bank does not aggregate such loans for evaluation purposes. Payments
received on impaired loans are applied first to interest receivable and
then to principal.
Premises and Equipment
Land is carried at cost. Buildings and improvements, furnishings and
equipment and leasehold improvements are carried at cost, less accumulated
depreciation and amortization computed on the straight-line method over the
following estimated useful lives:
Years
-----
Building and improvements 10 - 50
Furnishings and equipment 4 - 20
Leasehold improvements Shorter of useful
lives or lease term
Construction in progress primarily represents facilities under construction
for future use in our business and includes all costs to acquire land and
construct buildings, as well as capitalized interest during the
construction period. Interest is capitalized at the Bank's average cost of
interest-bearing liabilities.
Significant renewals and betterments are charged to the property and
equipment account. Maintenance and repairs are charged to operations in the
year incurred. Rental income is netted against occupancy costs in the
consolidated statements of income.
--------------------------------------------------------------------------------
F-10
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Federal Home Loan Bank Stock
Federal law requires a member institution of the Federal Home Loan Bank
system to hold restricted stock of its district Federal Home Loan Bank
according to a predetermined formula. The restricted stock is carried at
cost.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets principally represent the excess cost
over the fair value of the net assets of the institutions acquired in
purchase transactions. Goodwill is evaluated annually by reporting unit and
an impairment loss recorded if indicated. The impairment test is performed
in two phases. The first step of the goodwill impairment test compares the
fair value of the reporting unit with its carrying amount, including
goodwill. If the fair value of the reporting unit exceeds its carrying
amount, goodwill of the reporting unit is considered not impaired; however,
if the carrying amount of the reporting unit exceeds its fair value, an
additional procedure must be performed. That additional procedure compares
the implied fair value of the reporting unit's goodwill (as defined in SFAS
No. 142), with the carrying amount of that goodwill. An impairment loss is
recorded to the extent that the carrying amount of goodwill exceeds its
implied fair value. Fair value is determined by a combination of the
Comparable Transaction and Discounted Cash Flow approaches. No impairment
charges were required to be recorded in the years ended June 30, 2006, 2005
or 2004. If an impairment loss is determined to exist in the future, such
loss will be reflected as an expense in the consolidated statements of
income in the period in which the impairment loss is determined. Separate
intangible assets, including core deposit intangibles that are not deemed
to have indefinite lives, continue to be amortized over their useful lives,
which is estimated to be ten years.
Bank Owned Life Insurance
Bank owned life insurance is accounted for using the cash surrender value
method and is recorded at its realizable value. The change in the net asset
value is recorded as a component of non-interest income.
Income Taxes
The Company and its subsidiaries file consolidated federal income tax
returns. Income taxes are allocated based on the contribution of income to
the consolidated income tax returns. Separate state income tax returns are
filed.
Federal and state income taxes have been provided on the basis of the
reported income. The amounts reflected on our tax returns differ from these
provisions due principally to temporary differences in the reporting of
certain items for financial reporting and income tax reporting purposes.
Deferred income taxes are recorded to recognize such temporary differences.
Interest Rate Risk
The Bank is principally engaged in the business of attracting deposits from
the general public and using these deposits, together with other funds, to
purchase securities and to make loans secured by real estate. The potential
for interest-rate risk exists as a result of the generally shorter duration
of interest-sensitive liabilities compared to the generally longer duration
of interest-sensitive assets. In a rising rate environment, liabilities
will reprice faster than assets, thereby reducing net interest income. For
this reason, management regularly monitors the maturity structure of the
Bank's assets and liabilities in order to measure its level of
interest-rate risk and to plan for future volatility.
--------------------------------------------------------------------------------
F-11
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Net Income per Common Share
Basic EPS is based on the weighted average number of common shares actually
outstanding adjusted for Employee Stock Ownership Plan ("ESOP") shares not
yet committed to be released and unvested restricted stock awards. Diluted
EPS reflects the potential dilution that could occur if securities or other
contracts to issue common stock, such as unvested restricted stock awards
and outstanding stock options, were exercised or converted into common
stock or resulted in the issuance of common stock that then shared in the
earnings of the Company. Diluted EPS is calculated by adjusting the
weighted average number of shares of common stock outstanding to include
the effect of contracts or securities exercisable or which could be
converted into common stock, if dilutive, using the treasury stock method.
Shares issued and reacquired during any period are weighted for the portion
of the period they were outstanding.
The 10,000 shares issued to Kearny MHC in connection with the Company's
reorganization in 2001 were "replaced" with 50,916,250 shares, or 70% of
the shares issued in the Company's initial public offering. This
transaction is analogous to a stock split or significant stock dividend,
therefore, net income per common share for those shares have been
retroactively restated for all periods presented.
Reclassification
Certain amounts as of and for the years ended June 30, 2005 and 2004 have
been reclassified to conform to the current year's presentation.
NOTE 2 - BUSINESS COMBINATIONS
On September 11, 2002, the Company and the Bank entered into a merger agreement
with West Essex Bancorp, Inc. (West Essex), West Essex Savings Bank (WESB) and
its 100% owned subsidiaries. On July 1, 2003, the Company purchased West Essex's
common stock held by public stockholders for $35.10 per share, in cash. (The
purchase price was transferred to a third party escrow agent as of June 30,
2003.) The purchase of minority interest shares was recorded as the acquisition
of the noncontrolling interests of a subsidiary utilizing the purchase method of
accounting and the immediately following merger of the Company and West Essex,
and the Bank and WESB, were recorded as a combination of entities under common
control. The amount paid to minority shareholders of West Essex in excess of
their interest in West Essex amounted to $50,517,000, which was recorded as
goodwill. Merger related expenses, which included legal, professional and filing
fees and other expenses, were $592,000 for the year ended June 30, 2004.
NOTE 3 - STOCK OFFERING
On June 7, 2004, the Board of Directors of the Company and the Bank adopted a
plan of stock issuance pursuant to which the Company subsequently sold common
stock representing a minority ownership of the estimated pro forma market value
of the Company to eligible depositors of the Bank. On February 23, 2005, the
Company completed the minority stock offering in which it sold 21,821,250
shares, valued at $10.00 per share, representing 30% of its outstanding common
stock. Kearny MHC (the "MHC") owns the remaining 70% of the outstanding common
stock, or 50,916,250 shares. The MHC is a federally-chartered mutual holding
company organized on March 30, 2001, and is subject to regulation by the Office
of Thrift Supervision. So long as the MHC is in existence, it will continue to
own a majority of the outstanding common stock of the Company. The Office of
Thrift Supervision also regulates the Company and the Bank.
--------------------------------------------------------------------------------
F-12
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - STOCK OFFERING (CONTINUED)
Following the sale of common stock, all depositors who had membership or
liquidation rights with respect to the Bank as of the effective date of the
transaction continue to have such rights solely with respect to the MHC as long
as they continue to hold deposit accounts with the Bank. In addition, all
persons who become depositors of the Bank subsequent to the date of the
transaction have such membership and liquidation rights with respect to the
holding company. Borrowers of the Bank as of the date of the transaction have
the same membership rights in the holding company that they had in the Bank
immediately prior to the date of the transaction as long as their borrowings
remain outstanding.
The minority stock offering resulted in net proceeds of $214.6 million, after
expenses of $3.6 million. The Company used 50% of the net proceeds to make a
capital contribution to the Bank. The Company also provided a term loan to the
Bank's Employee Stock Ownership Plan (the "ESOP") to enable it to purchase
1,745,700 shares of the Company's common stock for the plan.
On November 9, 2005, the Company announced that it received regulatory approval
to begin the purchase of up to 1,425,655 shares or approximately 2% of the
outstanding shares of its common stock in open market transactions for use in
funding the Company's 2005 Stock Compensation and Incentive Plan previously
approved by stockholders. During the year ended June 30, 2006, the Company
purchased 1,371,341 shares at a total cost of $18,941,000, or approximately
$13.81 per share.
On July 18, 2006, the Company announced that the Board of Directors authorized a
stock repurchase plan to acquire up to 1,091,063 shares, or 5% of the Company's
outstanding common stock held by persons other than Kearny MHC. This stock
repurchase plan commences after the Company completes its purchase of shares in
the open market to fund the Company's 2005 Stock Compensation and Incentive
Plan.
