UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2020
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-37399
KEARNY FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
Maryland
30-0870244
(State or other jurisdiction ofincorporation or organization)
(I.R.S. EmployerIdentification Number)
120 Passaic Ave., Fairfield, New Jersey
07004
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code
973-244-4500
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.01 par value
KRNY
The NASDAQ Stock Market LLC
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. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filers,” “accelerated filers,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: November 2, 2020.
$0.01 par value common stock — 89,510,451 shares outstanding
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
INDEX
Page
Number
PART I—FINANCIAL INFORMATION
Item 1:
Financial Statements
Consolidated Statements of Financial Condition at September 30, 2020 (Unaudited) and June 30, 2020
1
Consolidated Statements of Income for the Three Months Ended September 30, 2020 and September 30, 2019 (Unaudited)
2
Consolidated Statements of Comprehensive Income for the Three Months Ended September 30, 2020 and September 30, 2019 (Unaudited)
4
Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended September 30, 2020 and September 30, 2019 (Unaudited)
5
Consolidated Statements of Cash Flows for the Three Ended September 30, 2020 and September 30, 2019 (Unaudited)
6
Notes to Consolidated Financial Statements (Unaudited)
8
Item 2:
Management’s Discussion and Analysis of Financial Condition and Results of Operations
48
Item 3:
Quantitative and Qualitative Disclosure About Market Risk
60
Item 4:
Controls and Procedures
63
PART II—OTHER INFORMATION
Legal Proceedings
64
Item 1A:
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5:
Other Information
Item 6:
Exhibits
65
SIGNATURES
66
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In Thousands, Except Share and Per Share Data)
September 30,
June 30,
2020
(Unaudited)
Assets
Cash and amounts due from depository institutions
$
18,628
20,391
Interest-bearing deposits in other banks
127,190
160,576
Cash and cash equivalents
145,818
180,967
Investment securities available for sale, at fair value (amortized cost $1,484,501), net of
allowance for credit losses of $0 at September 30, 2020
1,508,542
1,385,703
Investment securities held to maturity (fair value $33,136 and $34,069), respectively,
net of allowance for credit losses of $0 at September 30, 2020
31,576
32,556
Loans held-for-sale
20,170
20,789
Loans receivable
4,954,750
4,498,397
Less: allowance for credit losses on loans
(64,860
)
(37,327
Net loans receivable
4,889,890
4,461,070
Premises and equipment
61,808
57,389
Federal Home Loan Bank ("FHLB") of New York stock
55,118
58,654
Accrued interest receivable
20,368
17,373
Goodwill
210,895
Core deposit intangibles
4,420
3,995
Bank owned life insurance
278,639
262,380
Deferred income tax assets, net
33,319
25,480
Other real estate owned
178
Other assets
49,468
40,746
Total Assets
7,310,209
6,758,175
Liabilities and Stockholders' Equity
Liabilities
Deposits:
Non-interest-bearing
487,710
419,138
Interest-bearing
4,552,202
4,011,144
Total deposits
5,039,912
4,430,282
Borrowings
1,077,540
1,173,165
Advance payments by borrowers for taxes
17,008
16,569
Other liabilities
51,689
53,982
Total Liabilities
6,186,149
5,673,998
Stockholders' Equity
Preferred stock, $0.01 par value, 100,000,000 shares authorized;
none issued and outstanding
-
Common stock, $0.01 par value; 800,000,000 shares authorized;
89,510,451 shares and 83,663,192 shares issued and outstanding, respectively
895
837
Paid-in capital
769,269
722,871
Retained earnings
378,134
387,911
Unearned employee stock ownership plan shares;
2,910,115 shares and 2,960,289 shares, respectively
(28,212
(28,699
Accumulated other comprehensive income
3,974
1,257
Total Stockholders' Equity
1,124,060
1,084,177
Total Liabilities and Stockholders' Equity
See notes to unaudited consolidated financial statements.
- 1 -
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Data)
Three Months Ended
2019
Interest Income
Loans
52,180
48,600
Taxable investment securities
7,336
9,328
Tax-exempt investment securities
454
693
Other interest-earning assets
914
1,278
Total Interest Income
60,884
59,899
Interest Expense
Deposits
11,062
16,055
5,660
7,157
Total Interest Expense
16,722
23,212
Net Interest Income
44,162
36,687
Provision for (reversal of) credit losses
4,059
(782
Net Interest Income after Provision for
(Reversal of) Credit Losses
40,103
37,469
Non-Interest Income
Fees and service charges
1,076
1,468
Loss on sale and call of securities
(377
(14
Gain on sale of loans
1,890
605
Income from bank owned life insurance
1,596
1,580
Electronic banking fees and charges
405
318
Bargain purchase gain
3,053
Other income
90
Total Non-Interest Income
7,733
3,962
Non-Interest Expense
Salaries and employee benefits
16,977
15,777
Net occupancy expense of premises
3,122
2,969
Equipment and systems
3,570
3,089
Advertising and marketing
500
535
Federal deposit insurance premium
472
Directors' compensation
748
770
Merger-related expenses
4,349
Other expense
3,835
3,104
Total Non-Interest Expense
33,573
26,244
Income before Income Taxes
14,263
15,187
Income tax expense
2,884
3,817
Net Income
11,379
11,370
- 2 -
CONSOLIDATED STATEMENTS OF INCOME (Continued)
Net Income per Common Share (EPS)
Basic
0.13
Diluted
Weighted Average Number of Common Shares
Outstanding
86,008
84,756
86,009
84,793
- 3 -
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands, Unaudited)
Other Comprehensive Income, net of tax:
Net unrealized gain on securities available
for sale
788
7,293
Amortization of net unrealized loss on securities
available for sale transferred to held to maturity
421
Net realized loss on sale and call of
securities available for sale
265
9
Fair value adjustments on derivatives
1,645
(2,207
Benefit plan adjustments
19
335
Total Other Comprehensive Income
2,717
5,851
Total Comprehensive Income
14,096
17,221
- 4 -
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In Thousands, Except Share and Per Share Data, Unaudited)
Common Stock
Paid-In
Retained
Unearned
ESOP
Accumulated
Other
Comprehensive
Shares
Amount
Capital
Earnings
Income
Total
Balance - June 30, 2019
89,126
891
787,394
366,679
(30,644
2,839
1,127,159
Net income
Other comprehensive income, net
of income tax expense
ESOP shares committed to be
released (50 shares)
173
486
659
Stock option expense
451
Share repurchases
(2,326
(23
(30,559
(30,582
Restricted stock plan shares
earned (68 shares)
985
Cancellation of shares issued for
restricted stock awards
(59
Cash dividends declared
($0.06 per common share)
(5,045
Balance - September 30, 2019
86,786
868
758,385
373,004
(30,158
8,690
1,110,789
Balance - June 30, 2020
83,663
Cumulative effect of change in
accounting principle - Topic 326
(14,239
Balance - July 1, 2020 as
adjusted for change in
accounting principle
373,672
1,069,938
of income tax
(100
487
387
456
earned (69 shares)
1,016
(7
(49
Shares issued in conjunction with
the acquisition of MSB
Financial Corp.
5,854
58
45,075
45,133
($0.08 per common share)
(6,917
Balance - September 30, 2020
89,510
- 5 -
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows from Operating Activities:
Adjustment to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment
1,425
1,126
Net accretion of premiums, discounts and loan fees and costs
(4,723
(3,045
Deferred income taxes and valuation allowance
855
1,365
Realized gain on bargain purchase
(3,053
Amortization of intangible assets
308
Amortization of benefit plans’ unrecognized net gain
21
475
Loans originated for sale
(121,596
(56,826
Proceeds from sale of mortgage loans held-for-sale
124,105
59,203
Gain on sale of mortgage loans held-for-sale, net
(1,890
(605
Realized loss on sale and call of investment securities available for sale
377
14
Realized loss on disposition of premises and equipment
106
Increase in cash surrender value of bank owned life insurance
(1,596
(1,580
ESOP, stock option plan and restricted stock plan expenses
1,859
2,095
Increase in interest receivable
(1,294
(33
Increase in other assets
(3,456
(16,714
Increase (decrease) in interest payable
62
(664
(Decrease) increase in other liabilities
(663
15,135
Net Cash Provided by Operating Activities
6,136
10,948
Cash Flows from Investing Activities:
Purchases of:
Investment securities available for sale
(259,381
(8,198
Proceeds from:
Repayments/calls/maturities of investment securities available for sale
120,894
36,674
Repayments/calls/maturities of investment securities held to maturity
940
Sales of investment securities available for sale
19,600
3,646
Purchase of loans
(21,586
(7,567
Net decrease in loans receivable
104,354
84,804
Purchase of interest rate caps
(1,476
Additions to premises and equipment
(1,367
(977
Redemption of FHLB stock
6,881
Net cash acquired in acquisition
4,296
Net Cash (Used in) Provided by Investing Activities
(25,369
107,357
- 6 -
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Cash Flows from Financing Activities:
Net increase in deposits
150,000
49,978
Repayment of term FHLB advances
(865,000
(835,030
Proceeds from term FHLB advances
775,000
825,000
Net decrease in other short-term borrowings
(68,635
(31,271
Net decrease in advance payments by borrowers for taxes
(355
(785
Repurchase and cancellation of common stock of Kearny Financial Corp.
Cancellation of shares repurchased on vesting to pay taxes
Dividends paid
(6,877
(5,186
Net Cash Used in Financing Activities
(15,916
(27,935
Net (Decrease) Increase in Cash and Cash Equivalents
(35,149
90,370
Cash and Cash Equivalents - Beginning
38,935
Cash and Cash Equivalents - Ending
129,305
Supplemental Disclosures of Cash Flows Information:
Cash paid during the period for:
Income taxes, net of refunds
5,371
2,429
Interest
16,660
23,876
Non-cash investing and financing activities:
Fair value of assets acquired, net of cash and cash equivalents acquired
567,816
Fair value of liabilities assumed
523,926
In conjunction with the adoption of ASU 2019-04, the following qualifying held to
maturity securities were transferred to available for sale:
Debt securities transferred from held to maturity to available for sale
537,732
In conjunction with the adoption of ASU 2016-02, the following assets and liabilities
were recognized:
Operating lease right-of-use assets
17,243
Operating lease liabilities
17,758
- 7 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The unaudited consolidated financial statements include the accounts of Kearny Financial Corp. (the “Company”), its wholly-owned subsidiary, Kearny Bank (the “Bank”) and the Bank’s wholly-owned subsidiaries, CJB Investment Corp. and KFS Insurance Services, Inc. The Company conducts its business principally through the Bank. Management prepared the unaudited consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”), including the elimination of all significant inter-company accounts and transactions during consolidation.
Basis of Presentation
The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and Regulation S-X and do not include information or footnotes necessary for a complete presentation of financial condition, income, comprehensive (loss) income, changes in stockholders’ equity and cash flows in conformity with GAAP. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the unaudited consolidated financial statements have been included. The results of operations for the three-month period ended September 30, 2020 are not necessarily indicative of the results that may be expected for the entire fiscal year or any other period.
The data in the consolidated statement of financial condition for June 30, 2020 was derived from the Company’s 2020 Annual Report on Form 10-K. That data, along with the interim unaudited financial information presented in the consolidated statements of financial condition, income, comprehensive income, changes in stockholders’ equity and cash flows should be read in conjunction with the audited consolidated financial statements, including the notes thereto, included in the Company’s 2020 Annual Report on Form 10-K.
Risks and Uncertainties
As previously disclosed, on March 11, 2020, the World Health Organization declared the outbreak of COVID-19 a global pandemic. The COVID-19 pandemic has adversely affected, and may continue to adversely affect, local, national and global economic activity. The spread of the outbreak has caused significant disruptions to the U.S. economy, significant reductions in the targeted federal funds rate and has disrupted banking and other financial activity in the areas in which the Company operates. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted to, among other provisions, provide emergency assistance for individuals, families and businesses affected by the COVID-19 pandemic.
These reductions in interest rates and other effects of the COVID-19 pandemic may continue to materially and adversely affect the Company's financial condition and results of operations in future periods. It is unknown how long the adverse conditions associated with the COVID-19 pandemic will last and what the complete financial effect will be to the Company. It is possible that estimates made in the financial statements could be materially and adversely impacted as a result of these conditions, including estimates regarding expected credit losses on loans receivable, impairment of investment securities and impairment of goodwill. Although the Company continues to operate while taking steps to ensure the safety of employees and clients, COVID-19 could also potentially create widespread business continuity issues for the Company.
The extent to which the COVID-19 pandemic will continue to impact the Company’s business, financial condition and results of operations in future periods will depend on future developments, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic, as well as further actions the Company may take as may be required by government authorities or that the Company determines is in the best interests of its employees and clients. There is no certainty that such measures will be sufficient to mitigate the risks posed by the pandemic.
Adoption of New Accounting Standards
On July 1, 2020, the Company adopted ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. The Company adopted ASU 2016-13 using a modified retrospective approach. Results for reporting periods beginning after July 1, 2020 are presented under Topic 326, while prior period amounts continue to be reported in accordance with previously applicable GAAP. At adoption, the Company increased its allowance for credit losses by $20.2 million, comprised of $19.6 million for loans receivable and $536,000 for unfunded commitments. Upon adoption the Company recorded a cumulative effect adjustment that reduced stockholders’ equity by $14.2 million, net of tax.
