KEARNY FINANCIAL CORP. 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 the planned merger of MSB Financial Corp. ("MSBF")
with and into the Company, with the Company surviving the merger as the
surviving corporation (the "Merger"). Factors that could cause future results to
vary from current management expectations include, but are not limited to, the
inability to obtain approvals and/or meet the other closing conditions required
to close the Merger in a timely manner, general economic conditions, 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 and under Item 1A. Risk Factors of the Quarterly Report on Form 10-Q.
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.
Proposed Acquisition of MSBF
OnDecember 18, 2019 , the Company and MSBF, the holding company forMillington Bank , announced that the companies had entered into a definitive agreement pursuant to which the Company will acquire MSBF. Consideration will be paid to MSBF stockholders in a combination of stock and cash. Under the terms of merger agreement MSBF will merge with and into the Company and each outstanding share of MSBF common stock will be exchanged for 1.3 shares of the Company's common stock or$18.00 in cash. MSBF stockholders may elect cash or stock, or a combination thereof, subject to proration to ensure that, in the aggregate, 10% of MSBF shares will be converted into cash and 90% of MSBF shares will be converted into the Company's common stock. Upon closing, the Company's stockholders holders will own approximately 94% of the combined company and MSBF stockholders will own approximately 6% of the combined company. As ofDecember 31, 2019 , MSBF had approximately$593.1 million of assets, gross loans of$513.7 million and deposits of$472.8 million and operated four New Jersey branches located in Somerset and Morris counties. The required approvals to complete this transaction include MSBF shareholder approval, regulatory approval, and the effectiveness of the registration statement to be filed by the Company with respect to the common stock to be issued in the transaction. The Merger is expected to close during the second calendar quarter of 2020.
Comparison of Financial Condition at
Executive Summary. Total assets decreased by$24.4 million to$6.61 billion atDecember 31, 2019 from$6.63 billion atJune 30, 2019 . The net decrease in total assets primarily reflected decreases in the balance of net loans receivable and loans held-for-sale that were partially offset by increases in investment securities, cash and cash equivalents and other assets.Investment Securities . Investment securities classified as available for sale increased by$687.9 million to$1.40 billion atDecember 31, 2019 from$714.3 million atJune 30, 2019 . The net increase in the portfolio largely reflected the adoption of ASU 2019-04 onJuly 1, 2019 , upon which the Company reclassified$537.7 million of investment securities from held to maturity to available for sale. In addition, the net increase in the portfolio reflected security purchases totaling$216.0 million during the six months endedDecember 31, 2019 and a$7.3 million increase in the fair value of the portfolio to a net unrealized gain of$9.3 million atDecember 31, 2019 from a net unrealized gain of$2.0 million atJune 30, 2019 . The net increase in the portfolio was partially offset by security sales totaling$3.7 million and$69.5 million in cash repayment of principal, net of premium amortization and discount accretion. - 48 - -------------------------------------------------------------------------------- Investment securities classified as held to maturity decreased by$540.6 million to$36.1 million atDecember 31, 2019 from$576.7 million atJune 30, 2019 . The decrease in held to maturity securities largely reflected the adoption of ASU 2019-04, as noted above. The decrease in the portfolio also reflected cash repayment of principal, net of discount accretion and premium amortization, totaling$2.9 million for the six months endedDecember 31, 2019 . Based on its evaluation, management has concluded that no other-than-temporary impairment was present within the investment portfolio as ofDecember 31, 2019 orJune 30, 2019 . Additional information regarding investment securities as of those dates is presented in Note 8, Note 9 and Note 10 to the unaudited consolidated financial statements. Loans Held-for-Sale. Our residential lending team continues to originate residential mortgage loans designated for sale into the secondary market thereby augmenting our sources of non-interest income through the recognition of loan sale gains. Loans held-for-sale totaled$6.0 million atDecember 31, 2019 as compared to$12.3 million atJune 30, 2019 and are reported separately from the balance of net loans receivable as of those dates. During the six months endedDecember 31, 2019 , we sold$126.4 million of residential mortgage loans resulting in net sale gains totaling$1.3 million . Net Loans Receivable. Loans receivable, net of unamortized premiums, deferred costs and the allowance for loan losses, decreased by$183.9 million to$4.46 billion atDecember 31, 2019 from$4.65 billion atJune 30, 2019 . The decrease in net loans receivable was primarily attributable to elevated levels of loan prepayment activity outpacing new loan origination and purchase volume during the six months endedDecember 31, 2019 . The detail of the changes in loan portfolio is presented below: December 31, June 30, Increase/ 2019 2019 (Decrease) (In Thousands) Residential mortgage loans: One- to four-family residential mortgage$ 1,331,301 $ 1,344,044 $ (12,743 ) Home equity loans and lines of credit 89,916 96,165 (6,249 ) Total residential mortgage loans 1,421,217 1,440,209
(18,992 )
Commercial loans: Multi-family commercial mortgage loans 1,856,591 1,946,391 (89,800 ) Nonresidential commercial mortgage loans 1,172,213 1,258,869 (86,656 ) Commercial business 67,887 65,763 2,124 Construction 16,221 13,907 2,314 Total commercial loans 3,112,912 3,284,930 (172,018 ) Other consumer loans 4,908 5,814 (906 ) Total loans 4,539,037 4,730,953 (191,916 )
Deferred fees, premiums and other, net (46,340 ) (52,025 )
5,685
Allowance for loan losses (30,937 ) (33,274 ) 2,337
Net loans receivable $ 4,461,760 $ 4,645,654 $ (183,894 )
Residential mortgage loan origination volume for the six months ended December
31, 2019 , excluding loans held-for-sale, totaled $132.1 million , comprising
$122.8 million of one- to four-family first mortgage loan originations and $9.3
million of home equity loan and line of credit originations. Residential
mortgage loan originations for the period were augmented with the purchase of
one- to four-family first mortgage loans totaling $2.7 million .