During the year ended June 30, 2006, the federally chartered mutual holding
company of the Company, Kearny MHC, waived its right, upon non-objection from
the Office of Thrift Supervision, to receive cash dividends of $9,674,000 paid
during the year.
NOTE 4 - SECURITIES AVAILABLE FOR SALE
June 30, 2006
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Carrying
Cost Gains Losses Value
--------- ---------- ---------- --------
(In Thousands)
Mutual funds $ 7,654 $ - $ 230 $ 7,424
Trust preferred securities due after ten years 10,896 134 108 10,922
------- ------- ------- -------
$18,550 $ 134 $ 338 $18,346
======= ======= ======= =======
--------------------------------------------------------------------------------
F-13
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - SECURITIES AVAILABLE FOR SALE
June 30, 2005
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Carrying
Cost Gains Losses Value
--------- ---------- ---------- --------
(In Thousands)
Common stock $ 128 $8,423 $ - $ 8,551
Mutual funds 14,134 161 155 14,140
Trust preferred securities due after ten years 10,891 200 191 10,900
-------- ------- ----- -------
$25,153 $8,784 $346 $33,591
======== ======= ===== =======
During the years ended June 30, 2006 and 2005, proceeds from sales of securities
available for sale totaled $15,750,000 and $8,866,000 and resulted in gross
gains of $8,844,000 and $7,705,000, respectively. There were no sales of
securities available for sale during the year ended June 30, 2004. At June 30,
2006, securities available for sale with a carrying value of $9,859,000 are
callable within one year.
The age of unrealized losses and fair value of related securities available for
sale at June 30, 2006 and 2005 were as follows:
Less than 12 Months 12 Months or More Total
----------------------- ------------------------ --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----- ------ ----- ------ ----- ------
(In Thousands)
June 30, 2006:
Mutual funds $ - $ - $ 7,424 $230 $ 7,424 $230
Trust preferred
securities - - 4,341 108 4,341 108
----- ----- ------- ---- ------- ----
Total $ - $ - $11,765 $338 $11,765 $338
===== ===== ======= ==== ======= ====
June 30, 2005:
Mutual funds $ - $ - $ 7,201 $155 $ 7,201 $155
Trust preferred
securities - - 5,210 191 5,210 191
----- ----- ------- ---- ------- ----
Total $ - $ - $12,411 $346 $12,411 $346
====== ====== ======= ==== ======= ====
As of June 30, 2006 and 2005, management has concluded that the unrealized
losses are temporary in nature since they are primarily related to market
interest rates and not related to the underlying credit quality of the issuer of
the securities. Additionally, we have the intent and ability to hold these
investments for a time necessary to recover the amortized cost. As of June 30,
2006, there was one mutual fund and two trust preferred securities in unrealized
loss positions compared to one and three, respectively, in unrealized loss
positions as of June 30, 2005.
--------------------------------------------------------------------------------
F-14
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - SECURITIES HELD TO MATURITY
June 30, 2006
-------------------------------------------
Gross Gross Estimated
Carrying Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In Thousands)
Government agencies:
After five years but within ten years $ 963 $ 38 $ 1 $ 1,000
After ten years 7,773 14 1 7,786
-------- -------- -------- --------
8,736 52 2 8,786
-------- -------- -------- --------
Obligations of states and political subdivisions:
Within one year 4,339 5 21 4,323
After one year but within five years 17,194 76 430 16,840
After five years but within ten years 120,775 672 3,043 118,404
After ten years 58,004 56 1,966 56,094
-------- -------- -------- --------
200,312 809 5,460 195,661
-------- -------- -------- --------
$209,048 $ 861 $ 5,462 $204,447
======== ======== ======== ========
June 30, 2005
-----------------------------------------
Government agencies:
Within one year $ 17,000 $ - $ 152 $ 16,848
After one year but within five years 235,019 4 4,065 230,958
After five years but within ten years 494 81 - 575
After ten years 12,956 - 112 12,844
-------- -------- -------- --------
265,469 85 4,329 261,225
-------- -------- -------- --------
Obligations of states and political subdivisions:
Within one year 4,202 11 3 4,210
After one year but within five years 16,139 216 78 16,277
After five years but within ten years 99,841 2,453 261 102,033
After ten years 84,447 1,327 298 85,476
-------- -------- -------- --------
204,629 4,007 640 207,996
-------- -------- -------- --------
$470,098 $ 4,092 $ 4,969 $469,221
======== ======== ======== ========
--------------------------------------------------------------------------------
F-15
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - SECURITIES HELD TO MATURITY (CONTINUED)
During the year ended June 30, 2006, securities held to maturity with a total
aggregate carrying value of $249,027,000 were sold for total proceeds of
$241,206,000 and resulted in gross losses of $7,821,000. The Company sold its
entire portfolio of government agency notes to restructure the securities
portfolio by reinvesting the proceeds at current market interest rates to
improve the Company's net interest margin. There were no sales of securities
held to maturity during the years ended June 30, 2005 and 2004. During the years
ended June 30, 2006, 2005 and 2004, proceeds from calls of securities totaled
$-0-, $10,000,000, and $103,749,000, respectively, resulting in no gains or
losses. At June 30, 2006, securities held to maturity with a carrying value of
$3,467,000 are callable within one year.
At June 30, 2006 and 2005, securities held to maturity with carrying value of
approximately $294,000 and $293,000, respectively, was pledged to secure public
funds on deposit.
At June 30, 2006 and 2005, all obligations of states and political subdivisions
were guaranteed by insurance policies issued by various insurance companies.
The age of unrealized losses and fair value of related securities held to
maturity at June 30, 2006 and 2005 were as follows:
Less than 12 Months 12 Months or More Total
----------------------- ------------------------ --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----- ------ ----- ------ ----- ------
(In Thousands)
June 30, 2006:
Government agencies $ - $ - $ 809 $ 2 $ 809 $ 2
Obligations of states
and
political subdivisions 89,281 2,747 49,700 2,713 138,981 5,460
-------- -------- -------- -------- -------- --------
Total $ 89,281 $ 2,747 $ 50,509 $ 2,715 $139,790 $ 5,462
======== ======== ======== ======== ======== ========
June 30, 2005:
Government agencies $ 754 $ 6 $254,116 $ 4,323 $254,870 $ 4,329
Obligations of states
and
political subdivisions 19,469 221 32,923 419 52,392 640
-------- -------- -------- -------- -------- --------
Total $ 20,223 $ 227 $287,039 $ 4,742 $307,262 $ 4,969
======== ======== ======== ======== ======== ========
As of June 30, 2006 and 2005, management has concluded that the unrealized
losses are temporary in nature since they are primarily related to market
interest rates and not related to the underlying credit quality of the issuers
of the securities. Additionally, we have the intent and ability to hold these
investments for the time necessary to recover the amortized cost. As of June 30,
2006, there were two Government agencies and 304 obligations of states and
political subdivisions in unrealized loss positions compared to 37 and 113,
respectively, in unrealized loss positions as of June 30, 2005.
--------------------------------------------------------------------------------
F-16
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - LOANS RECEIVABLE
June 30,
---------------------
2006 2005
--------- ---------
(In Thousands)
Real estate mortgage $ 572,933 $ 479,451
--------- ---------
Commercial business 3,208 2,930
--------- ---------
Consumer:
Home equity loans 93,639 54,199
Home equity lines of credit 12,988 14,850
Passbook or certificate 2,884 2,831
Other 247 264
--------- ---------
109,758 72,144
--------- ---------
Construction 22,078 8,094
--------- ---------
Total Loans 707,977 562,619
Unamortized premium (discounts) on purchased loans 73 (65)
Deferred loan costs and fees, net 1,014 880
--------- ---------
$ 709,064 $ 563,434
========= =========
At June 30, 2006 and 2005, real estate mortgage loans included $465,822,000 and
$382,766,000, respectively, of loans secured by one-to-four-family residential
properties.
The Bank has granted loans to officers and directors of the Company and its
Subsidiaries and to their associates. Related party loans are made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with unrelated persons and do
not involve more than normal risk of collectibility. As of June 30, 2006 and
2005 such loans totaled approximately $3,732,000 and $3,188,000, respectively.