- 8 -
Allowance for Credit Losses
The allowance for credit losses represents the estimated amount considered necessary to cover lifetime expected credit losses inherent in financial assets at the balance sheet date. The measurement of expected credit losses is applicable to loans receivable and securities measured at amortized cost. It also applies to off-balance sheet credit exposures such as loan commitments and unused lines of credit. The allowance is established through a provision for credit losses that is charged against income. The methodology for determining the allowance for credit losses is considered a critical accounting policy by management because of the high degree of judgment involved, the subjectivity of the assumptions used, and the potential for changes in the forecasted economic environment that could result in changes to the amount of the recorded allowance for credit losses. The allowance for credit losses is reported separately as a contra-asset on the consolidated statement of financial condition. The expected credit loss for unfunded lending commitments and unfunded loan commitments is reported on the Consolidated Statement of Financial Condition in other liabilities while the provision for credit losses related to unfunded commitments is reported in other non-interest expense.
Allowance for Credit Losses on Loans Receivable
The allowance for credit losses on loans is deducted from the amortized cost basis of the loan to present the net amount expected to be collected. Expected losses are evaluated and calculated on a collective, or pooled, basis for those loans which share similar risk characteristics. At each reporting period, the Company evaluates whether loans within a pool continue to exhibit similar risk characteristics. If the risk characteristics of a loan change, such that they are no longer similar to other loans in the pool, the Company will evaluate the loan with a different pool of loans that share similar risk characteristics. If the loan does not share risk characteristics with other loans, the Company will evaluate the loan on an individual basis. The Company evaluates the pooling methodology at least annually. Loans are charged off against the allowance for credit losses when the Company believes the balances to be uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged off or expected to be charged off.
The Company has chosen to segment its portfolio consistent with the manner in which it manages credit risk. Such segments include multi-family, nonresidential mortgage, commercial business, construction, one- to four-family residential, home equity and consumer. For most segments the Company calculates estimated credit losses using a probability of default and loss given default methodology, the results of which are applied to the aggregated discounted cash flow of each individual loan within the segment. The point in time probability of default and loss given default are then conditioned by macroeconomic scenarios to incorporate reasonable and supportable forecasts that affect the collectability of the reported amount.
The Company estimates the allowance for credit losses on loans via a quantitative analysis which considers relevant available information from internal and external sources related to past events and current conditions, as well as the incorporation of reasonable and supportable forecasts. The Company evaluates a variety of factors including third party economic forecasts, industry trends and other available published economic information in arriving at its forecasts. After the reasonable and supportable forecast period, the Company reverts, on a straight-line basis, to average historical losses. Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a troubled debt restructuring will be executed with an individual borrower or the renewal option is included in the original or modified contract at the reporting date and are not unconditionally cancelable by the Company.
Also included in the allowance for credit losses on loans are qualitative reserves to cover losses that are expected but, in the Company’s assessment, may not be adequately represented in the quantitative analysis or the forecasts described above. Factors that the Company considers include changes in lending policies and procedures, business conditions, the nature and size of the portfolio, portfolio concentrations, the volume and severity of past due loans and non-accrual loans, the effect of external factors such as competition, legal and regulatory requirements, among others. Furthermore, the Company considers the inherent uncertainty in quantitative models that are built upon historical data.
Individually Evaluated Loans
On a case-by-case basis, the Company may conclude that a loan should be evaluated on an individual basis based on its disparate risk characteristics. When the Company determines that a loan no longer shares similar risk characteristics with other loans in the portfolio, the allowance will be determined on an individual basis using the present value of expected cash flows or, for collateral-dependent loans, the fair value of the collateral as of the reporting date, less estimated selling costs, as applicable. If the fair value of the collateral is less than the amortized cost basis of the loan, the Company will charge off the difference between the fair value of the collateral, less costs to sell at the reporting date and the amortized cost basis of the loan.
- 9 -
Acquired Loans
Acquired loans are included in the Company's calculation of the allowance for credit losses. How the allowance on an acquired loan is recorded depends on whether or not it has been classified as a Purchased Credit Deteriorated (“PCD”) loan. PCD loans are loans acquired at a discount that is due, in part, to credit quality. PCD loans are accounted for in accordance with ASC Subtopic 326-20 and are initially recorded at fair value as determined by the sum of the present value of expected future cash flows and an allowance for credit losses at acquisition. The allowance for PCD loans is recorded through a gross-up effect, while the allowance for acquired non-PCD loans is recorded through provision expense, consistent with originated loans. Thus, the determination of which loans are PCD and non-PCD can have a significant impact on the accounting for these loans. Subsequent to acquisition, the allowance for PCD loans will generally follow the same estimation, provision and charge-off process as non-PCD acquired and originated loans.
Allowance for Credit Losses on Off-Balance Sheet Commitments
The Company is required to include unfunded commitments that are expected to be funded in the future within the allowance calculation, other than those that are unconditionally cancelable. To arrive at that reserve, the reserve percentage for each applicable segment is applied to the unused portion of the expected commitment balance and is multiplied by the expected funding rate. To determine the expected funding rate, the Company uses a historical utilization rate for each segment. As noted above, the allowance for credit losses on unfunded loan commitments is included in other liabilities on the consolidated statement of financial condition and the related credit expense is recorded in other non-interest expense in the consolidated statements of income.
Allowance for Credit Losses on Held to Maturity Securities
The Company’s entire portfolio of held to maturity securities consists of municipal bonds which are highly rated by major rating agencies and have a long history of no credit losses. In estimating the net amount expected to be collected for held to maturity securities in an unrealized loss position, a historical loss based method is utilized.
Allowance for Credit Losses on Available for Sale Securities
For available for sale securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more than likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For securities available for sale that do not meet the above criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, the Company considers the extent to which fair value is less than amortized cost, any changes to the rating by a rating agency, and adverse conditions related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income, net of tax. The Company elected the practical expedient of zero loss estimates for securities issued by U.S. government entities and agencies. These securities are either explicitly or implicitly guaranteed by the U.S. government, are highly rate by major agencies and have a long history of no credit losses.
Changes in the allowance for credit losses are recorded as provision for, or reversal of, credit loss expense. Losses are charged against the allowance when management believes the uncollectibility of an available for sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met.
Accrued Interest Receivable
The Company made an accounting policy election to exclude accrued interest receivable from the amortized cost basis of loans, available for sale securities, and held to maturity securities. Accrued interest receivable on loans is reported as a component of accrued interest receivable on the Consolidated Statement of Financial Condition, totaled $16.2 million at September 30, 2020 and is excluded from the estimate of credit losses. Accrued interest receivable on available of sale securities and held to maturity securities, also a component of accrued interest receivable on the Consolidated Statement of Financial Condition, totaled $3.9 million and $241,000, respectively, at September 30, 2020 and is excluded from the estimate of credit losses.
- 10 -
2. NET INCOME PER COMMON SHARE (“EPS”)
Basic EPS is based on the weighted average number of common shares actually outstanding, including both vested and unvested restricted stock awards, adjusted for Employee Stock Ownership Plan (“ESOP”) shares not yet committed to be released. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as 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 following schedule shows the Company’s earnings per share calculations for the periods presented:
Three Months Ended September 30,
Weighted average number of common shares
outstanding - basic
Effect of dilutive securities
37
outstanding- diluted
Basic earnings per share
Diluted earnings per share
Stock options for 3,910,398 and 3,245,000 shares of common stock were not considered in computing diluted earnings per share at September 30, 2020 and September 30, 2019, respectively, because they were considered anti-dilutive.
3. SUBSEQUENT EVENTS
The Company has evaluated events and transactions occurring subsequent to the statement of financial condition date of September 30, 2020, for items that should potentially be recognized or disclosed in these consolidated financial statements. The evaluation was conducted through the date this document was filed.
4. ACQUISITION OF MSB FINANCIAL CORP.
On July 10, 2020, the Company completed its acquisition of MSB Financial Corp. (“MSB”), and its subsidiary Millington Bank. In accordance with the merger agreement, approximately $9.8 million in cash and 5,853,811 shares of Company common stock was distributed to former MSB shareholders in exchange for their shares of MSB common stock.
The assets acquired and liabilities assumed have been accounted for under the acquisition method of accounting. The assets and liabilities, both tangible and intangible, were recorded at their fair values as of July 10, 2020 based on management’s best estimate using the information available as of the merger date. The application of the acquisition method of accounting resulted in the recognition of bargain purchase gain of $3.1 million and a core deposit intangible of $690,000. Accounting guidance provides that an acquirer must recognize adjustments to provisional amounts that are identified during the measurement period, which runs through July 10, 2021, in the measurement period in which the adjustment amounts are determined. The acquirer must record in the financial statements, the effect on earnings of changes in depreciation, amortization or other income effects, if any, as a result of the changes to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. Items that could be subject to adjustment include credit fair value adjustments on loans, core deposit intangible and the deferred income tax assets resulting from the acquisition.
- 11 -
The Company recorded the assets acquired and liabilities assumed through the merger at fair value as summarized in the following table:
As Recorded
by MSB
Fair Value Adjustments
at Acquisition
(In Thousands)
Cash paid for acquisition
9,830
Value of stock issued
Total purchase price
54,963
14,126
Investment securities
4,000
(510
(a)
3,490
537,589
(7,345
(b)
530,244
Allowance for loan losses
(6,037
6,037
(c)
7,698
(3,221
(d)
4,477
FHLB stock
3,345
1,701
690
(e)
14,663
Deferred income taxes, net
1,729
2,152
(f)
3,881
4,830
495
(g)
5,325
Total assets acquired
583,644
(1,702
581,942
458,392
1,786
(h)
460,178
FHLB borrowings
62,900
794
810
(756
(i)
54
Total liabilities assumed
522,896
1,030
Net assets acquired
58,016
Explanation of certain fair value related adjustments:
Represents the fair value adjustments on investment securities.
Represents the fair value adjustments on the net book value of loans, which includes an interest rate mark and credit mark adjustment and the reversal of deferred fees/costs and premiums.
Represents the elimination of MSB’s allowance for loan losses.
Represents the fair value adjustments to reflect the fair value of land and buildings and premises and equipment, which will be amortized on a straight-line basis over the estimated useful lives of the individual assets.
Represents the intangible assets recorded to reflect the fair value of core deposits. The core deposit asset was recorded as an identifiable intangible asset and will be amortized on an accelerated basis over the estimated average life of the deposit base.
Represents an adjustment to net deferred tax assets resulting from the fair value adjustments related to the acquired assets, liabilities assumed and identifiable intangible assets recorded.
Represents an adjustment to other assets acquired.
Represents fair value adjustments on time deposits, which will be treated as a reduction of interest expense over the remaining term of the time deposits.
Represents an adjustment to other liabilities assumed.
- 12 -
The fair value of loans acquired from MSB was estimated using cash flow projections based on the remaining maturity and repricing terms. Cash flows were adjusted by estimating future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value using a risk-adjusted market rate for similar loans. There was no carryover of MSB’s allowance for loan losses associated with the loans that were acquired. For information regarding purchased loans which have been determined to be PCD, refer to Note 8, Loans Receivable.
The core deposit intangible asset recognized is being amortized over its estimated useful life of approximately 10 years utilizing the sum-of-the-years digits method.
The fair value of retail demand and interest bearing deposit accounts was assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. The fair value of time deposits was estimated by discounting the contractual future cash flows using market rates offered for time deposits of similar remaining maturities.
5. MERGER RELATED EXPENSES
Merger-related expenses were recorded in the Consolidated Statements of Income as a component of non-interest expense and include costs relating to the Company’s acquisition of MSB, as described above. These charges represent one-time costs associated with acquisition activities and do not represent ongoing costs of the fully integrated combined organization. Accounting guidance requires that acquisition-related transactional and restructuring costs incurred by the Company be charged to expense as incurred. Direct acquisition and other charges incurred in connection with the MSB merger totaled $4.3 million for the three months ended September 30, 2020 and $951,000 for the fiscal year ended June 30, 2020. Direct acquisition and other charges were recorded in merger-related expense on the consolidated statements of income.
- 13 -
6. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2019, the FASB issued ASU 2019-12, “Income taxes (Topic 740); Simplifying the Accounting for Income Taxes”. ASU 2019-12 provides amendments intended to reduce the cost and complexity in accounting for income taxes while maintaining or improving the usefulness of the information provided to users of financial statements. ASU 2019-12 removes the following exceptions from ASC 740, Income Taxes: (i) exceptions to the incremental approach for intraperiod tax allocation; (ii) exceptions to accounting for basis differences when a foreign subsidiary becomes an equity method investment or a foreign equity method investment become a subsidiary; and (iii) exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses. ASU 2019-12 provides the following amendments that simplify and improve guidance with Topic 740: (i) franchise taxes that are based partially on income; (ii) transactions that result in a step up in the tax basis of goodwill; (iii) separate financial statements of legal entities that are not subject to tax; (iv) enacted changes in tax laws in interim periods; and (v) employee stock ownership plans and investments in qualified affordable housing projects accounted for using the equity method. For public business entities, the amendments in the ASU 2019-12 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The Company is currently evaluating the impact of adopting this ASU on its consolidated financial statements.