Commercial loan origination volume for the six months ended December 31, 2019
totaled $94.9 million , which comprised $70.8 million of commercial mortgage loan
originations augmented by $21.7 million of commercial business loan originations
and construction loan disbursements totaling $2.4 million . Commercial loan
originations were augmented with the funding of purchased loans totaling $31.6
million during the six months ended December 31, 2019 .
Additional information about the Company's loans at
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Nonperforming Loans. Nonperforming loans increased by $1.7 million to $22.0
million , or 0.49% of total loans at December 31, 2019 , from $20.3 million , or
0.43% of total loans at June 30, 2019 . Nonperforming loans generally include
those loans reported as 90 days and over past due while still accruing and loans
reported as nonaccrual with such balances totaling $19,000 and $21.9 million ,
respectively, at December 31, 2019 .
Additional information about the Company's nonperforming loans at December 31,
2019 and June 30, 2019 is presented in Note 12 to the unaudited consolidated
financial statements.
Allowance for Loan Losses. During the six months ended December 31, 2019 , the
balance of the allowance for loan losses ("ALLL") decreased by $2.3 million to
$30.9 million at December 31, 2019 from $33.3 million , at June 30, 2019 ,
resulting in an ALLL to total loans ratio of 0.68% and 0.70% as of those dates,
respectively. The decrease resulted from a loan loss provision reversal of $2.2
million during the six months ended December 31, 2019 coupled with charge-offs
and net of recoveries totaling $90,000 during that same period.
The portion of the allowance for loan losses attributable to loans individually
evaluated for impairment decreased by $18,000 to $13,000 at December 31, 2019
from $31,000 at June 30, 2019 . This balance reflected an allowance for
impairment on $187,000 of impaired loans while an additional $27.3 million of
impaired loans had no allowance. By comparison, the balance at June 30, 2019
reflected an allowance for impairment on $363,000 of impaired loans while an
additional $24.2 million of impaired loans had no allowance for impairment.
The portion of the allowance for loan losses attributable to loans collectively
evaluated for impairment decreased by $2.3 million to $30.9 million at December
31, 2019 from $33.2 million at June 30, 2019 . This decrease was attributable to
changes in a combination of historical and environmental loss factors. With
regard to historical loss factors, our loan portfolio experienced an annualized
net charge-off rate of 0.00% for the six months ended December 31, 2019 , a
decrease of two basis points from the 0.02% rate for the year ended June 30,
2019 . The annual average net charge off rate for June 30, 2019 had previously
decreased by one basis point from 0.03% for the prior year ended June 30,
2018 . The effect of the net change in historical loss factors resulted in a
decrease in the applicable portion of the allowance attributable to these
factors of approximately $635,000 to $1.5 million at December 31, 2019 from $2.1
million at June 30, 2019 .
With regard to environmental loss factors, the Company made minor adjustments to
such factors during the six months ended December 31, 2019 resulting in a $1.7
decrease in the portion of the allowance for loan losses attributable to
environmental loss factors to $29.4 million at December 31, 2019 from $31.1
million at June 30, 2019 . This decrease was largely attributable to the decrease
in the balance of the unimpaired portion of the loan portfolio coupled with the
noted adjustments to environmental loss factors.