During the year ended June 30, 2006, new loans to related parties totaled
$775,000 and repayments totaled approximately $231,000.
The activity in the allowance for loan losses is as follows:
Years Ended June 30,
-----------------------------------
2006 2005 2004
------- ------- -------
(In Thousands)
Balance - beginning $ 5,416 $ 5,144 $ 5,180
Provisions charged to operations 72 68 -
Loans charged off (42) (9) (36)
Loans recovered 5 213 -
------- ------- -------
Balance - ending $ 5,451 $ 5,416 $ 5,144
======= ======= =======
--------------------------------------------------------------------------------
F-17
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - LOANS RECEIVABLE (CONTINUED)
At June 30, 2006 and 2005, nonaccrual loans for which the accrual of interest
had been discontinued totaled approximately $942,000 and $1,922,000,
respectively. Had these loans been performing in accordance with their original
terms, the interest income recognized for the years ended June 30, 2006, 2005
and 2004, would have been $81,000, $162,000, and $177,000, respectively.
Interest income recognized on such loans was $9,000, $69,000, and $118,000,
respectively.
There were no impaired loans at the end of June 30, 2006 and 2005. $-0-,
$88,000, and $-0- was received and recognized for impaired loans during the
years ended June 30, 2006, 2005 and 2004, respectively. The average balance of
impaired loans impaired during the years ended June 30, 2006, 2005 and 2004
approximated $-0-, $235,000, and $243,000, respectively.
NOTE 7 - MORTGAGE-BACKED SECURITIES HELD TO MATURITY
June 30, 2006
-------------------------------------------
Gross Gross Estimated
Carrying Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
(In Thousands)
Government National Mortgage Association $ 42,323 $ 717 $ 394 $ 42,646
Federal Home Loan Mortgage Corporation 264,747 301 9,012 256,036
Federal National Mortgage Association 382,892 253 11,498 371,647
-------- -------- -------- --------
$689,962 $ 1,271 $ 20,904 $670,329
======== ======== ======== ========
June 30, 2005
-----------------------------------------
Government National Mortgage Association $ 63,399 $ 1,767 $ 196 $ 64,970
Federal Home Loan Mortgage Corporation 305,059 2,465 1,712 305,812
Federal National Mortgage Association 389,663 3,985 1,700 391,948
-------- -------- -------- --------
$758,121 $ 8,217 $ 3,608 $762,730
======== ======== ======== ========
Net premiums of approximately $2,538,000 and $3,613,000 at June 30, 2006 and
2005, respectively, are included in the carrying amounts of mortgage-backed
securities held to maturity.
There were no sales of mortgage-backed securities held to maturity during the
years ended June 30, 2006, 2005 and 2004. At June 30, 2006 and 2005,
mortgage-backed securities with carrying value of approximately $283,000 and
$426,000, respectively, was pledged to secure public funds on deposit.
--------------------------------------------------------------------------------
F-18
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - MORTGAGE-BACKED SECURITIES HELD TO MATURITY (CONTINUED)
The age of unrealized losses and fair value of related mortgage-backed
securities held to maturity at June 30, 2006 and 2005 were as follows:
Less than 12 Months 12 Months or More Total
----------------------- ------------------------ --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----- ------ ----- ------ ----- ------
(In Thousands)
June 30, 2006 $314,766 $8,352 $279,931 $12,552 $594,697 $20,904
======== ====== ======== ======= ======== ========
June 30, 2005 $143,550 $ 986 $230,786 $ 2,622 $374,336 $ 3,608
======== ====== ======== ======= ======== ========
As of June 30, 2006 and 2005, management has concluded that the unrealized
losses are temporary in nature since they are primarily related to market
interest rates and not related to the underlying credit quality of the issuers
of the securities. Additionally, we have the intent and ability to hold these
investments for the time necessary to recover the amortized cost. As of June 30,
2006, there were 320 mortgage-backed securities in unrealized loss positions
compared to 117 in unrealized loss positions as of June 30, 2005.
NOTE 8 - PREMISES AND EQUIPMENT
June 30,
---------------------------
2006 2005
-------- -------
(In Thousands)
Land $ 8,968 $ 8,984
Buildings and improvements 29,760 27,288
Leasehold improvements 505 490
Furnishings and equipment 10,242 9,455
Construction in progress - 516
------- -------
49,475 46,733
Less accumulated depreciation and amortization 13,534 11,756
------- -------
$35,941 $34,977
======= =======
NOTE 9 - INTEREST RECEIVABLE
June 30,
---------------------------
2006 2005
-------- -------
(In Thousands)
Loans $3,038 $ 2,266
Mortgage-backed securities 3,267 3,481
Investments 2,531 4,683
------- -------
$8,836 $10,430
====== =======
--------------------------------------------------------------------------------
F-19
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - GOODWILL AND OTHER INTANGIBLE ASSETS
Core Deposit
Goodwill Intangibles
-------- -----------
(In Thousands)
Balance at June 30, 2003 $31,746 $2,836
Amortization - (636)
West Essex Savings Bank acquisition (see Note 2) 50,517 -
------- ------
Balance at June 30, 2004 82,263 2,200
Amortization - (636)
------- ------
Balance at June 30, 2005 82,263 1,564
Amortization - (636)
------- ------
Balance at June 30, 2006 $82,263 $ 928
======= ======
The gross carrying amount of core deposit intangibles was $5,987,000 at both
June 30, 2006 and 2005, while accumulated amortization totaled $5,059,000 and
$4,423,000 at June 30, 2006 and 2005, respectively. Amortization is expected to
total $636,000 in the year ending June 30, 2007, $241,000 in the year ending
June 30, 2008, and $43,000 in the year ending June 30, 2009.
NOTE 11 - DEPOSITS
June 30,
--------------------------------------------------------
2006 2005
-------------------- -------------------------
Weighted Weighted
Average Average
Interest Interest
Amount Rate Amount Rate
------ ---- ------ ----
(Dollars In Thousands)
Non-interest bearing demand $ 61,080 - % $ 56,142 - %
Interest-bearing demand 122,129 1.56 99,308 0.78
Savings and club 377,431 1.15 450,211 1.12
Certificates of deposit 883,098 3.83 923,116 2.81
---------- ----------
$1,443,738 2.78 % $1,528,777 2.08 %
========== ==========
--------------------------------------------------------------------------------
F-20
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - DEPOSITS (CONTINUED)
Certificates of deposit with balances of $100,000 or more at June 30, 2006 and
2005, totaled approximately $205,955,000 and $209,552,000, respectively.
Deposits in excess of $100,000 are not insured by the Federal Deposit Insurance
Corporation.
A summary of certificates of deposit by maturity follows:
June 30,
-----------------------------
2006 2005
-------- --------
(In Thousands)
One year or less $658,218 $701,710
After one to two years 179,609 148,557
After two to three years 20,481 43,275
After three to four years 17,875 9,367
After four to five years 6,826 20,019
After five years 89 188
-------- --------
$883,098 $923,116
======== ========
Interest expense on deposits consists of the following:
Years Ended June 30,
--------------------------------------------------
2006 2005 2004
------- ------- -------
(In Thousands)
Demand $ 931 $ 752 $ 882
Savings and clubs 5,065 5,422 5,508
Certificates of deposits 29,073 20,358 21,692
------- ------- -------
$35,069 $26,532 $28,082
======= ======= =======
--------------------------------------------------------------------------------
F-21
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - ADVANCES FROM FHLB
Fixed rate advances from the Federal Home Loan Bank ("FHLB") of New York mature
as follows:
June 30,
--------------------------------------------------------
2006 2005
-------------------- -------------------------
Weighted Weighted
Average Average
Interest Interest
Amount Rate Amount Rate
------ ---- ------ ----
(Dollars In Thousands)
Twelve months ending June 30:
2006 $ - - % $ 582 6.03 %
2007 5,618 5.91 % 5,618 5.91 %
2008 37,487 5.41 % 37,487 5.41 %
2009 8,000 5.47 % 8,000 5.47 %
2010 - - % - - %
2011 10,000 5.40 % 10,000 5.40 %
------- -------
$61,105 5.46 % $61,687 5.47 %
======= =======
At June 30, 2006, of the $55,487,000 in advances due after one year, $42,000,000
are callable, all of which are callable within one year.