On July 1, 2020 the Company adopted ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU replaced the incurred loss methodology with an expected loss methodology that is referred to as the CECL methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost including loan receivables and held to maturity debt securities. This ASU also applies to off-balance exposures. In addition, this ASU made certain changes to the accounting for available for sale securities debt securities. Credit losses are required to be presented as an allowance rather than as a write-down on available for sale debt securities management does not intend to sell or believes that it is more likely than not they will be required to sell. The Company adopted Topic 326 and all its related updates on July 1, 2020, using the modified retrospective approach for financial assets measured at amortized cost. Results for reporting periods after July 1, 2020 are presented in accordance to the guidance under Topic 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. Upon adoption the Company recorded a cumulative effect adjustment that reduced stockholders’ equity by $14.2 million, net of tax. Additional information regarding the adoption of ASU 2016-13 is presented in Note 1, Summary of Significant Accounting Policies.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This ASU simplifies subsequent measurement of goodwill by eliminating Step 2 of the impairment test while retaining the option to perform the qualitative assessment for a reporting unit to determine whether the quantitative impairment test is necessary. The ASU also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform a quantitative goodwill impairment test. Therefore, the same impairment assessment applies to all reporting units. For public entities, ASU 2017-04 is effective for fiscal years beginning after December 15, 2019 with early adoption permitted for interim or annual goodwill impairment testing dates beginning after January 1, 2017. The Company is applying the amendments of ASU 2017-04 prospectively for goodwill impairment testing conducted after July 1, 2020.
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7. SECURITIES
At September 30, 2020, there was no allowance for credit losses on available for sale securities. The following tables present the amortized cost, gross unrealized gains and losses and estimated fair values for available for sale securities and the amortized cost, gross unrecognized gains and losses and estimated fair values for held to maturity securities as of the dates indicated:
September 30, 2020
Amortized
Cost
Gross
Unrealized
Gains
Losses
Fair
Value
Available for sale:
Debt securities:
Obligations of state and political subdivisions
49,697
1,180
50,877
Asset-backed securities
260,174
239
1,612
258,801
Collateralized loan obligations
198,015
1,625
196,398
Corporate bonds
121,436
1,123
283
122,276
Trust preferred securities
2,967
194
2,773
Total debt securities
632,289
2,550
3,714
631,125
Mortgage-backed securities:
Collateralized mortgage obligations (1)
25,065
705
25,770
Residential pass-through securities (1)
611,981
13,734
625,715
Commercial pass-through securities (1)
215,166
10,794
28
225,932
Total mortgage-backed securities
852,212
25,233
877,417
Total securities available for sale
1,484,501
27,783
3,742
(1)
Government-sponsored enterprises.
June 30, 2020
52,843
1,211
54,054
177,413
4,966
172,447
198,619
4,831
193,788
142,942
1,267
570
143,639
340
2,627
574,784
2,478
10,707
566,555
30,043
860
30,903
543,819
18,135
561,954
214,575
11,716
226,291
788,437
30,711
819,148
1,363,221
33,189
- 15 -
Unrecognized
Held to maturity:
1,560
33,136
Total securities held to maturity
1,513
34,069
The following tables present the amortized cost and estimated fair values of debt securities, by contractual maturity, at September 30, 2020:
Due in one year or less
6,696
6,727
Due after one year through five years
85,068
86,141
Due after five years through ten years
289,819
291,495
Due after ten years
282,282
279,898
663,865
664,261
- 16 -
Sales of securities available for sale were as follows for the periods presented below:
Available for sale securities sold:
Proceeds from sales of securities
Gross realized gains
12
Gross realized losses
(385
(28
Net loss on sales of securities
(16
Calls of securities available for sale during the three months ended September 30, 2020 and September 30, 2019 resulted in gross gains of $8,000 and $2,000, respectively. During the three months ended September 30, 2020 and September 30, 2019, there were no gains or losses recorded on sales and calls of securities held to maturity.
The carrying value of securities pledged for borrowings at the FHLB and other institutions, and securities pledged for public funds and other purposes, were as follows as of the dates presented below:
Securities pledged:
Pledged for borrowings at the FHLB of New York
166,267
155,288
Pledged to secure public funds on deposit
107,260
19,944
Pledged for potential borrowings at the Federal
Reserve Bank of New York
342,601
366,482
Pledged as collateral for depositor sweep accounts
7,830
Total carrying value of securities pledged
616,128
549,544
- 17 -
The following tables present the gross unrealized losses on securities and the estimated fair value of the related securities, aggregated by investment category and length of time that securities have been in a continuous unrealized loss position within the available for sale portfolio at September 30, 2020 and June 30, 2020:
Less than 12 Months
12 Months or More
Number of Securities
(Dollars in Thousands)
Securities Available for Sale:
81,712
1,006
54,166
606
13
135,878
53,946
228
134,037
1,397
18
187,983
33,302
199
19,916
84
7
53,218
Commercial pass-through securities
15,496
184,456
1,461
210,892
2,281
41
395,348
146,494
25,954
1,004
16
172,448
71,282
1,245
122,506
3,586
24,764
236
39,651
334
64,415
2,626
242,540
5,443
190,737
5,264
45
433,277
At September 30, 2020 and June 30, 2020, there were no held to maturity securities with unrecognized losses.
Available for sale securities are evaluated to determine if a decline in fair value below the amortized cost basis has resulted from a credit loss or other factors. An impairment related to credit factors would be recorded through an allowance for credit losses. The allowance is limited to the amount by which the security’s amortized cost basis exceeds the fair value. An impairment that has not been recorded through an allowance for credit losses shall be recorded through other comprehensive income, net of applicable taxes. Investment securities will be written down to fair value through the consolidated statement of income when management intends to sell, or may be required to sell, the securities before they recover in value. The issuers of these securities continue to make timely principal and interest payments and none of these securities were past due or were placed in nonaccrual status at September 30, 2020. Management believes that the unrealized losses on these securities are a function of changes in market interest rates and credit spreads, not changes in credit quality. Therefore, no allowance for credit losses was recorded at September 30, 2020.
At September 30, 2020, the Company’s entire portfolio of held to maturity securities consists of municipal bonds which are highly rated by major rating agencies and have a long history of no credit losses. None of the securities in the Company’s portfolio of held to maturity municipal bonds were in an unrealized loss position. The Company continually monitors the municipal bond sector of the market and reviews collectability including such factors as the financial condition of the issuers including credit ratings in effect as of the reporting period.
- 18 -
8. LOANS RECEIVABLE
The following table sets forth the composition of the Company’s loan portfolio at September 30, 2020 and June 30, 2020:
Commercial loans:
Multi-family mortgage
2,110,300
2,059,568
Nonresidential mortgage
1,124,330
960,853
Commercial business (1)
255,888
138,788
Construction
79,178
20,961
Total commercial loans
3,569,696
3,180,170
One- to four-family residential mortgage
1,353,197
1,273,022
Consumer loans:
Home equity loans
71,540
82,920
Other consumer
4,136
3,991
Total consumer loans
75,676
86,911
Total loans
4,998,569
4,540,103
Unaccreted yield adjustments
(43,819
(41,706
Total loans receivable, net of yield adjustments
Includes Paycheck Protection Program (“PPP”) loans of $83.4 million and $69.0 million as of September 30, 2020 and June 30, 2020, respectively. The balance of PPP loans at September 30, 2020 includes loans acquired in conjunction with the Company’s acquisition of MSB Financial Corp. on July 10, 2020.
- 19 -
Past Due Loans
Past due status is based on the contractual payment terms of the loans. The following tables present the payment status of past due loans as of September 30, 2020 and June 30, 2020, by loan segment:
Multi-Family Mortgage
Non-
Residential
Mortgage
Commercial
Business
Home
Equity
Consumer
Current
1,100,082
255,524
79,154
1,345,532
71,057
4,129
4,965,778
Past due:
30-59 days
6,171
24
1,558
7,761
60-89 days
497
1,024
1,587
90 days and over
17,580
304
5,083
471
23,443
Total past due
24,248
364
7,665
483
32,791
941,714
138,439
1,264,267
82,358
3,981
4,511,288
3,211
169
3,380
14,478
1,038
15,534
4,661
349
4,506
380
9,901
19,139
8,755
562
10
28,815
Nonperforming Loans
Loans are generally placed on nonaccrual status when contractual payments become 90 or more days past due or when the Company does not expect to receive all principal and interest payments (“P&I”) owed substantially in accordance with the terms of the loan agreement, regardless of past due status. Loans that become 90 days past due, but are well secured and in the process of collection, may remain on accrual status. Nonaccrual loans are generally returned to accrual status when all payments due are brought current and we expect to receive all remaining P&I payments owed substantially in accordance with the terms of the loan agreement. Payments received in cash on nonaccrual loans, including both the principal and interest portions of those payments, are generally applied to reduce the carrying value of the loan. The Company did not recognize interest income on non-accrual loans for the three months ended September 30, 2020 and September 30, 2019.
- 20 -
The following tables present information relating to the Company’s nonperforming loans as of September 30, 2020 and June 30, 2020:
Performing
2,107,376
1,097,576
255,349
76,640
1,341,463
70,959
4,131
4,953,494
Nonperforming:
90 days and over past due accruing
238
Nonaccrual loans with
allowance for credit losses
3,191
124
1,401
4,727
Nonaccrual loans with no
2,924
23,325
415
2,538
10,333
575
40,110
Total nonperforming
26,754
539
11,734
581
2,056,606
936,917
138,196
1,264,663
82,078
3,986
4,503,407
Nonaccrual
2,962
23,936
592
8,359
842
36,691
36,696
- 21 -
Troubled Debt Restructurings (“TDRs”)
On a case-by-case basis, the Company may agree to modify the contractual terms of a loan to assist a borrower who may be experiencing financial difficulty, as well as to preserve the Company’s position in the loan. If the borrower is experiencing financial difficulties and a concession has been made at the time of such modification, the loan is classified as a TDR. At September 30, 2020, the Company had TDRs totaling $20.1 million. The allowance for credit losses associated with the TDRs presented in the tables below totaled $210,000 and $8,000 as of September 30, 2020 and June 30, 2020, respectively. As of September 30, 2020, there were no significant commitments to lend additional funds to borrowers whose loans had been restructured in a TDR.
The following tables present total TDR loans at September 30, 2020 and June 30, 2020:
Accrual
Non-accrual
# of Loans
(Dollars In Thousands)
Multi-family mortgage loans
110
2,755
2,865
Commercial business
5,103
434
5,537
5,213
15
8,651
13,864
One- to four-family residential
mortgage
2,067
3,541
33
5,608
543
97
640
7,823
35
12,289
20,112
112
5,442
5,554
5,179
446
11
5,625
5,291
8,850
22
14,141
2,407
20
3,811
34
6,218
715
448
1,163
32
8,413
38
13,109
70
21,522
- 22 -
The following tables present information regarding the restructuring of the Company’s troubled debts during the three months ended September 30, 2020 and September 30, 2019.
Three Months Ended September 30, 2020
Pre-modification
Recorded
Investment
Post-modification
Residential mortgage
309
Three Months Ended September 30, 2019
3
1,775
1,829
1,002
938
82
81
2,859
2,848
During the three months ended September 30, 2019, TDRs resulted in charge-offs of $8,000 which were recognized at modification. During the three months ended September 30, 2020, there were no charge-offs related to TDRs. During the three months ended September 30, 2020 and 2019, there were no troubled debt restructuring defaults.
Loan modifications generally involve a reduction in interest rates and/or extension of maturity dates and also may include step up interest rates in their modified terms which will impact their weighted average yield in the future. The residential mortgage loan which qualified as a TDR during the three months ended September 30, 2020, capitalized prior past due amounts and modified the loan’s repayment terms.
- 23 -
In March 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by COVID-19. The interagency statement was effective immediately and impacted accounting for loan modifications. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term modifications such as payment deferrals, fee waivers, extension of repayment terms, or other delays in payment that are insignificant. Provisions of the CARES Act largely mirrored the provisions of the interagency statement, providing that modified loans were not to be considered TDRs if they were performing at December 31, 2019 and other considerations set forth in the interagency statements were met. Borrowers considered current are those that are less than 30 days past due at the time a modification program is implemented or at December 31, 2019. As of September 30, 2020, the Company had 63 non-TDR modified loans totaling approximately $76.9 million.
The following table sets forth the composition of these loans by loan segments as of September 30, 2020:
# of Loans (1)
Balance (1)
15,910
41,660
2,684
2,537
23
62,791
36
13,866
252
76,909
Includes loans acquired in conjunction with the Company’s acquisition of MSB Financial Corp. on July 10, 2020.
- 24 -
Individually Analyzed Loans
Effective July 1, 2020, individually analyzed loans include loans which do not share similar risk characteristics with other loans. TDR’s will generally be evaluated for individual impairment, however, after a period of sustained repayment performance which permits the credit to be returned to accrual status, a TDR would generally be removed from individual impairment analysis and returned to its corresponding pool. As of September 30, 2020, the carrying value of individually analyzed loans totaled $44.8 million, of which $32.5 million were considered collateral dependent.