The calculation of probable incurred losses within a loan portfolio and the
resulting allowance for loan losses is subject to estimates and assumptions that
are susceptible to significant revisions as more information becomes available
and as events or conditions effecting individual borrowers and the marketplace
as a whole change over time. Future additions to the allowance for loan losses
may be necessary if economic and market conditions deteriorate in the future
from those currently prevalent in the marketplace. In addition, our banking
regulators, as an integral part of their examination process, periodically
review our loan and foreclosed real estate portfolios and the related allowance
for loan losses and valuation allowance for foreclosed real estate. The
regulators may require the allowance for loan losses to be increased based on
their review of information available at the time of the examination, which may
negatively affect our earnings. Finally, changes in accounting standards
promulgated by the Financial Accounting Standards Board , such as those discussed
in Note 7 to the unaudited consolidated financial statements regarding the use
of a current expected credit loss ("CECL") model to calculate credit losses, may
require increases in the allowance for loan losses upon adoption of the
applicable accounting standard.
Additional information about the allowance for loan losses at
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$15.5 million to$662.6 million atDecember 31, 2019 from$647.1 million atJune 30, 2019 . - 50 - -------------------------------------------------------------------------------- The increase in other assets primarily reflected the adoption of a new accounting standard that requires leases to be recognized on our Consolidated Statements of Condition as a right of use asset and lease liability. Our operating lease right of use asset totaled approximately$17.0 million as ofDecember 31, 2019 . The remaining increases and decreases in other assets for the six months endedDecember 31, 2019 generally reflected normal operating fluctuations in their respective balances.
Additional information about the Company's operating lease right of use asset at
Deposits. Total deposits increased by$41.2 million to$4.19 billion atDecember 31, 2019 from$4.15 billion atJune 30, 2019 . The net increase in deposit balances reflected a$38.2 million increase in interest-bearing deposits coupled with a$3.0 million increase in non-interest-bearing deposits. The increase in interest-bearing deposits reflected increases in interest-bearing checking accounts and savings accounts totaling$217.0 million and$38.7 million , respectively, which were partially offset by a decrease in the balance of certificates of deposits totaling$217.5 million . The net increase in deposit balances for the six months endedDecember 31, 2019 was comprised of changes in the balances of retail deposits as well as non-retail deposits acquired through various wholesale channels. In conjunction with our ongoing strategy to realign our deposit base in favor of core deposits, retail deposits increased by$232.4 million to$4.08 billion atDecember 31, 2019 from$3.85 billion atJune 30, 2019 while wholesale deposits decreased$191.2 million to$110.7 million atDecember 31, 2019 from$301.9 million atJune 30, 2019 .
The balance of wholesale deposits, as of
Additional information about the Company's deposits atDecember 31, 2019 andJune 30, 2019 is presented in Note 14 to the unaudited consolidated financial statements. Borrowings. The balance of borrowings decreased by$46.9 million to$1.28 billion atDecember 31, 2019 from$1.32 billion atJune 30, 2019 . The decrease in borrowings primarily reflected maturities of$30.0 million of long-term FHLB advances, a$15.0 million decrease in overnight borrowings and a$2.7 million decrease in depositor sweep account balances. Additional information about the Company's borrowings atDecember 31, 2019 andJune 30, 2019 is presented in Note 15 to the unaudited consolidated financial statements. Other Liabilities. The balance of other liabilities increased by$13.9 million to$52.0 million atDecember 31, 2019 from$38.1 million atJune 30, 2019 . The increase in other liabilities primarily reflected the adoption of a new accounting standard that requires leases to be recognized on our Consolidated Statements of Condition as a right of use asset and lease liability, as noted above. Our operating lease liability totaled approximately$17.5 million as ofDecember 31, 2019 .
Additional information about the Company's operating lease liability at
Stockholders' Equity. Stockholders' equity decreased by$32.6 million to$1.09 billion atDecember 31, 2019 from$1.13 billion atJune 30, 2019 largely reflecting the impact of our share repurchases during the first six months of fiscal 2020. InMarch 2019 we announced our fourth share repurchase program through which we authorized the repurchase of 9,218,324 shares, or 10%, of our outstanding shares as of that date. During the six months endedDecember 31, 2019 , we repurchased 3,900,051 shares of our common stock at a total cost of$52.3 million and an average cost of$13.40 per share. The shares of common stock repurchased during the period represented 42.3% of the total shares to be repurchased under our fourth share repurchase program. Cumulatively, the Company has repurchased a total of 6,982,294 shares or 75.7% of the shares to be repurchased under its fourth share repurchase program at a total cost of$93.6 million and at an average cost of$13.40 per share. The net decrease in stockholders' equity was partially offset by net income of$22.0 million , or$0.26 per share, for the six months endedDecember 31, 2019 from which we declared and paid regular quarterly cash dividends totaling$0.13 per share. Cash dividends declared and paid during the six months endedDecember 31, 2019 reduced stockholders' equity by$10.8 million . The change in stockholders' equity also reflected a$5.1 million increase in accumulated other comprehensive income during the six months endedDecember 31, 2019 . - 51 -
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Analysis of Net Interest Income
Net interest income represents the difference between income we earn on our
interest-earning assets and the expense we pay on interest-bearing liabilities.
