Kearny Financial Corp. annual report, FY2017

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Kearny Financial Corp. — FY2017 Form 10-K

Business context and reporting period

This filing reports the fiscal year ended June 30, 2017, with June 30, 2016 as the primary comparable year. Although the request metadata says “2016 Q4,” the filing is an annual report for FY2017; its unaudited fourth-quarter results are also noted below. Kearny Financial operates Kearny Bank, serving New Jersey and New York through 42 branches. The Bank converted from a federal to a New Jersey savings-bank charter on June 29, 2017.

Management’s strategy is to evolve from a traditional thrift toward a full-service community bank, shifting assets from securities and residential mortgage lending toward commercial lending. Commercial mortgages and business loans reached 79.3% of total loans.

Financial performance and position

  • Profit: FY2017 net income was $18.6 million, or $0.22 per diluted share, versus $15.8 million, or $0.18, in FY2016. Fourth-quarter net income was $4.4 million, or $0.05 per diluted share.
  • Revenue and margins: Interest income was $139.1 million and interest expense $36.5 million, producing net interest income of $102.6 million, up 8.0%. Net interest margin increased to 2.41% from 2.35%; net interest rate spread rose to 2.14% from 2.06%. Non-interest income was $11.3 million. The efficiency ratio worsened to 71.2% from 68.5%.
  • Costs and credit provision: Non-interest expense rose 12.0% to $81.1 million, including higher compensation and equity-plan expense. Provision for loan losses fell to $5.4 million from $10.7 million.
  • Returns: Return on average assets was 0.40%, and return on average equity was 1.68%, compared with 0.36% and 1.36%, respectively, in FY2016.
  • Assets and lending: Total assets grew 7.1% to $4.82 billion. Net loans increased 21.4% to $3.22 billion; commercial mortgage loans increased 34.2% to $2.50 billion. Securities declined to $1.11 billion from $1.25 billion. Cash and equivalents fell to $78.2 million from $199.2 million.
  • Credit quality: Nonperforming assets decreased to $20.5 million, or 0.43% of assets, from $21.9 million, or 0.49%. Nonperforming loans were $18.9 million, or 0.58% of loans. The allowance for loan losses was $29.3 million, 0.90% of loans, versus $24.2 million, 0.91%.
  • Funding, debt, and liquidity: Deposits increased 8.7% to $2.93 billion. Borrowings rose to $806.2 million, including $775.7 million of FHLB advances; $630.2 million of advances were contractually due within one year. The Bank reported $882.1 million of additional FHLB borrowing capacity without additional collateral. Certificates of deposit totaled $1.29 billion, with $610.8 million maturing within one year. Brokered deposits were $244.2 million, or 8.3% of deposits.
  • Cash flow and capital: Operating cash flow was $38.5 million; investing activities used $453.5 million and financing activities provided $294.1 million. Cash decreased $121.0 million. Stockholders’ equity was $1.06 billion, down $90.4 million, primarily due to share repurchases. Bank regulatory capital ratios included a 15.47% Tier 1 leverage ratio and 23.30% total risk-based capital ratio; the Bank and Company were reported well capitalized.

Material changes versus FY2016

  • Net income increased $2.8 million, supported by higher net interest income and lower loan-loss provision, partly offset by an $8.7 million increase in non-interest expense.
  • Average earning-asset yield rose 14 basis points to 3.27%; average cost of interest-bearing liabilities rose 6 basis points to 1.13%.
  • Commercial mortgage and business lending expanded, while one- to four-family mortgage loans declined. Securities and cash balances contracted as funds were deployed into loans.
  • Share repurchases totaled 8.89 million shares for $126.0 million during FY2017. The Company completed its first 10% repurchase plan and began a second plan authorizing up to 8.56 million shares.
  • The 2016 Equity Incentive Plan contributed to higher expenses. The Company recognized $3.6 million of related pre-tax expense during FY2017, with recurring annual plan expense estimated at approximately $6.2 million before tax based on original grant values.
  • Accumulated other comprehensive income improved by $17.8 million, primarily reflecting changes in the fair values of available-for-sale securities and derivatives.

Outlook, commentary, risks, and unusual items

  • Management plans continued commercial mortgage growth, expansion of commercial business and SBA lending, increased residential mortgage originations for sale, and further reduction of the securities portfolio. It also intends to pursue deposit growth, operating efficiencies, and potential acquisitions. No quantified earnings or growth guidance is provided.
  • The Bank describes itself as liability-sensitive. Its one-year cumulative gap was negative 13.73%. In its modeled +300 basis-point scenario, economic value of equity declined 15% and one-year net interest income declined 0.68%; management cautions that these models rely on assumptions and are not forecasts.
  • Key risks include rapid commercial-loan growth and limited seasoning, commercial real estate and geographic concentration, interest-rate and funding-cost pressure, deposit competition and renewal risk, and reliance on wholesale funding. Management also cites securities credit and valuation risk, operational and cybersecurity risks, regulatory change, and possible future goodwill impairment.
  • The allowance is based on management estimates; future deterioration or regulatory review could require additional provisions. The new CECL credit-loss standard was expected to apply in a fiscal year after December 15, 2019; its impact was not yet determinable.
  • FY2017 unusual or notable items include $1.1 million of gains on loan sales (including $713,000 from residential mortgage sales), securities sales with gross gains of $1.3 million and gross losses of $1.7 million, and a $15.0 million subordinated-debt investment. Management reported no material pending litigation and no other-than-temporary securities impairment at year-end.
  • The independent auditor issued an unqualified opinion on the consolidated financial statements and internal controls; management also concluded disclosure controls and internal control over financial reporting were effective.

Most important facts for investors to verify

  • Confirm the reporting-period distinction: this is FY2017, not a 2016 Q4 filing; review the separate fourth-quarter figures if the requested comparison is quarterly.
  • Track commercial real estate concentration, loan seasoning, underwriting performance, and whether credit losses remain consistent with the low FY2017 charge-off rate.
  • Assess near-term funding needs: FHLB advances and certificates of deposit maturing within one year, wholesale-deposit stability, and the cost and availability of replacement funding.
  • Monitor net interest margin under rising rates, including the effects of liability sensitivity, deposit repricing, and derivative hedges.
  • Reconcile repurchases, equity-plan dilution, dividends, and the remaining authorization under the second repurchase plan against capital and earnings generation.
  • Review management’s future CECL estimate and the assumptions supporting the allowance for loan losses.