For collateral dependent loans where management has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and repayment of the loan is to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral, less costs to sell, and the amortized cost basis of the loan as of the measurement date. See Note 16 for additional disclosure regarding fair value of individually analyzed collateral dependent loans.
The following table presents the carrying value of collateral dependent individually analyzed loans:
Carrying Value
Related Allowance
Nonresidential mortgage (1)
24,120
580
Commercial business (2)
24,319
Residential mortgage (3)
7,722
218
Home equity loans (3)
32,512
798
Secured by income-producing property.
(2)
Secured by business assets.
(3)
Secured by one- to four-family properties.
- 25 -
The following table presents, under previously applicable GAAP, loans individually evaluated for impairment by portfolio segment as of June 30, 2020:
Carrying value of impaired loans:
Non-impaired loans
936,805
132,999
1,262,256
81,363
4,494,981
Impaired loans:
Impaired loans with no allowance
for impairment
22,516
5,622
10,659
1,557
43,316
Impaired loans with allowance
for impairment:
Recorded investment
1,532
167
107
1,806
Allowance for impairment
(41
(47
(1
(89
Balance of impaired loans net
of allowance for impairment
1,491
120
1,717
Total impaired loans, excluding
allowance for impairment:
24,048
5,789
10,766
45,122
Unpaid principal balance
of impaired loans:
Total impaired loans
3,544
25,898
8,778
73
12,908
1,950
53,151
Credit Quality Indicators
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually to classify the loans as to credit risk. The Company uses the following definitions for risk ratings:
Pass – Loans that are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less cost to acquire and sell, of any underlying collateral in a timely manner.
Special Mention – Loans which do not currently expose the Company to a sufficient degree of risk to warrant an adverse classification but have some credit deficiencies or other potential weaknesses.
Substandard – Loans which are 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 Company will sustain some loss if the deficiencies are not corrected.
Doubtful – Loans which have all of the weaknesses inherent in those classified as Substandard, with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable, on the basis of currently existing facts, conditions and values.
Loss – Loans which considered uncollectible or of so little value that their continuance as assets is not warranted.
- 26 -
The following table presents the risk category of loans as of September 30, 2020 by loan segment and vintage year:
Term Loans Amortized Cost by Origination Year for Fiscal Years ended June 30,
2021
2018
2017
Prior
Revolving Loans
Multi-family mortgage:
Pass
71,975
261,063
436,822
413,844
416,703
486,683
2,087,090
Special Mention
10,060
Substandard
10,226
13,150
Doubtful
Total multi-family mortgage
416,768
426,929
496,743
Non-residential mortgage:
10,968
85,510
79,459
79,873
296,213
533,504
6,249
1,091,776
4,373
16,028
12,153
28,181
Total non-residential mortgage
312,241
550,030
Commercial business:
18,802
97,441
5,086
28,363
11,684
26,666
62,032
250,074
2,370
147
2,543
1,598
1,337
187
3,271
Total commercial business
97,525
5,097
32,331
11,896
28,018
62,219
Construction loans:
1,454
17,123
14,354
20,643
15,715
1,592
5,735
76,616
2,562
Total construction loans
4,154
Residential mortgage:
50,150
204,875
114,802
111,794
178,430
673,678
921
1,334,650
713
452
589
573
16,220
17,834
Total residential mortgage
205,327
115,391
179,003
690,611
Home equity loans:
206
4,672
8,192
4,158
3,366
20,943
28,637
70,174
175
26
201
68
1,097
1,165
Total home equity loans
3,434
22,215
28,663
Other consumer loans
280
565
818
240
137
1,899
75
4,014
116
121
1,904
192
153,835
671,785
660,133
665,807
949,355
1,793,675
103,979
- 27 -
The following table presents, under previously applicable GAAP, the risk category of loans as of June 30, 2020 by loan segment:
2,055,520
932,202
132,818
1,258,246
81,120
3,979
4,484,846
1,086
2,585
981
157
9,187
24,278
3,385
13,795
1,643
46,069
Purchased Credit Deteriorated Loans
Loans acquired in a business combination after July 1, 2020 are recorded in accordance with ASC Topic 326, after which acquired loans are separated into two types. PCD loans are acquired loans that, as of the acquisition date, have experienced a more-than-insignificant deterioration in credit quality since origination. Non-PCD loans are acquired loans that have experienced no or insignificant deterioration in credit quality since origination. To distinguish between the two types of acquired loans, the Company evaluates risk characteristics that have been determined to be indicators of deteriorated credit quality. The determining criteria may involve loan specific characteristics such as payment status, debt service coverage or other changes in creditworthiness since the loan was originated, while others are relevant to recent economic conditions, such as borrowers in industries impacted by the pandemic.
As part of the acquisition of MSB, the Company has purchased loans, for which there was, at acquisition, evidence of more than insignificant deterioration of credit quality since origination. The carrying amount of those loans is as follows:
At July 10, 2020
Purchase price of PCD loans at acquisition
69,415
Allowance for credit losses at acquisition
(3,901
Non-credit discount at acquisition
(167
Amortized cost of acquired PCD loans at acquisition
65,347
Residential Mortgage Loans in Foreclosure
We may obtain physical possession of one- to four-family real estate collateralizing a residential mortgage loan via foreclosure or through an in-substance repossession. As of September 30, 2020, we held one single-family property in other real estate owned with an aggregate carrying value of $178,000 that was acquired through a foreclosure on a residential mortgage loan. As of that same date, we held nine residential mortgage loans with aggregate carrying values totaling $1.7 million which were in the process of foreclosure.
As of June 30, 2020, we held one single-family property in other real estate owned with an aggregate carrying value of $178,000 that was acquired through a foreclosure on a residential mortgage loan. As of that same date, we held nine residential mortgage loans with aggregate carrying values totaling $1.9 million which were in the process of foreclosure.
The States of New Jersey and New York have issued executive orders and enacted legislation declaring moratoriums on removing individuals from a residential property as a result of an eviction or foreclosure proceeding. The New Jersey order will be in effect until two months after the Governor has declared an end to the COVID-19 health crisis. The New York law will be in effect until the state’s COVID-19-related executive orders are no longer in effect. As a result, since March 28, 2020, the Company has temporarily suspended residential property foreclosure sales and evictions.
- 28 -
9. ALLOWANCE FOR CREDIT LOSSES
Adoption of Topic 326
On July 1, 2020, the Company adopted ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”, which replaces the incurred loss methodology with an expected loss methodology, referred to as the “CECL” methodology. See Note 1, Summary of Significant Accounting Policies for additional information on the adoption of Topic 326.
The following tables present the balance of the allowance for credit losses at September 30, 2020 and June 30, 2020. For the three months ended September 30, 2020, the balance of the allowance for credit losses is based on the CECL methodology, as noted above. For the year ended June 30, 2020, the allowance for loan losses is based upon the calculation methodology as described in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2020. The tables identify the valuation allowances attributable to specifically identified impairments on individually evaluated loans, including those acquired with deteriorated credit quality, as well as valuation allowances for impairments on loans evaluated collectively. The tables include the underlying balance of loans receivable applicable to each category as of those dates.
Balance of allowance for credit
losses:
Loans acquired with deteriorated
credit quality individually
analyzed
527
745
credit quality collectively
211
854
136
249
2,598
Loans individually
evaluated for impairment
681
736
Loans collectively
28,355
13,387
2,820
969
14,367
836
47
60,781
Total allowance for credit losses
28,566
15,094
4,355
1,105
14,835
858
64,860
Balance of Loans Receivable
Balance of loans receivable:
evaluated
1,658
200
3,853
366
6,077
5,690
31,733
11,711
9,408
4,995
369
63,911
24,858
339
7,881
215
38,755
2,101,686
1,066,081
243,638
67,232
1,336,468
70,590
4,889,826
Loans receivable, net of yield
adjustments
- 29 -
Allowance for Loan Losses
Balance of allowance for loan losses:
credit quality
89
20,916
8,722
1,879
4,859
568
37,238
Total allowance for loan losses
8,763
1,926
4,860
37,327
222
77
299
5,567
10,689
44,823
- 30 -
The following table presents the activity in the ACL on loans for the three months ended September 30, 2020:
Changes in the allowance for credit
losses for the three months ended
September 30, 2020:
At June 30, 2020 (prior to adoption
of ASC 326):
Impact of adopting Topic 326
8,408
2,390
(421
80
9,106
92
(15
19,640
Charge offs
(63
(10
(73
Recoveries
Initial allowance on PCD loans
250
1,720
1,007
99
720
105
3,901
Provision for credit losses
(1,008
2,221
149
93
For the accounting policy on the allowance for loan losses that was in effect prior to the adoption of Topic 326, see Note 1 to our Annual Report on Form 10-K for the fiscal year ended June 30, 2020. The following table presents the activity in the allowance for loan losses for the three months ended September 30, 2019:
Changes in the allowance for loan
September 30, 2019:
At June 30, 2019:
16,959
9,672
2,467
3,377
491
172
33,274
Total charge offs
(64
Total recoveries
Total provisions
(257
(301
(174
(70
(13
29
16,702
9,371
2,293
140
3,307
478
141
32,432
- 31 -
Allowance for Credit Losses on Off Balance Sheet Commitments
The following table presents the activity in the ACL on off balance sheet commitments for the three months ended September 30, 2020:
At June 30, 2020
Impact of adopting Topic 326 (1)
536
Provision recorded in other non-interest expense
468
Total allowance for credit losses on off balance sheet commitments
Adoption of CECL accounting standard effective July 1, 2020.
10. LEASES
The Company adopted ASU 2016-02, “Leases (Topic 842)” and all subsequent ASUs that modified Topic 842 on July 1, 2019. Topic 842 requires lessees to recognize a lease liability and a right-of-use asset, measured at the present value of the future minimum lease payments, at the lease commencement date. At the time of adoption, operating lease right-of-use assets of approximately $17.2 million and operating lease liabilities of approximately $17.8 million were recorded in other assets and other liabilities, respectively, on our Consolidated Statements of Financial Condition. The calculated amount of the right-of-use asset and lease liabilities are impacted by the length of the lease term and the discount rate used to calculate the present value of the minimum lease payments. The discount rate used in determining the lease liability for each individual lease was the Company’s incremental borrowing rate at the time of adoption of ASU 2016-02, on a collateralized basis, over a similar term.
As of September 30, 2020, the weighted average remaining lease term for operating leases was 7.91 years and the weighted average discount rate used in the measurement of operating lease liabilities was 2.36%.
The Company has elected to account for lease and non-lease components separately since such amounts are readily determinable under the Company’s lease contracts. Total operating lease costs for the three months ended September 30, 2020 and September 30, 2019 was $1.0 million and $1.1 million, respectively.
There were no sale and leaseback transactions, leveraged leases or lease transactions with related parties during the three months ended September 30, 2020. At September 30, 2020, the Company had no leases that had not yet commenced.
A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total operating lease liability at September 30, 2020 is as follows:
Less than one year
3,649
After one year but within two years
3,311
After two years but within three years
2,606
After three years but within four years
1,877
After four years but within five years
1,498
Greater than five years
7,007
Total undiscounted cash flows
19,948
Less: discount on cash flows
(2,028
Total lease liability
17,920
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11. DEPOSITS
Deposits are summarized as follows:
Non-interest-bearing demand
Interest-bearing demand
1,561,135
1,264,151
Savings
1,025,245
906,597
Certificates of deposits
1,965,822
1,840,396
12. BORROWINGS
Fixed rate advances from the FHLB of New York mature as follows:
Balance
Weighted
Average
Interest Rate
By remaining period to maturity:
0.40
%
865,000
0.45
One to two years
27,000
2.85
Two to three years
145,000
3.04
Three to four years
22,500
2.63
Four to five years
103,500
2.68
6,500
2.82
Total advances
1,079,500
1.10
1,169,500
1.08
Unamortized fair value adjustments
(1,960
(2,071
Total advances, net of
fair value adjustments
1,167,429
At September 30, 2020, FHLB advances were collateralized by the FHLB capital stock owned by the Bank and mortgage loans and securities with carrying values totaling approximately $3.13 billion and $166.3 million, respectively. At June 30, 2020, FHLB advances were collateralized by the FHLB capital stock owned by the Bank and mortgage loans and securities with carrying values totaling approximately $3.21 billion and $155.3 million, respectively.
Borrowings at June 30, 2020 also included overnight borrowings in the form of depositor sweep accounts totaling $5.7 million, while there were no such borrowings at September 30, 2020.
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13. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Risk Management Objective of Using Derivatives
The Company uses various financial instruments, including derivatives, to manage its exposure to interest rate risk. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to specific wholesale funding positions.