Net interest income depends on the volume of interest-earning assets and
interest-bearing liabilities and the interest rates earned on such assets and
paid on such liabilities.
Average Balance Sheet and Yields. The following tables reflect 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.
For the Three Months Ended December 31,
2019 2018
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
(Dollars in Thousands)
Interest-earning
assets:
Loans receivable (1) $ 4,547,126 $ 45,608 4.01 % $ 4,758,587 $ 49,015 4.12 %
Taxable investment
securities (2) 1,244,475 9,698 3.12 1,158,720 9,051 3.12
Tax-exempt securities
(2) 125,187 666 2.13 135,453 713 2.11
Other interest-earning
assets (3) 117,811 1,210 4.11 87,916 1,243 5.66
Total interest-earning
assets 6,034,599 57,182 3.79 6,140,676 60,022 3.91
Non-interest-earning
assets 590,746 587,921
Total assets $ 6,625,345 $ 6,728,597
Interest-bearing
liabilities:
Interest-bearing demand $ 982,163 $ 3,172 1.29 $ 792,989 $ 1,930 0.97
Savings 813,626 1,652 0.81 743,676 912 0.49
Certificates of deposit 2,063,066 10,766 2.09 2,214,932 9,885 1.79
Total interest-bearing
deposits 3,858,855 15,590 1.62 3,751,597 12,727 1.36
Borrowings 1,290,330 6,985 2.17 1,412,751 7,946 2.25
Total interest-bearing
liabilities 5,149,185 22,575 1.75 5,164,348 20,673 1.60
Non-interest-bearing
liabilities (4) 373,640 352,539
Total liabilities 5,522,825 5,516,887
Stockholders' equity 1,102,520 1,211,710
Total liabilities and
stockholders'
equity $ 6,625,345 $ 6,728,597
Net interest income $ 34,607 $ 39,349
Interest rate spread
(5) 2.04 % 2.31 %
Net interest margin (6) 2.29 % 2.56 %
Ratio of
interest-earning assets
to interest-bearing
liabilities 1.17 X 1.19 X
(1) 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.
(2) Fair value adjustments have been excluded in the balances of interest-earning
assets.
(3) Includes interest-bearing deposits at other banks and FHLB of
capital stock.
(4) Includes average balances of non-interest-bearing deposits of
and
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.
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For the Six Months Ended December 31,
2019 2018
Average Average
Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost
(Dollars in Thousands)
Interest-earning
assets:
Loans receivable (1) $ 4,601,659 $ 94,208 4.09 % $ 4,660,481 $ 96,452 4.14 %
Taxable investment
securities (2) 1,196,087 19,026 3.18 1,169,687 17,930 3.07
Tax-exempt securities
(2) 127,263 1,359 2.14 135,755 1,429 2.11
Other interest-earning
assets (3) 121,462 2,488 4.10 100,272 2,417 4.82
Total interest-earning
assets 6,046,471 117,081 3.87 6,066,195 118,228 3.90
Non-interest-earning
assets 588,286 591,964
Total assets $ 6,634,757 $ 6,658,159
Interest-bearing
liabilities:
Interest-bearing demand $ 933,003 $ 6,053 1.30 $ 790,568 $ 3,615 0.91
Savings 806,404 3,182 0.79 745,710 1,687 0.45
Certificates of deposit 2,121,199 22,410 2.11 2,130,964 17,964 1.69
Total interest-bearing
deposits 3,860,606 31,645 1.64 3,667,242 23,266 1.27
Borrowings 1,288,744 14,142 2.19 1,401,922 15,433 2.20
Total interest-bearing
liabilities 5,149,350 45,787 1.78 5,069,164 38,699 1.53
Non-interest-bearing
liabilities (4) 377,179 355,093
Total liabilities 5,526,529 5,424,257
Stockholders' equity 1,108,228 1,233,902
Total liabilities and
stockholders'
equity $ 6,634,757 $ 6,658,159
Net interest income $ 71,294 $ 79,529
Interest rate spread
(5) 2.09 % 2.37 %
Net interest margin (6) 2.36 % 2.62 %
Ratio of
interest-earning assets
to interest-bearing
liabilities 1.17 X 1.20 X
(1) 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.