FHLB advances at June 30, 2006 and 2005 are collateralized by the FHLB capital
stock owned by the Bank, investment securities held to maturity and
mortgage-backed securities held to maturity with fair values totaling
approximately $97,249,000 and $106,716,000 and carrying values totaling
approximately $103,748,000 and $100,806,000, respectively.
NOTE 13 - BENEFIT PLANS
Employee Stock Ownership Plan
Effective upon completion of the Company's initial public offering in
February 2005, the Bank established an Employee Stock Ownership Plan
("ESOP") for all eligible employees who complete a twelve-month period of
employment with the Bank, have attained the age of 21 and complete at least
1,000 hours of service in a plan year. The ESOP used $17,457,000 in
proceeds from a term loan obtained from the Company to purchase 1,745,700
shares of Company common stock. The term loan principal is payable over 144
equal installments through March 31, 2017. The interest rate on the term
loan is 5.50%. Each year, the Bank intends to make discretionary
contributions to the ESOP, which will be equal to principal and interest
payments required on the term loan. The Bank may further pay down the loan
with dividends paid, if any, on the Company common stock owned by the ESOP.
Shares purchased with the loan proceeds provide collateral for the term
loan and are held in a suspense account for future allocations among
participants. Contributions to the ESOP and shares released from the
suspense account are to be allocated among the participants on the basis of
compensation, as described by the Plan, in the year of allocation.
--------------------------------------------------------------------------------
F-22
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - BENEFIT PLANS
Employee Stock Ownership Plan (Continued)
The ESOP is accounted for in accordance with Statement of Position 93-6,
"Accounting for Employee Stock Ownership Plans," which was issued by the
American Institute of Certified Public Accountants. Accordingly, ESOP
shares pledged as collateral were initially recorded as unearned ESOP
shares in the consolidated statements of financial condition. Thereafter,
on a monthly basis, 12,123 shares are committed to be released,
compensation expense is recorded equal to the number of shares committed to
be released times the monthly average market price of the shares, and the
committed shares become outstanding for basic net income per common share
computations. ESOP compensation expense was approximately $1,867,000 and
$530,000 for the years ended June 30, 2006 and 2005, respectively.
At June 30, 2006 and 2005, the ESOP shares were as follows:
June 30,
-------------------------------
2006 2005
----------- -----------
Allocated shares 110,202 -
Shares committed to be released 83,766 48,492
Unearned shares 1,551,732 1,697,208
----------- -----------
Total ESOP Shares 1,745,700 1,745,700
=========== ===========
Fair value of unearned shares $22,965,634 $20,027,054
=========== ===========
Employee Stock Ownership Plan Benefit Equalization Plan ("BEP")
The Bank has a non-qualified plan to compensate senior officers of the bank
who participate in the Bank's ESOP for certain benefits lost under such
plan by reason of benefit limitations imposed by the Internal Revenue Code.
The plan expense for the year ended June 30, 2006 was approximately
$76,000. The liability totaled approximately $25,000 at June 30, 2006.
Thrift Plan
The Bank sponsors the Employees' Savings and Profit Sharing Plan and Trust
(the "Plan"), pursuant to Section 401(k) of the Internal Revenue Code, for
all eligible employees. Employees may elect to save up to 20% of their
compensation. The Bank will contribute a matching contribution up to 3% of
the employee annual compensation. The Plan expense amounted to
approximately $330,000, $281,000, and $264,000, for the years ended June
30, 2006, 2005 and 2004, respectively.
Retirement Plan
The Bank has a non-contributory multiple-employer pension plan covering all
eligible employees. Significant actuarial assumptions include the projected
unit credit cost valuation method and an annual investment rate of 7.75%,
8.25%, and 8.25%, for the years ended June 30, 2006, 2005 and 2004,
respectively. At the date of latest plan review, the net assets available
for plan benefits exceeded the actuarial present value of accumulated plan
benefits. Data for the actuarial present value of accumulated vested and
non-vested benefits is not determinable for this multiple-employer
retirement plan. During the years ended June 30, 2006, 2005 and 2004, total
pension plan expense and contributions to the plan were approximately
$2,172,000, $2,538,000, and $1,193,000, respectively.
--------------------------------------------------------------------------------
F-23
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - BENEFIT PLANS (CONTINUED)
Benefit Equalization Plan ("BEP")
The Bank has an unfunded non-qualified plan to compensate senior officers
of the Bank who participate in the Bank's qualified benefit plans for
certain benefits lost under such plans by reason of benefit limitations
imposed by Sections 415 and 401 of the Internal Revenue Code. There were
approximately $59,000 in contributions made to and benefits paid under the
BEP during each of the years ended June 30, 2006, 2005 and 2004.
The following table sets forth the BEP's funded status and components of
net periodic pension cost:
June 30,
2006 2005
------- -------
(In Thousands)
Change in benefit obligation:
Benefit obligation - beginning $ 1,949 $ 1,831
Service cost 59 42
Interest cost 176 135
Actuarial loss 421 -
Benefit payments (59) (59)
Increase due to the decrease in the discount rate 342 -
------- -------
Benefit obligation - ending $ 2,888 $ 1,949
======= =======
Change in plan assets:
Fair value of assets - beginning $ - $ -
Settlements 59 59
Contributions (59) (59)
------- -------
Fair value of assets - ending $ - $ -
======= =======
Reconciliation of funded status:
Accumulated benefit obligation $(1,850) $(1,209)
======= =======
Projected benefit obligation $(2,888) $(1,949)
Fair value of assets - -
------- -------
Funded status (2,888) (1,949)
Unrecognized prior service cost (47) (58)
Unrecognized net actuarial loss 1,493 913
------- -------
Accrued pension cost included in other liabilities $(1,442) $(1,094)
======= =======
Value assumptions:
Discount rate 6.25% 7.50%
Salary increase rate 5.50% 5.50%
--------------------------------------------------------------------------------
F-24
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - BENEFIT PLANS (CONTINUED)
Benefit Equalization Plan ("BEP") (Continued)
Years Ended June 30,
--------------------
2006 2005 2004
---- ---- ----
(In Thousands)
Net periodic pension expense:
Service cost $ 59 $ 42 $ 24
Interest cost 176 135 98
Amortization of unrecognized past service
costs (12) 8 8
Amortization of unrecognized net actuarial loss 182 122 77
---- ---- ----
$405 $307 $207
==== ==== ====
Valuation assumptions:
Discount rate 6.25% 7.50% 7.50%
Salary increase rate 5.50% 5.50% 5.50%
It is estimated that contributions of approximately $81,000 will be made
during the year ending June 30, 2007.
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid:
2007 $ 81,000
2008 105,000
2009 117,000
2010 123,000
2011-2015 972,000
Postretirement Welfare Plan
The Bank has a postretirement group term life insurance plan covering all
eligible employees. The benefits are based on age and years of service. The
plan is unfunded. During the years ended June 30, 2006, 2005 and 2004,
contributions and benefits paid totaled $5,000, $7,000, and $6,000,
respectively. The valuation measurement date has been changed from July 1
to April 1 effective April 1, 2006.