Fair Values of Derivative Instruments on the Statement of Financial Condition
The tables below present the fair value of the Company’s derivative financial instruments as well as their classification on the Statement of Financial Condition as of September 30, 2020 and June 30, 2020:
Asset Derivatives
Liability Derivatives
Location
Fair Value
Derivatives designated as hedging
instruments:
Interest rate contracts
15,857
235
18,177
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using derivatives are primarily to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company has entered into interest rate swaps and caps as part of its interest rate risk management strategy. These interest rate products are designated as cash flow hedges. As of September 30, 2020, the Company had a total of 14 interest rate swaps and caps with a total notional amount of $1.23 billion hedging specific wholesale funding positions.
For derivatives designated as cash flow hedges, the gain or loss on the derivative is recorded in other comprehensive income, net of tax, and subsequently reclassified into interest expense in the same period during which the hedged transaction affects earnings.
Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable rate wholesale funding positions. During the three months ended September 30, 2020, the Company had $2.4 million of reclassifications to interest expense. During the next twelve months, the Company estimates that $7.3 million will be reclassified as an increase in interest expense.
- 34 -
The tables below present the pre-tax effects of the Company’s derivative instruments on the Consolidated Statements of Income for the three months ended September 30, 2020 and 2019:
Amount of Gain
(Loss) Recognized
in OCI on
Derivatives
Location of Gain
(Loss) Reclassified
from Accumulated
OCI into Income
Derivatives in cash flow
hedging relationships:
(111
Interest expense
(2,372
(1,759
1,371
Offsetting Derivatives
The tables below present a gross presentation, the effects of offsetting, and a net presentation of the Company’s derivatives in the Consolidated Statements of Financial Condition as of September 30, 2020 and June 30, 2020, respectively. The net amounts presented for derivative assets or liabilities can be reconciled to the tabular disclosure of fair value. The tabular disclosure of fair value provides the location that derivative assets and liabilities are presented on the Consolidated Statements of Financial Condition.
Gross Amounts Not Offset
Gross Amount Recognized
Gross Amounts Offset
Net Amounts Presented
Financial Instruments
Cash Collateral Received
Net Amount
Assets:
479
(304
Cash Collateral Posted
Liabilities:
16,161
(15,857
- 35 -
(357
18,534
(18,177
Credit-risk-related Contingent Features
The Company has agreements with each of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, then the Company could also be declared in default on its derivative obligations and could be required to terminate its derivative positions with the counterparty. The Company also has agreements with its derivative counterparties that contain a provision where if the Company fails to maintain its status as a well-capitalized institution, then the Company could be required to terminate its derivative positions with the counterparty. As of September 30, 2020, the termination value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to those agreements was $16.5 million.
As required under the enforceable master netting arrangement with its derivatives counterparties, at September 30, 2020, the Company posted financial collateral of $15.9 million that was not included as offsetting amount.
In addition to the derivative instruments noted above, the Company’s pipeline of loans held for sale at September 30, 2020 and June 30, 2020, included $124.5 million and $127.2 million, respectively, of in process loans whose terms included interest rate locks to borrowers, which are considered free-standing derivative instruments whose fair values are not material to our financial condition or results of operations.
14. BENEFIT PLANS
Components of Net Periodic Expense
The following table sets forth the aggregate net periodic benefit expense for the Bank’s Benefit Equalization Plan, Postretirement Welfare Plan, Directors’ Consultation and Retirement Plan and Atlas Bank Retirement Income Plan:
Affected Line Item in the Consolidated
Statements of Income
Service cost
Interest cost
Miscellaneous non-interest expense
Amortization of unrecognized loss
Expected return on assets
Net periodic benefit cost
85
78
- 36 -
15. INCOME TAXES
The following table presents a reconciliation between the reported income taxes for the periods presented and the income taxes which would be computed by applying the federal income tax rate of 21% to income for the three months ended September 30, 2020 and September 30, 2019:
Income before income taxes
Statutory federal tax rate
Federal income tax expense at statutory rate
2,995
3,189
(Reduction) increases in income taxes resulting from:
Tax exempt interest
(94
(144
State tax, net of federal tax effect
784
1,241
Incentive stock option compensation expense
17
Income from bank-owned life insurance
(327
(333
Non-deductible merger-related expenses
49
(641
Other items, net
98
(153
Total income tax expense
Effective income tax rate
20.22
25.13
The tax effects of existing temporary differences that give rise to deferred income tax assets and liabilities are as follows:
Deferred income tax assets:
Purchase accounting
12,134
11,668
Accumulated other comprehensive income:
Defined benefit plans
414
416
5,114
5,730
Allowance for credit losses
19,370
11,047
Benefit plans
2,302
2,290
Compensation
1,287
Stock-based compensation
2,482
Uncollected interest
1,460
1,362
Depreciation
978
268
Net operating loss carryover
Capital loss carryforward
329
Deferred loan fees and costs
Other items
796
1,039
46,267
37,934
Valuation allowance
(523
(535
45,744
37,399
Deferred income tax liabilities:
Unrealized gain on securities available for sale
7,047
6,541
4,632
4,655
746
723
12,425
11,919
Net deferred income tax asset
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16. FAIR VALUE OF FINANCIAL INSTRUMENTS
In January 2016, the FASB issued ASU 2016-01, “Financial Instruments”. This guidance amends existing guidance to improve accounting standards for financial instruments including clarification and simplification of accounting and disclosure requirements and the requirement for public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. The Company adopted the guidance effective July 1, 2018. Upon adoption, the fair value of the Company’s loan portfolio is now presented using an exit price method.
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1:
Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2:
Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability or inputs that are derived principally from, or corroborated by, market data by correlation or other means.
Level 3:
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
Assets Measured on a Recurring Basis:
The following methods and significant assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a recurring basis at September 30 2020 and June 30, 2020:
Investment Securities Available for Sale
The Company’s available for sale investment securities are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the securities’ terms and conditions, among other things. From time to time, the Company validates prices supplied by the independent pricing service by comparison to prices obtained from third-party sources or derived using internal models.
The Company has contracted with a third party vendor to provide periodic valuations for its interest rate derivatives to determine the fair value of its interest rate caps and swaps. The vendor utilizes standard valuation methodologies applicable to interest rate derivatives such as discounted cash flow analysis and extensions of the Black-Scholes model. Such valuations are based upon readily observable market data and are therefore considered Level 2 valuations by the Company.
- 38 -
Those assets measured at fair value on a recurring basis are summarized below:
Quoted
Prices
in Active
Markets for
Identical
(Level 1)
Significant
Observable
Inputs
(Level 2)
Unobservable
(Level 3)
Debt securities available for sale:
Mortgage-backed securities available for sale:
Collateralized mortgage obligations
Residential pass-through securities
Total assets
1,508,717
Total liabilities
- 39 -
Quoted Prices
1,385,938
Assets Measured on a Non-Recurring Basis:
The following methods and assumptions were used to estimate the fair values of the Company’s assets measured at fair value on a non-recurring basis at September 30, 2020 and June 30, 2020:
Collateral Dependent Individually Analyzed / Impaired Loans:
The fair value of collateral dependent loans that are individually analyzed or were previously deemed impaired is determined based upon the appraised fair value of the underlying collateral, less costs to sell. Such collateral primarily consists of real estate and, to a lesser extent, other business assets. Management may also adjust appraised values to reflect estimated market value declines or apply other discounts to appraised values resulting from its knowledge of the collateral. Internal valuations may be utilized to determine the fair value of other business assets. For non-collateral-dependent loans, management estimates fair value using discounted cash flows based on inputs that are largely unobservable and instead reflect management’s own estimates of the assumptions as a market participant would in pricing such loans. Collateral dependent individually analyzed / impaired loans are considered a Level 3 valuation by the Company.
- 40 -
Other Real Estate Owned
Other real estate owned is recorded at estimated fair value, less estimated selling costs when acquired, thus establishing a new cost basis. Fair value is generally based on independent appraisals. These appraisals include adjustments to comparable assets based on the appraisers’ market knowledge and experience. When an asset is acquired, the excess of the loan balance over fair value, less estimated selling costs, is charged to the allowance for loan losses. If further declines in the estimated fair value of the asset occur, a write-down is recorded through expense. The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of changes in economic conditions.
Those assets measured at fair value on a non-recurring basis are summarized below:
Collateral dependent loans:
2,731
Non-residential mortgage
3,401
6,132
Other real estate owned, net:
2,339
2,282
129
4,750
- 41 -
The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company has utilized adjusted Level 3 inputs to determine fair value:
Valuation
Techniques
Input
Range
Market valuation of
underlying collateral
Adjustments to reflect current
conditions/selling costs
7% - 10%
7.90
9% - 12%
10.02
6.00%
6.00
7% - 9%
8.17
10.27
0% - 0%
0.00
The fair value of impaired loans is generally determined based on an independent appraisal of the fair value of a loan’s underlying collateral.
The fair value basis of impaired loans and other real estate owned is adjusted to reflect management’s estimates of selling costs including, but not necessarily limited to, real estate brokerage commissions and title transfer fees.
The fair value basis of other real estate owned is generally determined based upon the lower of an independent appraisal of the property’s fair value or the applicable listing price or contracted sales price.
At September 30, 2020, collateral dependent loans valued using Level 3 inputs comprised loans with principal balances totaling $6.9 million and valuation allowances of $800,000 reflecting fair values of $6.1 million. By comparison, at June 30, 2020, under previously applicable GAAP, impaired loans valued using Level 3 inputs comprised loans with principal balances totaling $4.8 million and valuation allowances of $89,000 reflecting fair values of $4.8 million.
Once a loan is foreclosed, the fair value of the other real estate owned continues to be evaluated based upon the fair value of the repossessed real estate originally securing the loan. At September 30, 2020, the Company held other real estate owned totaling $178,000 whose carrying value was written down utilizing Level 3 inputs. By comparison, at June 30, 2020, the Company held other real estate owned totaling $178,000 whose carrying value was written down utilizing Level 3 inputs.
- 42 -
The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of September 30, 2020 and June 30, 2020:
Carrying
Financial assets:
Investment securities held to maturity
20,956
4,926,728
FHLB Stock
Interest receivable
16,235
Financial liabilities:
5,057,201
3,074,090
1,983,111
1,117,783
Interest payable on deposits
258
242
Interest payable on borrowings
1,680
21,550
4,462,232
13,215
4,449,877
2,589,886
1,859,991
1,215,529
395
295
100
1,723
- 43 -
Commitments. The fair value of commitments to fund credit lines and originate or participate in loans held in portfolio or loans held for sale 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 loan commitments, including those relating to loans held for sale that are considered derivative instruments for financial statement reporting purposes, the 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, is not considered material for disclosure.
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 fair value exists for a significant portion of the financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments 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.
The fair value estimates are based on existing on-and-off balance sheet financial instruments without attempting to value 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.
17. COMPREHENSIVE INCOME
The components of accumulated other comprehensive income included in stockholders’ equity at September 30, 2020 and June 30, 2020 are as follows:
Net unrealized gain on securities available for sale
24,041
22,482
Tax effect
(7,047
(6,541
Net of tax amount
16,994
15,941
(17,157
(19,418
(12,043
(13,688
(1,391
(1,412
(996
Total accumulated other comprehensive income
- 44 -
Other comprehensive income and related tax effects for the three months ended September 30, 2020 and September 30, 2019 are presented in the following table:
Net unrealized holding gain on securities
available for sale
1,182
10,157
Amortization of net unrealized holding loss on
securities available for sale transferred to held
to maturity (1)
596
Net realized loss on sale and call of securities
available for sale (2)
2,261
(3,130
Benefit plans:
Amortization of actuarial loss
Net actuarial loss (3)
470
Net change in benefit plan accrued expense
Other comprehensive income before taxes
3,841
8,111
(1,124
(2,260
Total other comprehensive income
Represents amounts reclassified out of accumulated other comprehensive income and included in interest income on taxable securities.
Represents amounts reclassified out of accumulated other comprehensive income and included in gain on sale of securities on the consolidated statements of income.
Represents amounts reclassified out of accumulated other comprehensive income and included in the computation of net periodic pension expense. See Note 14 – Benefit Plans for additional information.
- 45 -
18. REVENUE RECOGNITION
Effective July 1, 2018, the Company adopted ASU 2014-09 Revenue from Contracts with Customers and all subsequent amendments to the ASU (collectively, "ASC 606”), which (i) creates a single framework for recognizing revenue from contracts with customers that fall within its scope and (ii) revises when it is appropriate to recognize a gain (loss) from the transfer of nonfinancial assets, such as OREO. The majority of the Company’s revenues come from interest income and other sources, including loans, leases, securities, and derivatives that are outside the scope of ASC 606. The Company’s services that fall within the scope of ASC 606 are presented within non-interest income and are recognized as revenue as the Company satisfies its obligation to the customer. Services within the scope of ASC 606 include deposit service charges on deposits, interchange income, and the sale of OREO.
The Company, using a modified retrospective transition approach, determined that there was no cumulative effect adjustment to retained earnings as a result of adopting the new standard, nor did the standard have a material impact on our consolidated financial statements including the timing or amounts of revenue recognized.
All of the Company’s revenue from contracts with customers within the scope of ASC 606 is recognized within non-interest income. The following table presents the Company’s sources of non-interest income for the three months ended September 30, 2020 and 2019. Sources of revenue outside the scope of ASC 606 are noted as such.