(2) Fair value adjustments have been excluded in the balances of interest-earning
assets.
(3) Includes interest-bearing deposits at other banks and FHLB of
capital stock.
(4) Includes average balances of non-interest-bearing deposits of
and
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.
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Comparison of Operating Results for the Three Months Ended
Net Income. Net income for the three months endedDecember 31, 2019 was$10.7 million , or$0.13 per diluted share compared to$10.8 million , or$0.12 per diluted share for the three months endedDecember 31, 2018 . The decrease in net income reflected a decrease in net-interest income, as detailed above, that was partially offset by an increase in non-interest income and decreases in non-interest expense and the provision for loan losses. Collectively, these factors contributed to an overall decrease in pre-tax income and a corresponding decrease in the provision for income taxes. Net income for the quarter endedDecember 31, 2019 was impacted by a non-recurring increase of$153,000 in non-interest expense and a non-recurring decrease of$236,000 in non-interest income which were recognized in conjunction with the Company's previously completed branch consolidations. In addition, net income reflected the Company's recognition of certain merger-related expenses totaling$219,000 related to its proposed acquisition of MSBF, as noted earlier. Net Interest Income. Net interest income decreased by$4.7 million to$34.6 million for the three months endedDecember 31, 2019 . The decrease between the comparative periods resulted from a decrease of$2.8 million in interest income coupled with an increase of$1.9 million in interest expense. Net interest rate spread declined by 27 basis points to 2.04% for the quarter endedDecember 31, 2019 . The decrease in the net interest rate spread reflected a 12 basis points decrease in the average yield on interest-earning assets to 3.79% and a 15 basis points increase in the average cost of interest-bearing liabilities to 1.75%.
The factors resulting in the decrease in our net interest rate spread also
affected our net interest margin. In total, our net interest margin decreased 27
basis points to 2.29% for the three months ended
Interest Income. Total interest income decreased by$2.8 million to$57.2 million for the three months endedDecember 31, 2019 . The decrease in interest income partly reflected a$106.1 million decrease in the average balance of interest-earning assets and a 12 basis point decrease in their yield to 3.79%. Interest income on loans decreased by$3.4 million to$45.6 million for the three months endedDecember 31, 2019 . The decrease in interest income on loans was primarily attributable to a$211.5 million decrease in the average balance of loans to$4.55 billion during the three months endedDecember 31, 2019 . The average yield on loans decreased 11 basis points to 4.01%. The increase in interest income on interest-earning assets, excluding loans, was due to the increase in interest income on taxable investment securities. The increase in interest income on taxable investment securities was primarily attributable to an$85.8 increase in the their average balance while the average yield remained stable at 3.12% for the three months endedDecember 31, 2019 andDecember 31, 2018 . The average yield on other interest earning assets decreased by 155 basis points to 4.11% for the three months endedDecember 31, 2019 , primarily due to a decrease in the average yield on the balances of our interest-bearing deposits at other banks and FHLB stock holdings. Interest Expense. Total interest expense increased by$1.9 million to$22.6 million for the three months endedDecember 31, 2019 . The increase in interest expense reflected a 15 basis point increase in the average cost of interest-bearing liabilities to 1.75% partially offset by a$15.2 million decrease in the average balance of interest-bearing liabilities to$5.15 billion for the three months endedDecember 31, 2019 . Interest expense attributed to deposits increased$2.9 million to$15.6 million for the three months endedDecember 31, 2019 . The increase in interest expense was attributable to increases in the average balance and average cost of interest-bearing deposits. The average balance of interest-bearing deposits increased$107.3 million to$3.86 billion for the three months endedDecember 31, 2019 , while the average cost of interest-bearing deposits increased 26 basis points to 1.62% for that same period. Interest expense attributed to borrowings decreased by$961,000 to$7.0 million for the three months endedDecember 31, 2019 . The decrease in interest expense was attributable to a decrease in the average balance and a decrease in the average cost of borrowings. The average balance of borrowings decreased$122.4 million to$1.29 billion for the three months endedDecember 31, 2019 while the average cost of borrowings decreased 8 basis points to 2.17% for that same period. - 54 - -------------------------------------------------------------------------------- Provision for Loan Losses. The provision for loan losses decreased by$2.4 million to a provision reversal of$1.5 million for the three months endedDecember 31, 2019 compared to a provision expense of$971,000 for the three months endedDecember 31, 2018 . The decrease largely reflected the effects of a decrease in the outstanding balance of the loan portfolio that was collectively evaluated for impairment during the quarter endedDecember 31, 2019 , compared to a net increase in that portion of the portfolio for the quarter endedDecember 31, 2018 . Additional information regarding the allowance for loan losses and the associated provisions recognized during the three months endedDecember 31, 2019 and 2018 is presented in Note 12 to the unaudited consolidated financial statements as well as the Comparison of Financial Condition atDecember 31, 2019 andJune 30, 2019 .