--------------------------------------------------------------------------------
F-25
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - BENEFIT PLANS (CONTINUED)
Postretirement Welfare Plan (Continued)
The following table sets forth the accrued accumulated postretirement
benefit obligation and the net periodic postretirement benefit cost:
June 30,
------------------
2006 2005
---- ----
(In Thousands)
Change in benefit obligation:
Benefit obligation - beginning $ 451 $ 409
Service cost 25 20
Interest cost 25 27
Actuarial (gain) loss (32) 2
Premiums/claims paid (5) (7)
----- -----
Benefit obligation - ending $ 464 $ 451
===== =====
Change in plan assets:
Fair value of assets - beginning $ - $ -
Premiums/claims paid 5 7
Contributions (5) (7)
----- -----
Fair value of assets - ending $ - $ -
===== =====
Reconciliation of funded status:
Accumulated benefit obligation $(464) $(451)
Fair value of assets - -
----- -----
Funded status (464) (451)
Unrecognized net actuarial gain (38) (7)
Unrecognized prior service cost 54 63
----- -----
Accrued postretirement benefit cost included
in other liabilities $(448) $(395)
===== =====
Value assumptions:
Discount rate 6.25% 5.63%
Salary increase rate 3.25% 3.00%
--------------------------------------------------------------------------------
F-26
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - BENEFIT PLANS (CONTINUED)
Postretirement Welfare Plan (Continued)
Years Ended June 30,
--------------------
2006 2005 2004
---- ---- ----
(In Thousands)
Net periodic postretirement benefit cost:
Service cost $25 $20 $18
Interest cost 25 27 22
Amortization of unrecognized past service
liability 10 11 9
--- --- ---
$60 $58 $49
=== === ===
Valuation assumptions:
Discount rate 5.63% 6.63% 5.75%
Salary increase rate 3.00% 4.00% 3.25%
It is estimated that contributions of approximately $8,000 will be made
during the year ending June 30, 2007.
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid:
2007 $ 8,000
2008 10,000
2009 14,000
2010 16,000
2011 19,000
2012-2016 109,000
Directors' Consultation and Retirement Plan ("DCRP")
The Bank has an unfunded retirement plan for non-employee directors. The
benefits are payable based on term of service as a director. During each of
the years ended June 30, 2006, 2005 and 2004, contributions and benefits
paid totaled $89,000. The valuation measurement date has been changed from
July 1 to April 1 effective April 1, 2006.
--------------------------------------------------------------------------------
F-27
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - BENEFIT PLANS (CONTINUED)
Directors' Consultation and Retirement Plan ("DCRP") (Continued)
The following table sets forth the DCRP's funded status and components of
net periodic cost:
June 30,
-------------------
2006 2005
------- -------
(In Thousands)
Change in benefit obligation:
Projected benefit obligation - beginning $ 2,149 $ 1,561
Service cost 128 86
Interest cost 116 99
Actuarial (gain) loss (51) 157
Annuity payments (89) (89)
Plan amendments - 335
------- -------
Projected benefit obligation - ending $ 2,253 $ 2,149
======= =======
Change in plan assets:
Fair value of assets - beginning $ - $ -
Settlements 89 89
Contributions (89) (89)
------- -------
Fair value of assets - ending $ - $ -
======= =======
Reconciliation of funded status:
Accumulated benefit obligation $(1,965) $(1,879)
======= =======
Projected benefit obligation $(2,253) $(2,149)
Fair value of assets - -
------- -------
Funded status (2,253) (2,149)
Unrecognized transition obligation 132 175
Unrealized net actuarial loss 98 150
Unrecognized prior service cost 583 643
------- -------
Accrued cost included in other liabilities $(1,440) $(1,181)
======= =======
Value assumptions:
Discount rate 6.25% 5.63%
Fee increase rate 3.25% 3.00%
--------------------------------------------------------------------------------
F-28
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - BENEFIT PLANS (CONTINUED)
Directors' Consultation and Retirement Plan ("DCRP") (Continued)
Years Ended June 30,
--------------------
2006 2005 2004
---- ---- ----
(In Thousands)
Net periodic plan cost:
Service cost $128 $ 86 $ 78
Interest cost 116 99 83
Amortization of unrecognized transition
obligation 44 44 44
Amortization of unrecognized past service
liability 61 33 33
----- ---- ----
$349 $262 $238
===== ==== ====
Valuation assumptions:
Discount rate 5.63% 6.63% 5.75%
Fee increase rate 3.00% 4.00% 3.25%
It is estimated that contributions of approximately $172,000 will be made
during the year ending June 30, 2007.
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid:
2007 $ 172,000
2008 183,000
2009 194,000
2010 204,000
2011 212,000
2012-2016 1,071,000
--------------------------------------------------------------------------------
F-29
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - BENEFIT PLANS (CONTINUED)
Stock Compensation Plans
The Company has two stock-related compensation plans: stock options and
restricted stock awards. At the annual meeting held on October 24, 2005,
stockholders of the Company approved the Kearny Financial Corp. 2005 Stock
Compensation and Incentive Plan. The plan authorizes the award of up to
3,564,137 shares as stock options and 1,425,655 shares as restricted stock
awards. On October 24, 2005, non-employee directors received in aggregate
1,069,240 options and 427,696 shares of restricted stock. On December 5,
2005, certain officers of the Company and Bank received in aggregate
2,305,000 options and 910,000 shares of restricted stock. The Company
adopted SFAS No. 123R upon approval of the Plan, and began to expense the
fair value of all options over their vesting periods and began to expense
the fair value of all share-based compensation granted over the requisite
service periods.
SFAS No. 123R also requires the Company to realize as a financing cash flow
rather than an operating cash flow, as previously required, the benefits of
realized tax deductions in excess of previously recognized tax benefits on
compensation expense (which was $-0- for the twelve months ended June 30,
2006). In accordance with Staff Accounting Bulletin ("SAB") No. 107, the
Company classified share-based compensation for employees within salaries
and employee benefits to correspond with the same line item as the cash
compensation paid to employees. The Company classified share-based
compensation for non-employee directors within directors' compensation to
correspond with the same line item as the cash compensation paid to
non-employee directors.
Employee options and non-employee director options generally vest over a
five-year service period. Management recognizes compensation expense for
all option grants over the awards' respective requisite service periods.
Management estimated the fair values relating to all of fiscal 2006 option
grants using the Black-Scholes option-pricing model. Since there is no
historical information on the volatility of our stock, management based
expectations about future volatility on the average volatilities of similar
entities for an appropriate period following their initial public offering.
Thus, calculations to determine the stock volatility of mutual holding
companies converted since 1995, and a subset of the first group, all mutual
holding companies that converted after 2000, were used to derive the one
and three-year Beta for purposes of identifying a reasonable volatility
factor. Management estimated the expected life of the options assuming that
they must be no less than the vesting period, five years, and no greater
than their contractual life, ten years, in conjunction with an evaluation
of the grantees ages and lengths of service. The 10-year Treasury yield in
effect at the time of the grant provides the risk-free rate for periods
within the contractual life of the option. Management recognizes
compensation expense for the fair values of these awards, which have graded
vesting, on a straight-line basis over the requisite service period of the
awards.
Management used the following assumptions to estimate the fair values of
options granted:
Year Ended
June 30,
2006
----
Weighted average risk-free interest rate 4.53%
Expected dividend yield 1.62%
Weighted average volatility factor of the expected market price of the
Company's common stock 18.00%
Weighted average expected life of the options 6.50 years
--------------------------------------------------------------------------------
F-30
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - BENEFIT PLANS (CONTINUED)
Stock Compensation Plans (Continued)
Restricted shares generally vest in full after five years. The product of
the number of shares granted and the grant date market price of the
Company's common stock determine the fair value of restricted shares under
the Company's restricted stock plans. Management recognizes compensation
expense for the fair value of restricted shares on a straight-line basis
over the requisite service period of five years.
During the year ended June 30, 2006, the Company recorded $3.2 million of
share-based compensation expense, comprised of stock option expense of $1.2
million and restricted stock expense of $2.0 million.
The following is a summary of the Company's stock option activity and
related information for its option plans for the year ended June 30, 2006:
Weighted
Weighted Average
Average Remaining
Exercise Contractual Aggregate
Options Price Term Intrinsic Value
------- ----- ---- ---------------
(In Thousands)
Outstanding at June 30, 2005 - -
Granted 3,374 $12.34
Exercised - -
Forfeited - -
------------
Outstanding at June 30, 2006 3,374 $12.34 9.4 years $8,292
============
Exercisable at June 30, 2006 - - N/A N/A
The weighted average fair value of stock options granted during the year
ended June 30, 2006 was $2.95.
The following is a summary of the status of the Company' non-vested options
as of June 30, 2006 and changes during the year ended June 30, 2006:
Weighted
Average Grant
Options Date Fair Value
------- ---------------
(In Thousands)
Non-vested at June 30, 2005 - $ -
Granted 3,374 2.95
Exercised - -
Forfeited - -
----- -----
Non-vested at June 30, 2006 3,374 $2.95
===== =====
--------------------------------------------------------------------------------
F-31
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - BENEFIT PLANS (CONTINUED)
Stock Compensation Plans (Continued)
Expected future compensation expense relating to the 3.4 million non-vested
options outstanding as of June 30, 2006 is $8.7 million over a weighted
average period of 4.4 years.