Non-interest income:
Deposit-related fees and charges
476
Loan-related fees and charges (1)
727
992
Loss on sale and call of securities (1)
Gain on sale of loans (1)
Income from bank owned life insurance (1)
Electronic banking fees and charges (interchange income)
Bargain purchase gain (1)
Other income (1)
Total non-interest income
Not within the scope of ASC 606.
A description of the Company’s revenue streams accounted for under ASC 606 is as follows:
Service Charges on Deposit Accounts
The Company earns fees from deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed at the point in the time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s account balance.
- 46 -
Gains/Losses on Sales of OREO
The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. Gain/Losses on the sales of OREO falls within the scope of ASC 606, if the Company finances the transaction. Under ASC 606, if the Company finances the sale of OREO to the buyer, the Company is required to assess whether the buyer is committed to perform their obligations under the contract and whether the collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. Generally, the Company does not finance the sale of OREO properties.
Interchange Income
The Company earns interchange fees from debit and credit card holder transactions conducted through various payment networks. Interchange fees from cardholder transactions are recognized daily, concurrently with the transaction processing services provided by an outsourced technology solution.
- 47 -
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This Quarterly Report on Form 10-Q may include certain forward-looking statements based on current management expectations. Such forward-looking statements may be identified by reference to a future period or periods or by the use of forward-looking terminology, such as “may”, “will”, “believe”, “expect”, “estimate”, “anticipate”, “continue”, or similar terms or variations on those terms, or the negative of those terms. The actual results of the Company could differ materially from those management expectations. This includes statements regarding general economic conditions, public health crisis such as the governmental, social and economic effects of the novel coronavirus, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulations of federal, state and local tax authorities and failure to integrate or profitably operate acquired businesses. Additional potential factors include changes in interest rates, deposit flows, cost of funds, demand for loan products and financial services, competition and changes in the quality or composition of loan and investment portfolios of the Company. Other factors that could cause future results to vary from current management expectations include changes in accounting principles, policies or guidelines, and other economic, competitive, governmental and technological factors affecting the Company’s operations, markets, products, services and prices. Further description of the risks and uncertainties to the business are included in the Company’s other filings with the Securities and Exchange Commission.
Except as required by applicable law or regulation, the Company does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.
Acquisition of MSB
On July 10, 2020 the Company completed its acquisition of MSB, and its subsidiary Millington Bank. In conjunction with the acquisition, the Company acquired assets with fair values totaling $583.3 million, including loans and securities with fair values of $530.7 million and $4.8 million, respectively. The Company also assumed liabilities with fair values totaling $525.3 million, including deposits and borrowings with fair values of $460.2 million and $62.9 million, respectively. Merger consideration totaled $55.0 million and included approximately $9.8 million of cash and 5,853,811 shares of the Company’s common stock, which was distributed to former MSB shareholders in exchange for their shares of MSB common stock. As the fair value of net assets acquired exceeded the purchase price, a bargain purchase gain of $3.1 million was recognized.
Impact of COVID-19
As the Company’s business is primarily conducted within the states of New Jersey and New York, and those states have been significantly impacted by COVID-19, the operations and operating results of the Company have been similarly impacted.
Employee Matters. As the COVID-19 pandemic has unfolded, and stay-at-home orders were mandated by government officials, the majority of our non-branch personnel have transitioned to working remotely, and have continued to do so through September 30, 2020. Our information technology infrastructure has afforded us the ability to work remotely with little interruption as we continue to service the needs of our clients. For those essential employees who are unable to work from home, we have provided personal protective equipment, established guidelines to maintain appropriate social distancing and have initiated enhanced cleaning of our facilities to ensure a safe working environment.
Retail Branches. At the outset of the pandemic we modified our branch hours and access to ensure the safety of our employees and clients. Where possible, branch lobbies were transitioned to appointment-only access, with the majority of branch operations being conducted via our drive-up windows. As certain branches did not have drive-up capabilities, or suitable alternatives, we temporarily closed certain locations. In the months following and in accordance with the protocols recommended by the CDC, we have outfitted our branches with protective barriers and continued to provide our staff with personal protective equipment. In addition, we have instituted policies requiring our clients to wear face masks and to adhere to social distancing protocols while visiting our branch locations. With these modifications, as of September 30, 2020, all of our branches had re-opened their lobbies and were fully operational.
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Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) and Paycheck Protection Program and Health Care Enhancement Act (“PPP Enhancement Act”). On March 27, 2020 the CARES Act was signed into law. Among the more significant components of the CARES Act, as it pertains to the Company, was the creation of the Paycheck Protection Program (“PPP”), the modification of rules and regulations surrounding troubled debt restructured loans and modifications to the tax code to allow for the carryback of net operating losses.
The CARES Act authorized the Small Business Administration (“SBA”) to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program. As part of this program the SBA will guarantee 100% of the PPP loans made to eligible borrowers. As a qualified SBA lender, the Bank is automatically authorized to originate PPP loans. On April 16, 2020, the original authorization of $349 billion in funding for the PPP program was exhausted. On April 23, 2020, the PPP Enhancement Act was signed into law and provided an additional $310 billion in funding for the PPP program. As of September 30, 2020 and including loans acquired in conjunction with the Company’s acquisition of MSB, we had approximately 940 loans with total outstanding balances of $83.4 million under the PPP.
Under Section 4013 of the CARES Act, and based upon regulatory guidance promulgated by federal banking regulators, qualifying short-term loan modifications resulting in payment deferrals that are attributable to the adverse impact of COVID-19, are not considered to be troubled debt restructurings (“TDRs”). Additional information regarding loans modified in accordance with this guidance are provided in the tables below.
The CARES Act included multiple provisions which impacted the tax code. One such provision restored net operating loss (“NOL”) carrybacks that were eliminated by the 2017 Tax Cuts and Jobs Act. The new carryback provision allows for a five year carryback of NOLs incurred by corporations in the 2018, 2019 and 2020 tax years. As a result of this provision the Company was able to carry back NOLs, which had been recorded at the current statutory federal rate of 21%, at the prior statutory rate of 34%.
Loan Portfolio. The government-mandated closure of certain businesses and the curtailment of non-essential travel has created an increased level of risk to certain segments of the loan portfolio. Additional disclosures surrounding portfolio-wide loan-to-value ratios for real estate secured loans, exposures to certain loan sectors and non-TDR loan modifications granted under section 4013 of the CARES Act are provided below.
The following table sets forth the composition of our real estate secured loans indicating the loan-to-value, by loan category, at September 30, 2020:
LTV
Commercial mortgage loans:
63%
Nonresidential mortgage loans
53%
Total commercial mortgage loans
3,234,630
60%
58%
44%
Total mortgage loans
4,659,367
59%
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The following table identifies our exposure to various loan sectors at September 30, 2020:
Real-Estate Secured (1)
Non-Real Estate Secured (1)
Hotel
4,357
51
1,479
5,836
Restaurant
9,805
3,888
13,693
Retail shopping center
321,787
52
55
131
321,842
Entertainment & recreation
5,153
871
6,024
Wholesale commercial business
N/A
20,569
Wholesale consumer unsecured
202
153
341,102
181
27,064
368,166
Total modifications represent any modification made during the year, including those made by MSB prior to acquisition. Active modifications in the table below reflect those loans whose modification includes a deferral that was still in effect at September 30, 2020. As of September 30, 2020, the Company had active modifications on 63 loans totaling $76.9 million in principal balances, representing 1.5% of total loans. Through September 30, 2020, the Company had modified a total of 843 non-TDR loans with an aggregate principal balance of $882.9 million.
Active Modifications (1)
Total Modifications (1)
Increase/(Decrease)
143
393,156
(136
(377,246
168
305,841
(157
(264,181
10,107
(56
(7,423
12,240
(4
(9,703
376
721,344
(353
(658,553
One- to four-family
residential mortgage
420
156,963
(384
(143,097
4,603
(43
(4,351
843
882,910
(780
(806,001
- 50 -
Comparison of Financial Condition at September 30, 2020 and June 30, 2020
Executive Summary. Total assets increased by $552.0 million to $7.31 billion at September 30, 2020 from $6.76 billion at June 30, 2020. As described in greater detail below, the increase was reflected in various categories of interest-earning and non-interest-earning assets and was primarily due to the Company’s acquisition of MSB. The net increase in total assets primarily reflected increases in investment securities, net loans receivable and other assets, partially offset by decreases in cash and equivalents and loans held-for-sale.
Investment Securities. Investment securities classified as available for sale increased by $122.8 million to $1.51 billion at September 30, 2020 from $1.39 billion at June 30, 2020. Included in this increase were securities acquired from MSB with a fair value that totaled $3.5 million at the time of acquisition. In addition, the net increase in the portfolio during the quarter ended September 30, 2020 reflected security purchases totaling $259.4 million and a $1.6 million increase in the fair value of the portfolio to a net unrealized gain of $24.0 million. The net increase in the portfolio was partially offset by security sales totaling $19.9 million and $121.6 million in principal repayment, net of premium amortization and discount accretion.
Investment securities classified as held to maturity decreased by $980,000 to $31.6 million at September 30, 2020 from $32.6 million at June 30, 2020. This decrease was attributable to principal repayment, net of discount accretion and premium amortization.
Additional information regarding investment securities as of those dates is presented in Note 7 to the unaudited consolidated financial statements.
Loans Held-for-Sale. Loans held-for-sale totaled $20.2 million at September 30, 2020 as compared to $20.8 million at June 30, 2020 and are reported separately from the balance of net loans receivable. During the quarter ended September 30, 2020, $122.2 million of residential mortgage loans were sold, resulting in net gains on sale of $1.9 million.
Net Loans Receivable. Net loans receivable increased by $428.8 million to $4.89 billion at September 30, 2020 from $4.46 billion at June 30, 2020. The increase largely reflected loans with fair values totaling $530.2 million that were acquired in conjunction with the acquisition of MSB. The increase in net loans receivable also reflected elevated levels of loan prepayment activity which outpaced new loan origination and purchase volume during the quarter ended September 30, 2020. Detail regarding the changes in the loan portfolio is presented below:
Increase/
(Decrease)
50,732
163,477
117,100
58,217
389,526
80,175
(11,380
145
Total consumer
(11,235
458,466
(2,113
(27,533
428,820
- 51 -
Commercial loan origination volume for the quarter ended September 30, 2020 totaled $100.4 million, which comprised $66.2 million of commercial mortgage loan originations augmented by $27.8 million of commercial business loan originations and construction loan disbursements of $6.4 million.
At September 30, 2020, the balance of commercial business loans included PPP loans totaling $83.4 million and include loans acquired in conjunction with the Company’s acquisition of MSB. Commercial loan originations were augmented with the funding of purchased loans totaling $21.6 million during the quarter ended September 30, 2020. Additionally, we acquired commercial business loans with fair values totaling approximately $389.3 million in our acquisition of MSB.
One- to four-family residential mortgage loan origination volume for the quarter ended September 30, 2020, excluding loans held-for-sale, totaled $80.9 million. Home equity loan and line of credit origination volume for the quarter ended September 30, 2020 totaled $3.3 million. Additionally, we acquired one- to four-family residential mortgage loan and home equity loans and lines of credit with fair values totaling approximately $121.7 million and $19.1 million, respectively, in our acquisition of MSB.
Additional information about the Company’s loans at September 30, 2020 and June 30, 2020 is presented in Note 8 to the unaudited consolidated financial statements.
Nonperforming Loans and Troubled Debt Restructurings (“TDRs”). Nonperforming loans increased by $8.4 million to $45.1 million, or 0.91% of total loans at September 30, 2020, from $36.7 million, or 0.82% of total loans at June 30, 2020. This increase was largely attributable to $5.8 million of non-performing loans acquired from MSB, whose fair values at acquisition reflected various levels of impairment. Non-performing loans at September 30, 2020 did not include $63.9 million of performing PCD loans acquired from MSB.
Troubled debt restructurings are loans where the Company has modified the contractual terms of the loan as a result of the financial condition of the borrower. Subsequent to their modification, TDRs are placed on non-accrual until such time as satisfactory payment performance has been demonstrated, at which time the loan may be returned to accrual. At September 30, 2020, the Company had accruing TDRs totaling $7.8 million, a decrease of $590,000 from $8.4 million at June 30, 2020. At September 30, 2020, the Company had non-accrual TDRs totaling $12.3 million, a decrease of $820,000 from $13.1 million at June 30, 2020.
Additional information about the Company’s nonperforming loans at September 30, 2020 and June 30, 2020 is presented in Note 8 to the unaudited consolidated financial statements.
Allowance for Credit Losses (“ACL”). At September 30, 2020, the ACL totaled $64.9 million, or 1.30% of total loans, reflecting an increase of $27.5 million from $37.3 million, or 0.82% of total loans at June 30, 2020. This increase resulted from the adoption of CECL totaling $19.6 million and the establishment of an ACL for loans acquired from MSB totaling $9.0 million, partially offset by a reduction in ACL attributable to the effects of a decrease in the overall balance of the portion of the loan portfolio that was collectively evaluated for impairment and net charge-offs.
See Note 1 to the unaudited consolidated financial statements regarding the process and methodology employed to estimate the ACL. Additional information about the ACL at September 30, 2020 and June 30, 2020 is presented in Note 9 to the unaudited consolidated financial statements.