Non-Interest Income. Non-interest income increased by
Fees and service charges increased by$887,000 to$2.1 million for the three months endedDecember 31, 2019 . The increase primarily reflected an increase in loan-related fees attributable to an increase in commercial loan prepayment activity. We recognized a net gain of$11,000 on the sale and call of securities during the three months endedDecember 31, 2019 while there were no such gains recorded during the earlier comparative period. Gain on sale of loans increased by$567,000 to$668,000 for the three months endedDecember 31, 2019 . The increase in loan sale gains primarily reflected an increase in the volume of residential mortgage loans originated and sold between comparative periods.
We recognized a net loss of
Miscellaneous non-interest income decreased by
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 decreased by
Salaries and employee benefits expense decreased by$525,000 to$15.2 million for the three months endedDecember 31, 2019 . The net decrease in salaries and employee benefits expense reflected decreases in wages and salaries attributable to the reduction in staffing levels associated with the previously completed branch consolidations as well as reductions in bonus compensation, employee stock-based compensation and payroll tax expense. These decreases were partially offset by increases in employee severance, employee benefit expense and ESOP expense. Net occupancy expense of premises increased by$321,000 to$3.1 million for the three months endedDecember 31, 2019 . This increase was largely attributable to$331,000 of lease termination costs recognized in conjunction with branch consolidations. Equipment and systems expense decreased by$331,000 to$3.0 million for the three months endedDecember 31, 2019 . This decrease was largely attributable to a decrease of$395,000 in core processing and$138,000 in telecommunication delivery channel expense partially offset by increases in other technology infrastructure costs. The reduction in core processing expense was attributable to$551,000 of non-recurring information technology expenses recognized by the Company, in the earlier comparative period, in conjunction with the conversion and integration of the core processing system of an acquired institution. Advertising and marketing expense increased by$103,000 to$890,000 for the three months endedDecember 31, 2019 . This increase largely reflected changes in advertising expenses across a variety of advertising formats including outdoor and electronic media reflecting normal fluctuations in the timing of certain campaigns supporting our loan and deposit growth initiatives. - 55 - -------------------------------------------------------------------------------- For the three months endedDecember 31, 2019 , the Company recorded no expense associated withFDIC insurance premiums compared to$421,000 for the three months endedDecember 31, 2018 . No expense was recorded in the current period as a result of theFDIC's Deposit Insurance Fund Reserve Ratio having reached a pre-established threshold defined by federal regulation. Upon reaching this threshold qualifying banks with total consolidated assets of less than$10 billion were awarded assessment credits to be utilized towards theirFDIC insurance premiums. Directors' compensation expense increased by$23,000 to$769,000 for the three months endedDecember 31, 2019 . The increase in expense primarily reflected an increase in director stock-based compensation.
Merger-related expenses increased by
Miscellaneous expense decreased by$232,000 to$3.2 million for the three months endedDecember 31, 2019 . The decrease in expense was largely attributable to the recovery of asset write-down costs totaling$288,000 which were recognized in conjunction with branch consolidations. The decrease in expense also reflected decreases in consulting expense, education expense and OREO expense that were partially offset by increases in loan expense and bad debt expense. Provision for Income Taxes. The provision for income taxes decreased by$102,000 to$3.5 million for the three months endedDecember 31, 2019 . The decrease in income tax expense primarily reflected the underlying differences in the level of the taxable portion of pre-tax income between comparative periods. Our effective tax rates for the three month periods endedDecember 31, 2019 andDecember 31, 2018 were 25.0% and 25.3% which, in relation to statutory income tax rates, reflected the effects of recurring sources of tax-favored income included in pre-tax income.