Upon exercise of vested options, management expects to draw on treasury
stock as the source of the shares. In July 2006, the Company announced a
stock repurchase plan to acquire up to 1,091,063 shares during the next
twelve months for general corporate purposes.
The following is a summary of the status of the Company's restricted shares
as of 2006 and changes during the year ended June 30, 2006:
Weighted
Restricted Average Grant
Shares Date Fair Value
------ ---------------
(In Thousands)
Non-vested at June 30, 2005 - $ -
Granted 1,338 12.34
Exercised - -
Forfeited - -
----- ------
Non-vested at June 30, 2006 1,338 $12.34
===== ======
Expected future compensation expense relating to the 1.3 million restricted
shares at June 30, 2006 is $14.5 million over a weighted average period of
4.4 years.
NOTE 14 - STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL
The Office of Thrift Supervision (the "OTS") imposes 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 the Bank, must file an
application or a notice with the OTS at least thirty days before making a
capital distribution. A savings institution must file an application for prior
approval of a capital distribution if: (i) it is not eligible for expedited
treatment under the applications processing rules of the OTS; (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 OTS or applicable regulations.
--------------------------------------------------------------------------------
F-32
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL (CONTINUED)
The Bank is subject to various regulatory capital requirements administered by
Federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory - and possibly additional discretionary - actions by
regulators that, if undertaken, could have a direct material effect on the
Bank's consolidated financial statements. Under capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines that involve quantitative measures of the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and classification
are also subject to qualitative judgments by the regulators about components,
risk weighting, and other factors.
The OTS 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 or agreement. The capital
distributions by Kearny Financial Corp., as a savings and loan holding company,
will not be subject to the OTS capital distribution rules.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of Total and Tier 1
capital (as defined in the regulations) to risk-weighted assets (as defined),
and of Tier 1 capital to adjusted total assets (as defined). The following
tables present a reconciliation of capital per accounting principles generally
accepted in the United States of America ("GAAP") and regulatory capital and
information as to the Bank's capital levels at the dates presented:
June 30,
--------------------
2006 2005
-------- --------
(In Thousands)
GAAP capital:
Consolidated capital $490,886 $505,482
Less: Unconsolidated capital of the Company (38,948) (109,653)
-------- --------
Bank capital 451,938 395,829
Less: Unrealized (gain) loss on securities 133 (5,485)
Goodwill (82,263) (82,263)
Intangible assets (928) (1,564)
-------- --------
Core and tangible capital 368,880 306,517
Add: General valuation allowance 5,451 5,416
Unrealized gain on equity securities - 3,467
-------- --------
Total Regulatory Capital $374,331 $315,400
======== ========
--------------------------------------------------------------------------------
F-33
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - STOCKHOLDERS' EQUITY AND REGULATORY CAPITAL (CONTINUED)
To be Well
Capitalized under
For Capital Adequacy Prompt Corrective
Actual Purposes Action Provisions
--------------------- -------------------- -------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in Thousands)
As of June 30, 2006:
Total capital (to risk-weighted
assets) $374,331 48.90% $=>61,235 =>8.00% $=>76,544 =>10.00%
Tier 1 capital (to risk-weighted
assets) 368,880 48.19 => - => - =>45,926 => 6.00
Core (Tier 1) capital (to adjusted
total assets 368,880 19.41 =>57,001 =>3.00 =>95,002 => 5.00
Tangible capital (to adjusted total
assets) 368,880 19.41 =>28,501 =>1.50 => - => -
As of June 30, 2005:
Total capital (to risk-weighted
assets) $315,400 45.19% $=>55,833 =>8.00% $=>69,791 =>10.00%
Tier 1 capital (to risk-weighted
assets) 306,517 43.92 => - => - =>41,875 => 6.00
Core (Tier 1) capital (to adjusted
total assets 306,517 15.94 =>57,672 =>3.00 =>96,119 => 5.00
Tangible capital (to adjusted total
assets) 306,517 15.94 =>28,836 =>1.50 => - => -
On February 6, 2006, the most recent notification from the OTS, the Bank was
categorized as well capitalized as of December 31, 2005, under the regulatory
framework for prompt corrective action. There are no conditions existing or
events which have occurred since notification that management believes have
changed the Bank's category.
NOTE 15 - INCOME TAXES
The Bank qualifies as a savings institution under the provisions of the Internal
Revenue Code (the "IRC"). Retained earnings at June 30, 2006, includes
approximately $30.5 million of bad debt allowance, pursuant to the IRC, for
which income taxes have not been provided. If such amount is used for purposes
other than to absorb bad debts, including distributions in liquidation, it will
be subject to income tax at the then current rate.
--------------------------------------------------------------------------------
F-34
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - INCOME TAXES (CONTINUED)
The components of income taxes are as follows:
Years Ended June 30,
-------------------------------------------------
2006 2005 2004
------ ------ ------
(In Thousands)
Current tax expense:
Federal income $1,312 $6,125 $3,600
State income 974 1,226 1,589
------ ------ ------
2,286 7,351 5,189
------ ------ ------
Deferred tax (benefit):
Federal income (7) 325 470
State income (2) 18 86
------ ------ ------
(9) 343 556
------ ------ ------
$2,277 $7,694 $5,745
====== ====== ======
The following table presents a reconciliation between the reported income taxes
and the income taxes which would be computed by applying the normal federal
income tax rate of 35% to income before income taxes:
Years Ended June 30,
-------------------------------------------------
2006 2005 2004
------ ------ ------
(In Thousands)
Federal income tax expense $4,160 $9,307 $6,525
Increases (reductions) in income taxes resulting from:
Tax exempt interest (2,392) (2,223) (1,780)
New Jersey state tax, net of federal income
tax effect 632 809 1,106
Nondeductible merger expenses - - 207
Other items, net (123) (199) (313)
------ ------ ------
Total income tax expense $2,277 $7,694 $5,745
====== ====== ======
Effective income tax rate 19.16% 28.93% 30.82%
===== ===== =====
The effective income tax rate represents total income tax expense divided by
income before income taxes.
--------------------------------------------------------------------------------
F-35
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - INCOME TAXES (CONTINUED)
The tax effects of existing temporary differences that give rise to deferred
income tax assets and liabilities are as follows:
June 30,
--------------------------
2006 2005
------ ------
(In Thousands)
Deferred income tax assets:
Allowance for loan losses $2,227 $2,212
Goodwill - 453
Benefit plans 1,449 1,184
Compensation 1,355 167
Other 71 61
------ ------
5,102 4,077
------ ------
Deferred income tax liabilities:
Unrealized gain on securities available for sale 71 2,953
Depreciation 1,164 541
Goodwill 392 -
Other 90 89
------ ------
1,717 3,583
------ ------
Net deferred income tax assets $3,385 $ 494
====== ======
NOTE 16 - COMMITMENTS
The Bank has non-cancelable operating leases for branch offices. The following
is a schedule by years of future minimum rental payments required under
operating leases that have initial or remaining non-cancelable lease terms in
excess of one year as of June 30, 2006:
Year Ended June 30:
2007 $ 271,000
2008 240,000
2009 203,000
2010 188,000
2011 185,000
Thereafter 641,000
----------
Total Minimum Payments Required $1,728,000
==========
--------------------------------------------------------------------------------
F-36
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - COMMITMENTS (CONTINUED)
The following schedule shows the composition of total rental expense for all
operating leases:
June 30,
------------------------------------
2006 2005 2004
-------- -------- --------
(In Thousands)
Minimum rentals $353,000 $372,000 $371,000
Rental income (40,000) (45,000) (28,000)
-------- -------- --------
$313,000 $327,000 $343,000
======== ======== ========
The Bank is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit. The Bank's exposure
to credit loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit is represented by the
contractual notional amount of those instruments. The Bank uses the same credit
policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments.