Other Assets. The aggregate balance of other assets, including premises and equipment, FHLB stock, interest receivable, goodwill, core deposit intangibles, bank owned life insurance, deferred income taxes, other real estate owned and other assets, increased by $37.1 million to $714.2 million at September 30, 2020 from $677.1 million at June 30, 2020.
The increase in other assets primarily reflected the impact of the MSB acquisition through which the Company acquired other assets with fair values totaling $5.3 million. The increase in other assets also reflected the Company’s recognition of a core deposit intangible totaling $690,000.
The remaining increases and decreases in other assets for the quarter ended September 30, 2020 generally reflected normal operating fluctuations in their respective balances.
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Deposits. Total deposits increased by $609.6 million to $5.04 billion at September 30, 2020 from $4.43 billion at June 30, 2020. The increase in deposits reflected the impact of the MSB acquisition through which the Company assumed deposits with fair values totaling $460.2 million, as well as organic growth in deposits of $149.4 million. The following table sets forth the distribution of total deposits, by type, at the dates indicated:
Non-interest-bearing deposits
68,572
296,984
118,648
Certificates of deposit
125,426
Interest-bearing deposits
541,058
609,630
Additional information about the Company’s deposits at September 30, 2020 and June 30, 2020 is presented in Note 11 to the unaudited consolidated financial statements.
Borrowings. The balance of borrowings decreased by $95.6 million to $1.08 billion at September 30, 2020 from $1.17 billion at June 30, 2020 and largely reflected the repayment of maturing FHLB advances totaling $90.0 million and a decrease in depositor sweep accounts totaling $5.6 million. In conjunction with the acquisition of MSB the Company assumed overnight FHLB advances with fair values totaling $62.9 million, which were immediately repaid.
Additional information about the Company’s borrowings at September 30, 2020 and June 30, 2020 is presented in Note 12 to the unaudited consolidated financial statements.
Other Liabilities. The balance of other liabilities decreased by $1.9 million to $68.7 million at September 30, 2020 from $70.6 million at June 30, 2020. The change in the balance of other liabilities reflected the adoption of CECL, as noted above. At adoption the Company increased its ACL by $536,000 for unfunded loan commitments while also recording a provision for ACL of $468,000 during the quarter. The remaining change generally reflected normal operating fluctuations in the balances of other liabilities during the period.
Stockholders’ Equity. Stockholders’ equity increased by $39.9 million to $1.12 billion at September 30, 2020 from $1.08 billion at June 30, 2020. The increase in stockholders’ equity for the quarter ended September 30, 2020 largely reflected $45.1 million of capital stock issued by the Company in conjunction with the acquisition of MSB, net income of $11.4 million and an increase of $2.7 million in accumulated other comprehensive income. Partially offsetting that increase were cash dividends paid totaling $6.9 million and a $14.2 million cumulative effect adjustment related to the adoption of CECL.
Book value per share decreased by $0.40 to $12.56 at September 30, 2020 while tangible book value per share decreased by $0.24 to $10.15 at September 30, 2020. These decreases were largely attributable to the combined effects of the July 1, 2020 adoption of CECL and the July 10, 2020 acquisition of MSB.
In March 2019 the Company announced its fourth share repurchase plan which authorized the repurchase of 9,218,324 shares, or 10%, of the outstanding shares as of that date. On October 19, 2020, the Company announced the resumption of that plan which had, on March 25, 2020, been temporarily suspended due to the risks and uncertainties associated with the COVID-19 pandemic. 761,030 shares of common stock remain to be repurchased under this plan. In addition, the Company announced the approval of a new repurchase plan totaling 4,475,523 shares, or 5% of the Company’s outstanding common stock which will be implemented upon the completion of the current stock repurchase plan. Cumulatively, the Company has repurchased a total of 8,457,294 shares or 91.7% of the shares to be repurchased under its current repurchase plan at a total cost of $111.1 million and at an average cost of $13.14 per share.
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Comparison of Operating Results for the Quarter ended September 30, 2020 and September 30, 2019
Net Income. Net income for the quarters ended September 30, 2020 and September 30, 2019 was $11.4 million, or $0.13, respectively, per basic and diluted share. Although the levels of net income and earnings per share were unchanged for the comparative periods, there were various changes among the components of net income during the quarters ended September 30, 2020 and September 30, 2019. Such changes included an increase in net interest income, as detailed below, an increase in non-interest income, a decrease in income tax expense that was partially offset by an increase to the provision for loan losses and an increase in non-interest expense. Net income for the quarter ended September 30, 2020 also reflected various non-recurring items recognized in conjunction with the Company’s acquisition of MSB.
Net Interest Income. Net interest income increased by $7.5 million to $44.2 million for the quarter ended September 30, 2020. The increase between the comparative periods resulted from a decrease of $6.5 million in interest expense coupled with an increase of $985,000 in interest income.
The increase in the average balances of interest-earning assets and interest-bearing liabilities reflected the impact of the MSB acquisition. The Company recorded purchase accounting adjustments to the carrying value of all assets acquired and liabilities assumed from MSB to reflect their fair values at the time of acquisition. Such adjustments generally accrete or amortize into interest income and interest expense, respectively, on a level-yield/cost basis over their estimated remaining lives. As a result, the post-acquisition yield or cost recognized by the Company on the assets and liabilities acquired generally reflects the comparable market interest rates for such instruments at the time of their acquisition.
The decrease in interest expense for the quarter ended September 30, 2020, reflected a 60 basis points decrease in the average cost of interest-bearing liabilities to 1.20%, partially offset by a $443.9 million increase in the average balance of interest-bearing liabilities to $5.59 billion. For the same period, interest expense on deposits decreased $5.0 million to $11.1 million and was attributable to a 67 basis points decrease in the cost of interest-bearing deposits partially offset by a $596.6 million increase in their average balance. For the quarter ended September 30, 2020, interest expense on borrowings decreased by $1.5 million to $5.7 million and was attributable to a decrease of $152.8 million in the average balance of borrowings coupled with a 22 basis points decrease in their cost.
The increase in interest income of $985,000 reflected an increase to the average balance of interest-earning assets of $580.6 million to $6.64 billion, partially offset by a 28 basis points decrease in their yield to 3.67%. Interest income on loans increased by $3.6 million to $52.2 million for the quarter ended September 30, 2020 and was primarily attributable to a $302.1 million increase in the average balance of loans to $4.96 billion. For the same period, the average yield on loans increased three basis points to 4.21%. The decrease in interest income on interest-earning assets, excluding loans, was due to decreases in interest income on taxable securities, tax-exempt securities and other interest-earning assets.
Net interest spread increased by 32 basis points to 2.47% for the quarter ended September 30, 2020, from 2.15% for the quarter ended September 30, 2019. Net interest margin increased 24 basis points to 2.66%, from 2.42%, for the same comparative periods. The increase in the spread and margin reflected a decrease in the average cost of interest-bearing liabilities that was partially offset by a decrease in the average yield on interest-earning assets.
Additional details surrounding the composition of, and changes to, net interest income are presented in the table below.
The following table reflects the components of the average balance sheet and of net interest income 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. No tax equivalent adjustments have been made to yield or costs. Non-accrual loans were included in the calculation of average balances, however interest receivable on these loans has been fully reserved for and therefore not included in interest income. The yields and costs set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense and exclude the impact of prepayment penalties, which are recorded to non-interest income.
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For the Quarter ended September 30,
Yield/
Interest-earning assets:
Loans receivable (1)
4,958,293
4.21
4,656,192
4.18
Taxable investment securities (2)
1,350,511
2.17
1,147,698
3.25
Tax-exempt securities (2)
82,603
2.20
129,339
2.14
Other interest-earning assets (3)
247,543
1.48
125,114
4.09
Total interest-earning assets
6,638,950
3.67
6,058,343
3.95
Non-interest-earning assets
624,252
585,826
7,263,202
6,644,169
Interest-bearing liabilities:
1,464,238
2,182
0.60
883,843
2,880
1.30
1,006,075
1,445
0.57
799,181
1,530
0.77
1,988,689
7,435
1.50
2,179,333
11,645
Total interest-bearing deposits
4,459,002
0.99
3,862,357
1.66
1,134,404
2.00
1,287,157
2.22
Total interest-bearing liabilities
5,593,406
1.20
5,149,514
1.80
Non-interest-bearing liabilities (4)
558,761
380,719
6,152,167
5,530,233
Stockholders' equity
1,111,035
1,113,936
Total liabilities and stockholders'
equity
Net interest income
Interest rate spread (5)
2.47
2.15
Net interest margin (6)
2.66
2.42
Ratio of interest-earning assets
to interest-bearing liabilities
1.19
X
1.18
Loans held-for-sale and non-accruing loans have been included in loans receivable and the effect of such inclusion was not material. Allowance for loan losses has been included in non-interest-earning assets.
Fair value adjustments have been excluded in the balances of interest-earning assets.
Includes interest-bearing deposits at other banks and FHLB of New York capital stock.
(4)
Includes average balances of non-interest-bearing deposits of $479,141,000 and $320,641,000, for the quarter ended September 30, 2020, and 2019, respectively.
(5)
Interest rate spread represents the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities.
(6)
Net interest margin represents net interest income as a percentage of average interest-earning assets.
Provision for Credit Losses. The provision for credit losses increased by $4.8 million to $4.1 million for the quarter ended September 30, 2020 as compared to a provision reversal of $782,000 for the quarter ended September 30, 2019. This increase was largely attributable to $5.1 million of provision expense on non-PCD loans acquired in connection with the acquisition of MSB, partially offset by the effects of a decrease in the balance of the portion of the loan portfolio that was collectively evaluated for impairment.
Additional information regarding the allowance for credit losses and the associated provisions recognized during the quarter ended September 30, 2020 and 2019 is presented in Note 9 to the unaudited consolidated financial statements as well as the Comparison of Financial Condition at September 30, 2020 and June 30, 2020.
Non-Interest Income. Non-interest income increased by $3.8 million to $7.7 million for the quarter ended September 30, 2020, primarily as the result of the $3.1 million bargain purchase gain recognized in conjunction with the acquisition of MSB. The remaining increases and decreases in non-interest income reflected the effects of several offsetting factors, as described below.
Fees and service charges decreased by $392,000 to $1.1 million for the quarter ended September 30, 2020. The decrease primarily reflected a decrease in loan-related fees attributable to a decrease in commercial loan prepayment activity.
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Gain (loss) on sale and call of securities reflected a net loss of $377,000 during the quarter ended September 30, 2020 compared to a net loss of $14,000 during the earlier comparative period.
Gain on sale of loans increased by $1.3 million to $1.9 million for the quarter ended September 30, 2020. The increase in loan sale gains reflected changes in the volume of loans originated and sold between comparative periods coupled with an increase in the margin at which such loans were sold.
Other non-interest income increased by $85,000 to $90,000 for the quarter ended September 30, 2020. The increase primarily reflected $106,000 of non-recurring losses on asset disposals recognized in the prior comparative period.
The remaining changes in the other components of non-interest income between comparative periods generally reflected normal operating fluctuations within those line items.
Non-Interest Expenses. Total non-interest expense increased by $7.3 million to $33.6 million for the quarter ended September 30, 2020 and was largely attributable to recurring and non-recurring expenses associated with the acquisition of MSB.
Salaries and employee benefits expense increased by $1.2 million to $17.0 million for the quarter ended September 30, 2020. The increase in salaries and employees benefits expense generally reflected increases associated with the additional employees retained in conjunction with the MSB acquisition while also reflecting increases in certain compensation and benefit expenses attributable to the Company’s existing roster of employees. These increases were partially offset by decreases in employee severance, and ESOP expense.
Net occupancy expense of premises increased by $153,000 to $3.1 million for the quarter ended September 30, 2020. This increase was largely attributable to the ongoing operating expenses associated with the owned and leased office facilities acquired by the Company in conjunction with the MSB acquisition. The change in net occupancy expense also reflected $187,000 of lease termination costs incurred in the prior comparative period for which no such costs were recorded in the current period.
Equipment and systems expense increased by $481,000 to $3.6 million for the quarter ended September 30, 2020. This increase was largely attributable to increases in technology infrastructure expense coupled with additional core processing and electronic banking delivery channel expense associated with the growth in clients and accounts associated with the acquisition of MSB.
Advertising and marketing expense decreased by $35,000 to $500,000 for the quarter ended September 30, 2020. This decrease largely reflected changes in advertising expense across a variety of advertising formats reflecting normal fluctuations in the timing of certain campaigns supporting our loan and deposit growth initiatives.
FDIC insurance premiums totaled $472,000 for the quarter ended September 30, 2020 for which no comparable expense was recorded during the prior comparative period. No expense was recorded in the prior comparative period as a result of credits available to the Bank under the FDIC’s Small Bank Assessment Credit program.
Merger-related expenses, associated with the Company’s acquisition of MSB, totaled $4.3 million for the quarter ended September 30, 2020. No comparable expense was recorded during the prior comparative period.