Comparison of Operating Results for the Six Months Ended
Net Income. Net income for the six months endedDecember 31, 2019 was$22.0 million , or$0.26 per diluted share compared to$21.9 million , or$0.23 per diluted share for the six months endedDecember 31, 2018 . The increase in net income reflected an increase in non-interest income, a decrease in the provision for loan losses and a decrease in non-interest expense that were partially offset by a decrease in net interest income, as detailed above. Collectively, these factors contributed to an overall increase in pre-tax income and a corresponding increase in the provision for income taxes. Net income for the six months endedDecember 31, 2019 was impacted by a non-recurring increase of$720,000 in non-interest expense and a non-recurring decrease of$342,000 in non-interest income which were recognized in conjunction with the Company's previously completed branch consolidations. In addition, net income reflected the Company's recognition of certain merger-related expenses totaling$219,000 related to its proposed acquisition of MSBF, as noted above. Net Interest Income. Net interest income decreased by$8.2 million to$71.3 million for the six months endedDecember 31, 2019 . The decrease between the comparative periods resulted from a decrease of$1.1 million in interest income and an increase of$7.1 million in interest expense. Net interest rate spread declined by 28 basis points to 2.09% for the six months endedDecember 31, 2019 . The decrease in the net interest rate spread reflected a 3 basis points decrease in the average yield on interest-earning assets to 3.87% and a 25 basis points increase in the average cost of interest-bearing liabilities to 1.78%.
The factors resulting in the decrease in our net interest rate spread also
affected our net interest margin. In total, our net interest margin decreased 26
basis points to 2.36% for the six months ended
Interest Income. Total interest income decreased by$1.1 million to$117.1 million for the six months endedDecember 31, 2019 . The decrease in interest income partly reflected a$19.7 million decrease in the average balance of interest-earning assets and a three basis point decrease in their yield to 3.87%. Interest income on loans decreased by$2.2 million to$94.2 million for the six months endedDecember 31, 2019 . The decrease in interest income on loans was primarily attributable to a$58.8 million decrease in the average balance of loans to$4.60 billion during the six months endedDecember 31, 2019 . The average yield on loans decreased five basis points to 4.09%. - 56 - -------------------------------------------------------------------------------- The increase in interest income on interest-earning assets, excluding loans, was primarily due to the increase in interest income on taxable investment securities. The average yield on taxable investment securities increased by 11 basis points to 3.18% for the six months endedDecember 31, 2019 , primarily attributable to an increase in the yield on our floating rate investment securities. The average yield on other interest earning assets decreased by 72 basis points to 4.10% for the six months endedDecember 31, 2019 , primarily due to a decrease in the average yield on the balances of our interest-bearing deposits at other banks and FHLB stock holdings. Interest Expense. Total interest expense increased by$7.1 million to$45.8 million for the six months endedDecember 31, 2019 . The increase in interest expense partly reflected an$80.2 million increase in the average balance of interest-bearing liabilities to$5.15 billion for the six months endedDecember 31, 2019 , while also reflecting a 25 basis point increase in the average cost of interest-bearing liabilities to 1.78%. Interest expense attributed to deposits increased$8.4 million to$31.6 million for the six months endedDecember 31, 2019 . The increase in this interest expense was attributable to increases in the average balance and average cost of interest-bearing deposits. The average balance of interest-bearing deposits increased$193.4 million to$3.86 billion for the six months endedDecember 31, 2019 , while the average cost of interest-bearing deposits increased 37 basis points to 1.64% for that same period. Interest expense attributed to borrowings decreased by$1.3 million to$14.1 million for the six months endedDecember 31, 2019 . The decrease in this interest expense was attributable to a decrease in the average balance and a decrease in the average cost of borrowings. The average balance of borrowings decreased$113.2 million to$1.29 billion for the six months endedDecember 31, 2019 , while the average cost of borrowings decreased one basis point to 2.19% for that same period. Provision for Loan Losses. The provision for loan losses decreased by$5.3 million to a provision reversal of$2.2 million for the six months endedDecember 31, 2019 compared to a provision expense of$3.1 million for the six months endedDecember 31, 2018 . The decrease largely reflected the effects of a decrease in the outstanding balance of the loan portfolio that was collectively evaluated for impairment during the six months endedDecember 31, 2019 , compared to a net increase in that portion of the portfolio for the six months endedDecember 31, 2018 . Additional information regarding the allowance for loan losses and the associated provisions recognized during the six months endedDecember 31, 2019 and 2018 is presented in Note 12 to the unaudited consolidated financial statements as well as the Comparison of Financial Condition atDecember 31, 2019 andJune 30, 2019 .
Non-Interest Income. Non-interest income increased by
Fees and service charges increased by$1.2 million to$3.6 million for the six months endedDecember 31, 2019 . The increase primarily reflected an increase in loan-related fees attributable to an increase in commercial loan prepayment activity.