The outstanding loan commitments are as follows:
June 30,
------------------
2006 2005
------- -------
(In Thousands)
Mortgage loans $37,698 $30,594
Home equity loans 2,819 3,089
Construction loans 3,907 2,300
Construction loans in process 11,368 6,489
Undisbursed funds from approved lines of credit 25,556 27,707
------- -------
$81,348 $70,179
======= =======
At June 30, 2006, the outstanding mortgage loan commitments include $32,052,000
for fixed rate loans with interest rates ranging from 4.625% to 6.80% and
$5,646,000 for adjustable rate loans with initial rates ranging from 4.125% to
6.60%. Home equity loan commitments include $2,369,000 for fixed rate loans with
interest rates ranging from 5.625% to 6.50% and $450,000 for adjustable rate
loans with an initial rate of 7.00%. Construction loan commitments are for loans
with interest rates 1.00% above the prime rate published in the Wall Street
Journal. Undisbursed funds from approved lines of credit are adjustable rate
loans with interest rates ranging from 1.00% below to 2.00% above the prime rate
published in the Wall Street Journal.
At June 30, 2005, the outstanding mortgage loan commitments include $23,673,000
for fixed rate loans with interest rates ranging from 4.50% to 6.75% and
$6,921,000 for adjustable rate loans with an initial rates ranging from 4.00% to
6.13%. Home equity loan commitments include $2,979,000 of fixed rate loans with
interest rates ranging from 4.38% to 7.00% and $110,000 for adjustable rate
loans with an initial rate of 5.50%. Construction loan commitments are for loans
with interest rates ranging from 1.00% to 1.50% above the prime rate published
in the Wall Street Journal. Undisbursed funds from approved lines of credit are
adjustable rate loans with interest rates ranging from 1.00% below to 2.00%
above the prime rate published in the Wall Street Journal.
--------------------------------------------------------------------------------
F-37
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - COMMITMENTS (CONTINUED)
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained if
deemed necessary by the Bank upon extension of credit is based on management's
credit evaluation of the counterparty.
The Bank has established an overnight line of credit and companion (DRA)
commitment, each in the amount of $100,000,000, with the Federal Home Loan Bank
of New York, which expire on July 31, 2006. As of June 30, 2006, no funds were
drawn against these credit lines.
At June 30, 2006, the Bank has commitments for building improvements in the
amount of $281,000. In addition, the Bank also has, in the normal course of
business, commitments for servicers and supplies. Management does not anticipate
losses on any of these transactions.
The Company and subsidiaries are also party to litigation which arises primarily
in the ordinary course of business. In the opinion of management, the ultimate
disposition of such litigation should not have a material adverse effect on the
consolidated financial position of the Company.
NOTE 17 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments:
Cash and Cash Equivalents, Interest Receivable and Interest Payable
The carrying amounts for cash and cash equivalents, interest receivable and
interest payable approximate fair value because they mature in three months
or less.
Securities Available for Sale, Securities Held to Maturity and Mortgage-Backed
Securities Held to Maturity
The fair values for securities available for sale, investment securities
held to maturity and mortgage-backed securities held to maturity are based
on quoted market prices when available. If quoted market prices are not
available, fair value is estimated using quoted market prices for similar
securities.
Loans Receivable
The fair value of loans receivable is estimated by discounting the future
cash flows, using the current rates at which similar loans would be made to
borrowers with similar credit ratings and for the same remaining
maturities, of such loans.
Deposits
The fair value of demand, savings and club accounts is equal to the amount
payable on demand at the reporting date. The fair value of certificates of
deposit is estimated using rates currently offered for deposits of similar
remaining maturities. The fair value estimates do not include the benefit
that results from the low-cost funding provided by deposit liabilities
compared to the cost of borrowing funds in the market.
--------------------------------------------------------------------------------
F-38
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Advances from FHLB
Fair value is estimated using rates currently offered for advances of
similar remaining maturities.
Commitments
The fair value of commitments to fund credit lines and originate or
participate in loans is estimated using fees currently charged to enter
into similar agreements taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. For
fixed rate loans commitments, fair value also considers the difference
between current levels of interest and the committed rates. The carrying
value, represented by the net deferred fee arising from the unrecognized
commitment, and the fair value, determined by discounting the remaining
contractual fee over the term of the commitment using fees currently
charged to enter into similar agreements with similar credit risk, are not
considered material for disclosure. The contractual amounts of unfunded
commitments are presented in Note 16.
The carrying amounts and estimated fair values of financial instruments are
as follows:
June 30,
-------------------------------------------------------------
2006 2005
---------------------------- --------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
(In Thousands)
Financial assets:
Cash and cash equivalents $ 230,279 $ 230,279 $ 139,865 $ 139,865
Securities available for sale 18,346 18,346 33,591 33,591
Securities held to maturity 209,048 204,447 470,098 469,221
Loans receivable 703,613 664,672 558,018 550,655
Mortgage-backed securities held to maturity 689,962 670,329 758,121 762,730
Interest receivable 8,836 8,836 10,430 10,430
Financial liabilities:
Deposits (A) 1,443,738 1,439,141 1,528,777 1,528,203
Advances from FHLB 61,105 61,073 61,687 63,814
Interest payable on advances 445 445 392 392
(A) Includes accrued interest payable on deposits
Limitations
Fair value estimates are made at a specific point in time based on relevant
market information and information about the financial instruments. These
estimates do not reflect any premium or discount that could result from
offering for sale at one time the entire holdings of a particular financial
instrument. Because no market value exists for a significant portion of the
financial instrument, fair value estimates are based on judgments regarding
future expected loss experience, current economic conditions, risk
characteristics of various financial instrument and other factors. These
estimates are subjective in nature, involve uncertainties and matters of
judgment and, therefore, cannot be determined with precision. Changes in
assumptions could significantly affect the estimates.
--------------------------------------------------------------------------------
F-39
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Limitations (Continued)
The fair value estimates are based on existing on-and-off balance sheet
financial instruments without attempting the value of anticipated future
business and the value of assets and liabilities that are not considered
financial instruments. Other significant assets and liabilities that are
not considered financial assets and liabilities include premises and
equipment, and advances from borrowers for taxes and insurance. In
addition, the ramifications related to the realization of the unrealized
gains and losses can have a significant effect on fair value estimates and
have not been considered in any of the estimates.
Finally, reasonable comparability between financial institutions may not be
likely due to the wide range of permitted valuation techniques and numerous
estimates which must be made given the absence of active secondary markets
for many of the financial instruments. This lack of uniform valuation
methodologies introduces a greater degree of subjectivity to these
estimated fair values.
NOTE 18 - PARENT ONLY FINANCIAL INFORMATION
Kearny Financial Corp. operates its wholly owned subsidiaries, Kearny Financial
Securities, Inc. and Kearny Federal Savings Bank and its wholly-owned
subsidiaries. The consolidated earnings of the subsidiaries are recognized by
the Company using equity method of accounting. Accordingly, the consolidated
earnings of the subsidiaries are recorded as increase in the Company's
investment in the subsidiaries. The following are the condensed financial
statements for Kearny Financial Corp. (Parent Company only) as June 30, 2006 and
2005, and for each of the years in the three-year period ended June 30, 2006.