Other expense increased by $731,000 to $3.8 million for the quarter ended September 30, 2020. The increase in other expense was largely attributable to $469,000 of credit loss expense for off-balance sheet exposure required in connection with the Company’s adoption of CECL.
Provision for Income Taxes. Provision for income taxes decreased by $933,000 to $2.9 million for the quarter ended September 30, 2020, from $3.8 million for the quarter ended September 30, 2019, resulting in effective tax rates of 20.2% and 25.1%, respectively.
This decrease reflected the effects of various non-recurring items recorded in conjunction with the Company’s acquisition of MSB, including a non-taxable bargain purchase gain and non-deductible merger related expenses, whose effects collectively decreased the effective tax rate and provision expense. In addition, the variance in income tax expense reflected a lower level of pre-tax net income, as compared to the prior period, resulting in a lower provision for income tax expense.
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Liquidity and Capital Resources
Liquidity, represented by cash and cash equivalents, is a product of operating, investing and financing activities. The Company’s primary sources of funds are deposits, borrowings, cash flows from investment securities and loans receivable and funds provided from operations. While scheduled payments from the amortization and maturity of loans and investment securities are relatively predictable sources of funds, general interest rates, economic conditions and competition greatly influence deposit flows and prepayments on loans and securities.
Liquidity, at September 30, 2020, included $145.8 million of short-term cash and equivalents supplemented by $1.51 billion of investment securities classified as available for sale. In addition, as of September 30, 2020, the Company had the capacity to borrow additional funds totaling $1.57 billion and $296.3 million, without pledging additional collateral, from the FHLB of New York and FRB, respectively. The Company also had the capacity to borrow, as of September 30, 2020, $615.0 million of additional funds, on an unsecured basis, via lines of credit established with other financial institutions.
At September 30, 2020, the Company had outstanding commitments to originate and purchase loans totaling approximately $74.3 million while such commitments totaled $45.6 million at June 30, 2020. As of those same dates, the Company’s pipeline of loans held for sale included $124.5 million and $127.2 million of loans in process whose terms included interest rate locks to borrowers that were paired with a non-binding, best-efforts, commitment to sell the loan to a buyer at a fixed price and within a predetermined timeframe after the sale commitment is established.
Construction loans in process and unused lines of credit were $42.3 million and $168.4 million, respectively, at September 30, 2020 compared to $17.0 million and $82.5 million, respectively, at June 30, 2020. The Company is also subject to the contingent liabilities resulting from letters of credit whose outstanding balances totaled $1.0 million and $217,000 at September 30, 2020 and June 30, 2020, respectively.
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 by the customer. 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 commitments and conditional obligations as we do for on-balance-sheet instruments. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Deposits increased $609.6 million to $5.04 billion at September 30, 2020 from $4.43 billion at June 30, 2020. The increase in deposit balances reflected a $541.1 million increase in interest-bearing deposits coupled with a $68.5 million increase in non-interest-bearing deposits. Borrowings from the FHLB of New York and other sources are generally available to supplement the Bank’s liquidity position or to replace maturing deposits. As of September 30, 2020, the Bank’s outstanding balance of FHLB advances, excluding fair value adjustments, totaled $1.08 billion.
Consistent with its goals to operate a sound and profitable financial organization, the Bank actively seeks to maintain its status as a well-capitalized institution in accordance with regulatory standards. As of September 30, 2020, the Company and the Bank exceeded all capital requirements of federal banking regulators.
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The following table sets forth the Bank’s capital position at September 30, 2020 and June 30, 2020, as compared to the minimum regulatory capital requirements that were in effect as of those dates:
At September 30, 2020
Actual
For Capital
Adequacy Purposes
To Be Well Capitalized
Under Prompt
Corrective Action
Provisions
Ratio
Total capital (to risk-weighted assets)
878,250
20.23
347,385
8.00
434,232
10.00
Tier 1 capital (to risk-weighted assets)
835,905
19.25
260,539
Common equity tier 1 capital (to risk-weighted assets)
195,404
4.50
282,251
6.50
Tier 1 capital (to adjusted total assets)
11.78
283,739
4.00
354,674
5.00
816,577
21.38
305,562
381,953
779,250
20.40
229,172
171,879
248,269
11.95
260,893
326,116
The following table sets forth the Company’s capital position at September 30, 2020 and June 30, 2020, as compared to the minimum regulatory capital requirements that were in effect as of those dates:
962,185
22.07
348,805
919,840
21.10
261,604
196,203
12.93
284,660
906,058
23.61
306,958
868,731
22.64
230,219
172,664
13.27
261,783
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As a result of the Economic Growth, Regulatory Relief, and Consumer Protection Act, the federal banking agencies have adopted a rule to establish for institutions with assets of less than $10 billion that meet other specified criteria a community bank leverage ratio (“CBLR”) that such institutions may elect to utilize in lieu of the generally applicable leverage and risk-based capital requirements noted above. The federal banking agencies have adopted 9% as the applicable ratio, effective March 31, 2020, and as a result of the Coronavirus Aid, Relief and Economic Security (“CARES”) Act, temporarily reduced the ratio to 8% in response to COVID-19. Institutions with capital meeting the specified requirements and electing to follow the alternative framework will be considered compliant with all applicable regulatory capital and leverage requirements, including the requirement to be “well capitalized.” The Company has elected not to utilize the CBLR framework.
In March 2020, the federal banking agencies announced an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL’s effect on regulatory capital, relative to the incurred loss methodology’s effect on regulatory capital, followed by a three-year transition period (five-year transition option). The Company is adopting the capital transition relief over the permissible five-year period.
Off-Balance Sheet Arrangements
In the normal course of our business of investing in loans and securities we are a party to financial instruments with off-balance-sheet risk. These financial instruments include significant purchase commitments, such as commitments related to capital expenditure plans and commitments to extend credit to meet the financing needs of our customers. We had no significant off-balance sheet commitments for capital expenditures as of September 30, 2020.
Recent Accounting Pronouncements
For a discussion of the expected impact of recently issued accounting pronouncements that have yet to be adopted by the Company, please refer to Note 6 to the unaudited consolidated financial statements.
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ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The majority of our assets and liabilities are sensitive to changes in interest rates. Consequently, interest rate risk is a significant form of business risk that we must manage. Interest rate risk is generally defined in regulatory nomenclature as the risk to earnings or capital arising from the movement of interest rates and arises from several risk factors including re-pricing risk, basis risk, yield curve risk and option risk.
We maintain an Asset/Liability Management (“ALM”) program in order manage our interest rate risk. The program is overseen by the Board of Directors through its Interest Rate Risk Management Committee. The Board of Directors has assigned the responsibility for the operational aspects of the ALM program to our Asset/Liability Management Committee (“ALCO”). The ALCO is a management committee comprising the Chief Executive Officer, Chief Operating Officer, Chief Financial Officer, Chief Lending Officer, Chief Credit Officer, Chief Banking Officer, Chief Risk Officer and Treasurer/Chief Investment Officer. Additional members of our management team may be asked to participate on the ALCO, as appropriate.
The quantitative analysis that we conduct measures interest rate risk from both a capital and earnings perspective. With regard to earnings, movements in interest rates and the shape of the yield curve significantly influence the amount of net interest income (“NII”) that we recognize. Movements in market interest rates, and the effect of such movements on the risk factors noted above, significantly influence the spread between the interest earned on our interest-earning assets and the interest paid on our interest-bearing liabilities. Our internal interest rate risk analysis calculates the sensitivity of our projected NII over a one year period utilizing a static balance sheet assumption through which incoming and outgoing asset and liability cash flows are reinvested into similar instruments. Product pricing and earning asset prepayment speeds are appropriately adjusted for each rate scenario.
With regard to capital, our internal interest rate risk analysis calculates the sensitivity of our Economic Value of Equity (“EVE”) ratio to movements in interest rates. EVE represents the present value of the expected cash flows from our assets less the present value of the expected cash flows arising from our liabilities adjusted for the value of off-balance sheet instruments. EVE attempts to quantify our economic value using a discounted cash flow methodology while the EVE ratio reflects that value as a form of capital ratio. The degree to which the EVE ratio changes for any hypothetical interest rate scenario from its base case measurement is a reflection of an institution’s sensitivity to interest rate risk.
For both earnings and capital at risk our interest rate risk analysis calculates a base case scenario that assumes no change in interest rates. The model then measures changes throughout a series of interest rate scenarios representing immediate and permanent, parallel shifts in the yield curve up and down 100, 200 and 300 basis points with additional scenarios modeled where appropriate. The model requires that interest rates remain positive for all points along the yield curve for each rate scenario which may preclude the modeling of certain falling rate scenarios during periods of lower market interest rates. The relatively low level of interest rates prevalent at September 30, 2020 and June 30, 2020 precluded the modeling of certain falling rate scenarios.
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The following tables present the results of our internal EVE analysis as of September 30, 2020 and June 30, 2020, respectively:
Economic Value of
Equity ("EVE")
EVE as a % of
Present Value of Assets
Change in
Interest Rates
$ Amount
of EVE
$ Change
in EVE
% Change
EVE Ratio
+300 bps
1,101,640
32,248
16.32
bps
+200 bps
1,123,035
53,643
16.25
133
+100 bps
1,117,864
48,472
15.84
0 bps
1,069,392
14.92
-100 bps
943,562
(125,830
(12
13.14
(178
961,579
11,882
15.57
113
988,278
38,581
15.61
117
988,410
38,713
15.28
949,697
14.44
829,775
(119,922
12.60
(184
There are numerous internal and external factors that may contribute to changes in our EVE ratio and its sensitivity. Changes in the composition and allocation of our balance sheet, or utilization of off-balance sheet instruments such as derivatives, can significantly alter the exposure to interest rate risk as quantified by the changes in the EVE sensitivity measures. Changes to certain external factors, most notably changes in the level of market interest rates and overall shape of the yield curve, can also alter the projected cash flows of our interest-earning assets and interest-costing liabilities and the associated present values thereof.
The following tables present the results of our internal NII analysis as of September 30, 2020 and June 30, 2020, respectively:
Net Interest
Income ("NII")
Balance Sheet
Composition
Measurement
Period
of NII
in NII
Static
One Year
172,152
(5,656
(3.18
175,864
(1,944
(1.09
178,978
1,170
0.66
177,808
180,162
2,354
1.32
146,062
(9,010
(5.81
150,502
(4,570
(2.95
154,612
(460
(0.30
155,072
162,070
6,998
4.51
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Notwithstanding the rate change scenarios presented in the EVE and NII-based analyses above, future interest rates and their effect on 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 maturities or periods of re-pricing, 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 the analyses set forth above. Additionally, an increase in credit risk may result as the ability of borrowers to service their debt may decrease in the event of an interest rate increase.
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ITEM 4.
CONTROLS AND PROCEDURES
As of the end of the period covered by this Report, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended). Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.
During the quarter ended September 30, 2020, there were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II
ITEM 1.
At September 30, 2020, neither the Company nor the Bank were involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business, which involve amounts in the aggregate believed by management to be immaterial to the financial condition of the Company and the Bank.
ITEM 1A.
There have been no material changes to the Risk Factors previously disclosed under Item 1A of the Company’s Annual Report on Form 10-K for the year ended June 30, 2020, previously filed with the Securities and Exchange Commission.
ISSUER PURCHASES OF EQUITY SECURITIES:
On March 13, 2019, the Company announced the authorization of a fourth repurchase plan for up to 9,218,324 shares or 10% of shares then outstanding. This plan has no expiration date. On March 25, 2020 the Company temporarily suspended its stock repurchase program due to the risks and uncertainties associated with the COVID-19 pandemic. Through September 30, 2020, the Company repurchased 8,457,294 shares, or 91.7% of the shares authorized for repurchase under the current repurchase program, at a cost of $111.1 million, or an average of $13.14 per share.
On October 19, 2020, the Company announced the resumption of its current stock repurchase plan, which has 761,030 shares of common stock remaining to be repurchased. In addition, the Company announced the approval of a new repurchase plan totaling 4,475,523 shares, or 5% of the Company’s outstanding common stock which will be implemented upon the completion of the current stock repurchase plan.
Not applicable.
ITEM 5.
None.
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ITEM 6.
The following Exhibits are filed as part of this report:
3.1
Articles of Incorporation of Kearny Financial Corp. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (File No. 333-198602), originally filed on September 5, 2014)
3.2
Bylaws of Kearny Financial Corp. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (File No. 333-198602), originally filed on September 5, 2014)
Form of Common Stock Certificate of Kearny Financial Corp. (Incorporated by reference to the Registrant’s Registration Statement on Form S-1 (File No. 333-198602), originally filed on September 5, 2014)
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101
The following materials from the Company’s Form 10-Q for the quarter ended September 30, 2020, formatted in Inline XBRL (Extensible Business Reporting Language): (i) the Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Income; (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholder’s Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to Consolidated Financial Statements.
101.INS
Inline XBRL Instance Document (The instance document does not appear in the interactive data file because its XBRL tags are embedded within the Inline XBRL document)
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Labels Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
104
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
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Pursuant to the requirements 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.
Date: November 6, 2020
By:
/s/ Craig L. Montanaro
Craig L. Montanaro
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Keith Suchodolski
Keith Suchodolski
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
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