Kearny Financial Corp. — Form 10-Q Summary
Business context and reporting period
Quarter ended December 31, 2015, the second quarter of fiscal 2016; financial statements are unaudited. Kearny operates principally through Kearny Bank. The period follows the May 2015 second-step conversion and stock offering, which generated approximately $670.7 million of net equity capital after specified costs and ESOP shares.
Financial performance and position
Amounts below are in millions of dollars except per-share data and ratios.
| Metric | Three months ended Dec. 31, 2015 | Prior-year quarter | Six months ended Dec. 31, 2015 | Prior-year six months |
|---|---|---|---|---|
| Interest income | $31.8 | $25.9 | $61.2 | $51.6 |
| Net interest income | $23.9 | $19.6 | $46.3 | $39.1 |
| Provision for loan losses | $3.4 | $1.7 | $6.1 | $2.6 |
| Non-interest income | $2.4 | $1.7 | $4.9 | $3.3 |
| Non-interest expense | $17.7 | $16.5 | $36.1 | $33.3 |
| Net income | $3.8 | $2.2 | $6.8 | $5.1 |
| Diluted EPS | $0.04 | $0.02 | $0.08 | $0.05 |
| Net interest margin | 2.38% | 2.38% | 2.33% | 2.39% |
For the quarter, net income rose about 75% year over year. Higher loan balances drove interest income and net interest income, partly offset by higher funding costs and loan-loss provisions. The quarterly net interest spread narrowed 16 basis points to 2.09%; management said capital-funded asset growth kept net interest margin level at 2.38%. For the six months, margin fell six basis points.
- Balance sheet at Dec. 31: assets $4.41 billion, up $167.9 million from June 30, 2015; net loans $2.58 billion, up $494.0 million (23.7%); deposits $2.58 billion, up $117.5 million; borrowings $620.4 million, up $48.9 million; stockholders’ equity $1.17 billion, broadly flat.
- Credit: allowance for loan losses was $20.5 million, or 0.79% of loans, versus $15.6 million, or 0.74%, at June 30. Nonperforming loans were $21.0 million, or 0.81% of loans, compared with $22.9 million, or 1.09%. Loans over 90 days past due and still accruing were zero.
- Cash and cash flow: cash and cash equivalents were $112.9 million, down $227.3 million from June 30 as excess offering proceeds were deployed, principally into loans. Six-month operating cash flow was $16.8 million; investing cash outflow was $406.0 million and financing cash inflow was $161.9 million.
- Capital and liquidity: Bank regulatory capital ratios were 26.37% total risk-based, 25.60% Tier 1 risk-based, and 16.12% Tier 1 leverage; the Bank exceeded applicable requirements. Available-for-sale securities totaled $721.4 million and were identified as a further liquidity source.
Material changes versus comparable periods
- Loan growth was led by commercial mortgages: commercial loans increased approximately $461 million from June 30, primarily through originations and purchases. Commercial mortgage balances reached $1.77 billion.
- Interest expense increased as both the balance and cost of interest-bearing liabilities rose; quarterly average cost of interest-bearing liabilities increased 17 basis points to 1.07%. The six-month provision for loan losses more than doubled, reflecting portfolio growth, updated loss factors, and commercial credit exposures.
- Non-interest income growth was primarily attributable to bank-owned life insurance income, which benefited from policies purchased in fiscal 2015. Expenses rose with staffing, marketing, loan servicing/underwriting, legal and regulatory costs; lower equipment and systems costs partly offset these increases.
- Available-for-sale securities’ net unrealized loss widened to $9.1 million from $2.2 million at June 30, largely reflecting wider market pricing spreads and certain corporate-security rating downgrades. Management reported no other-than-temporary impairment.
- Stockholders’ equity was affected by a $5.5 million six-month other comprehensive loss, partly offset by net income and reduced by $3.6 million in declared dividends.
Outlook, management commentary, risks and unusual items
- No specific earnings or revenue guidance was provided. Management planned to expand residential mortgage originations for sale into the secondary market, with infrastructure enhancements expected in the second half of fiscal 2016; management expects this activity to add recurring loan-sale gains and help manage interest-rate risk.
- The Bank began purchasing unsecured consumer loans originated through Lending Club. At quarter-end, the portfolio was $12.2 million across 680 loans; nearly all were current and none had defaulted or been charged off. The Company initially intends to limit the portfolio to about $25 million and monitor performance. Management’s estimated lifetime-based annual charge-off rate was 1.57%; the allowance applied total loss factors of 2.29%.
- Management characterized the balance sheet as liability-sensitive. Its one-year cumulative gap was (9.78%) and three-year gap (8.13%) at December 31. In a modeled +100 basis-point rate shock, EVE declined 6% and one-year net interest income increased 0.60%; the filing cautions that such modeled estimates depend on assumptions and may differ from actual outcomes. Management warned of possible further margin compression and sensitivity to rising funding costs.
- Available-for-sale portfolio values may face further volatility, particularly in credit-sector securities. The Company reported $12.6 million of unrealized losses on such securities, but no credit-related OTTI recognized in earnings. The filing also identifies general economic, regulatory, competitive, deposit-flow, credit-quality and interest-rate risks.
- Unusual or notable items included completion of the Bank of America loan-servicing transfer, with reimbursement of certain advances and discontinuation of the 0.25% annual servicing fee; a one-time recovery of historical data-network charges that reduced equipment expense; and the December 2015 freeze of future benefit accruals under the Directors Consultation and Retirement Plan effective after December 31.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. Pending legal proceedings were described as routine and immaterial; no material change to previously reported risk factors was identified.
Important facts investors should verify
- Whether rapid commercial-loan growth and the new Lending Club exposure perform within the assumptions supporting the allowance and management’s credit-quality assessment.
- Whether loan-loss provisions, nonperforming loans, charge-offs and recoveries continue to track portfolio growth, especially in commercial lending.
- Whether deposit pricing and borrowing costs further pressure net interest spread and margin as interest rates change.
- Whether liquidity remains adequate after the substantial reduction in cash, including available borrowing capacity, deposit mix and upcoming funding maturities.
- Whether the widening unrealized losses in credit-sector securities persist or indicate changing issuer credit conditions, notwithstanding management’s conclusion that impairments were temporary.
- Whether residential mortgage-sale initiatives and operational profitability measures are implemented as planned and produce the expected income and risk-management benefits.