CONDENSED STATEMENTS OF FINANCIAL CONDITION
June 30,
------------------
2006 2005
-------- -------
(In Thousands)
ASSETS
Cash and amounts due from depository institutions $ 22,535 $ 92,305
ESOP loan receivable 15,796 17,198
Accrued interest receivable 72 79
Investment in subsidiaries 451,945 395,831
Due from subsidiaries 2,241 -
Other assets 225 241
-------- --------
$492,814 $505,654
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Due to subsidiaries $ - $ 105
Other liabilities 1,928 67
Stockholders' equity 490,886 505,482
-------- --------
$492,814 $505,654
======== ========
--------------------------------------------------------------------------------
F-40
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - PARENT ONLY FINANCIAL INFORMATION (CONTINUED)
CONDENSED STATEMENTS OF INCOME
Years Ended June 30,
----------------------------------------------
2006 2005 2004
------- ------- -------
(In Thousands)
Net interest income $ 2,702 $ 1,723 $ 110
Gain on sale of securities available for sale - 71 -
Loss on sale of real estate owned (35) - -
Equity in undistributed earnings of subsidiaries 8,639 17,988 13,442
------- ------- -------
11,306 19,782 13,552
------- ------- -------
Directors' compensation 188 125 67
Merger expense - - 592
Other expenses 844 126 -
------- ------- -------
1,032 251 659
------- ------- -------
Income before Income Taxes 10,274 19,531 12,893
Income tax expense (benefit) 666 633 (4)
------- ------- -------
Net income $ 9,608 $18,898 $12,897
======= ======= =======
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended June 30,
----------------------------------------------
2006 2005 2004
------- ------- -------
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 9,608 $18,898 $12,897
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Equity in undistributed earnings of the
subsidiaries (8,639) (17,988) (13,442)
Amortization of premiums - - 2
Realized gain on sale of securities
available for sale - (71) -
Realized loss on sale of real estate owned 35 - -
(Increase) decrease in accrued interest
receivable 7 (76) -
(Increase) in intercompany accounts (9) - -
(Increase) decrease in other assets (84) 63 394
Increase (decrease) in other liabilities 919 (932) 16
------- ------- -------
Net Cash Provided by (Used in) Operating
Activities 1,837 (106) (133)
------- ------- -------
--------------------------------------------------------------------------------
F-41
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - PARENT ONLY FINANCIAL INFORMATION (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS (CONTINUED)
Years Ended June 30,
----------------------------------------------
2006 2005 2004
------- ------- -------
(In Thousands)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of securities available
for sale $ - $ 1,115 $ -
Proceeds from sale of real estate owned 65 - -
Loan to ESOP - (17,457) -
Repayment of loan to ESOP 1,402 259 -
Cash dividends paid on unallocated ESOP
shares used to repay loan receivable from
Bank (326) - -
Capital contributions to subsidiaries (50,015) (107,307) -
-------- --------- --------
Net Cash Used in Investing Activities (48,874) (123,390) -
-------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock of
Kearny Financial Corp. - 214,567 -
Refund of common stock offering expense 3 - -
Purchase of common stock of Kearny
Financial Corp. for treasury (2,268) - -
Purchase of common stock of Kearny
Financial Corp. for restricted stock plan (16,673) - -
Dividends paid to minority stockholders of
Kearny Financial Corp. (3,795) - -
-------- --------- --------
Net Cash Provided by (Used in) Financing
Activities (22,733) 214,567 -
-------- --------- --------
Net Increase (Decrease) in Cash and Cash
Equivalents (69,770) 91,071 (133)
CASH AND CASH EQUIVALENTS - BEGINNING 92,305 1,234 1,367
-------- --------- --------
CASH AND CASH EQUIVALENTS - ENDING $ 22,535 $ 92,305 $ 1,234
======== ========= ========
SUPPLEMENTARY DISCLOSURE OF NONCASH TRANSACTIONS
Cash dividend declared $ 942 $ - $ -
======== ========= ========
Minority interest in consolidated subsidiaries $ - $ - $ 17,336
======== ========= ========
Goodwill - West Essex acquisition $ - $ - $ 50,517
======== ========= ========
Deposit for acquisition of West Essex $ - $ - $(67,853)
======== ========= ========
--------------------------------------------------------------------------------
F-42
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations:
Year Ended June 30, 2006
------------------------------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
(In Thousands, Except Per Share Data)
Net income $9,608
======
Basic earnings per share, income available to common
stockholders $9,608 70,904 $0.14
=====
Effect of dilutive securities:
Stock options - 142
Restricted stock awards - 54
------ ------
$9,608 71,100 $0.14
====== ====== =====
Year Ended June 30, 2005
------------------------------------------------------
Net income $18,898
=======
Basic earnings per share, income available to common
stockholders $18,898 57,963 $0.33
=====
Effect of dilutive securities:
Stock options - -
Restricted stock awards - -
------- ------
$18,898 57,963 $0.33
======= ====== =====
Year Ended June 30, 2004
------------------------------------------------------
Net income $12,897
=======
Basic earnings per share, income available to common
stockholders $12,897 50,916 $0.25
=====
Effect of dilutive securities:
Stock options - -
Restricted stock awards - -
------- ------
$12,897 50,916 $0.25
======= ====== =====
--------------------------------------------------------------------------------
F-43
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a condensed summary of quarterly results of operations for the
years ended June 30, 2006 and 2005:
Year Ended June 30, 2006
----------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In Thousands, Except Per Share Data)
Interest income $ 21,971 $ 21,995 $ 22,456 $ 22,901
Interest expense 9,158 9,507 9,764 10,216
-------- -------- -------- --------
Net Interest Income 12,813 12,488 12,692 12,685
Provision for loan losses 75 64 106 (173)
-------- -------- -------- --------
Net Interest Income after Provision for
Loan Losses 12,738 12,424 12,586 12,858
Noninterest income 593 617 1,529 586
Noninterest expenses 9,378 10,138 11,419 11,111
-------- -------- -------- --------
Income before Income Taxes 3,953 2,903 2,696 2,333
Income taxes 989 577 250 461
-------- -------- -------- --------
Net Income $ 2,964 $ 2,326 $ 2,446 $ 1,872
======== ======== ======== ========
Net income per common share:
Basic $ 0.04 $ 0.03 $ 0.03 $ 0.03
======== ======== ======== ========
Diluted $ 0.04 $ 0.03 $ 0.03 $ 0.03
======== ======== ======== ========
Dividends declared per common share $ 0.09 $ 0.05 $ 0.05 $ 0.05
======== ======== ======== ========
--------------------------------------------------------------------------------
F-44
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
--------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (CONTINUED)
Year Ended June 30, 2005
----------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In Thousands, Except Per Share Data)
Interest income $ 19,907 $ 19,832 $ 21,078 $ 21,624
Interest expense 7,103 7,174 7,764 8,381
-------- -------- -------- --------
Net Interest Income 12,804 12,658 13,314 13,243
Provision for loan losses 151 (34) (110) 61
-------- -------- -------- --------
Net Interest Income after Provision for
Loan Losses 12,653 12,692 13,424 13,182
Noninterest income 494 410 492 8,107
Noninterest expenses 7,789 8,767 8,811 9,495
-------- -------- -------- --------
Income before Income Taxes 5,358 4,335 5,105 11,794
Income taxes 1,562 1,143 1,279 3,710
-------- -------- -------- --------
Net Income $ 3,796 $ 3,192 $ 3,826 $ 8,084
======== ======== ======== ========
Net income per common share:
Basic $ 0.07 $ 0.06 $ 0.06 $ 0.11
======== ======== ======== ========
Diluted $ 0.07 $ 0.06 $ 0.06 $ 0.11
======== ======== ======== ========
--------------------------------------------------------------------------------
F-45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
KEARNY FINANCIAL CORP.
Dated: September 5, 2006 By: /s/John N. Hopkins
-------------------------------------
John N. Hopkins
President and Chief Executive Officer
(Duly Authorized Officer)
Pursuant to the requirement of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on September 5, 2006
on behalf of the Registrant and in the capacities indicated.
By: /s/John N. Hopkins By: /s/Albert E. Gossweiler
-------------------------------------------- --------------------------------------------
John N. Hopkins Albert E. Gossweiler
President and Chief Executive Officer Senior Vice President and Chief
(Principal Executive Officer) Financial Officer
(Principal Financial Officer)
By: /s/William C. Ledgerwood By: /s/Theodore J. Aanensen
-------------------------------------------- --------------------------------------------
William C. Ledgerwood Theodore J. Aanensen
Senior Vice President and Treasurer, Director
Chief Accounting Officer
(Principal Accounting Officer)
By: /s/John J. Mazur, Jr. By: /s/Joseph P. Mazza
-------------------------------------------- --------------------------------------------
John J. Mazur Jr. Joseph P. Mazza
Chairman Director
By: /s/Matthew T. McClane By: /s/John F. McGovern
-------------------------------------------- --------------------------------------------
Matthew T. McClane John F. McGovern
Director Director
By: /s/Leopold W. Montanaro By: /s/John F. Regan
-------------------------------------------- --------------------------------------------
Leopold W. Montanaro John F. Regan
Director Director
By: /s/Henry S. Parow
--------------------------------------------
Henry S. Parow
Director