We recognized a net loss of
Gain on sale of loans increased by
The Company incurred a net loss of$28,000 related to the write down and sale of OREO during the six months endedDecember 31, 2019 compared to a net loss of$14,000 during the earlier comparative period.
Miscellaneous non-interest income decreased by
The remaining changes in the other components of non-interest income between
comparative periods generally reflected normal operating fluctuations within
those line items.
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Non-Interest Expenses. Total non-interest expense decreased by
Salaries and employee benefits expense decreased by$390,000 to$31.0 million for the six months endedDecember 31, 2019 . The net decrease in salaries and employee benefits expense reflected decreases in incentive compensation, employee overtime, bonus, and employee stock-based compensation expenses. These decreases were partially offset by increases in wages and salaries, employee severance, employee benefit expense, ESOP expense and payroll taxes. Net occupancy expense of premises increased by$554,000 to$6.1 million for the six months endedDecember 31, 2019 . This increase was largely attributable to$517,000 of non-recurring lease termination costs recognized in conjunction with the branch consolidations coupled with an increase in facility lease expenses arising from costs associated with forthcoming branch additions and relocations. Partially offsetting these increases were decreases in ongoing facility repairs and maintenance expenses. Equipment and systems expense decreased by$168,000 to$6.1 million for the six months endedDecember 31, 2019 . This decrease in expense was largely attributable to a decrease of$381,000 in core processing and$216,000 in telecommunication delivery channel expense partially offset by increases in other technology infrastructure costs. The reduction in core processing expense was attributable to$551,000 of non-recurring information technology expenses recognized by the Company, in the earlier comparative period, in conjunction with the conversion and integration of the core processing system of an acquired institution. Advertising and marketing expense increased by$61,000 to$1.4 million for the six months endedDecember 31, 2019 . This increase largely reflected changes in advertising expenses across a variety of advertising formats including outdoor and electronic media reflecting normal fluctuations in the timing of certain campaigns supporting our loan and deposit growth initiatives.
For the six months ended
Directors' compensation expense increased by$35,000 to$1.5 million for the six months endedDecember 31, 2019 . The increase in expense primarily reflected an increase in director-related expenses associated to stock based compensation.
Merger-related expenses increased by
Miscellaneous expense decreased by$481,000 to$6.4 million for the six months endedDecember 31, 2019 . The decrease in expense was largely attributable to the recovery of asset write-down costs totaling$288,000 which were recognized in conjunction with branch consolidations. The decrease in expense also reflected decreases in consulting expense and audit and accounting fees that were partially offset by increases in loan expense. Provision for Income Taxes. The provision for income taxes increased by$56,000 to$7.4 million for the six months endedDecember 31, 2019 . The increase in income tax expense primarily reflected the underlying differences in the level of the taxable portion of pre-tax income between comparative periods. Our effective tax rates for the six month periods endedDecember 31, 2019 andDecember 31, 2018 were 25.1% and 25.0% which, in relation to statutory income tax rates, reflected the effects of recurring sources of tax-favored income included in pre-tax income. - 58 -
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Liquidity and Capital Resources
Our liquidity, represented by cash and cash equivalents, is a product of our operating, investing and financing activities. Our primary sources of funds are deposits, 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. The Bank is required to have enough investments that qualify as liquid assets in order to maintain sufficient liquidity to ensure a safe operation. The balance of our cash and cash equivalents increased by$2.9 million to$41.8 million atDecember 31, 2019 from$38.9 million atJune 30, 2019 . Notwithstanding the increase in the balances of cash and cash equivalents during the period, the Company continues its ongoing effort to enhance earnings by generally limiting the level of lower-yielding, short-term liquid assets to the levels needed to meet its day-to-day funding obligations and overall liquidity risk management objectives. Short-term investments qualifying as liquid assets are supplemented by our portfolio of securities classified as available for sale whose balances atDecember 31, 2019 included$1.40 billion of investment securities that can readily be sold if necessary. AtDecember 31, 2019 , the Company had outstanding commitments to originate and purchase loans totaling approximately$50.5 million while such commitments totaled$27.7 million atJune 30, 2019 . As of those same dates, the Company's pipeline of loans held for sale included$31.3 million and$46.2 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$5.1 million and$72.9 million , respectively, atDecember 31, 2019 compared to$3.9 million and$78.5 million , respectively, atJune 30, 2019 . The Company is also subject to the contingent liabilities resulting from letters of credit whose outstanding balances totaled$274,000 and$612,000 atDecember 31, 2019 andJune 30, 2019 , 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$41.2 million to$4.19 billion atDecember 31, 2019 from$4.15 billion atJune 30, 2019 . The net increase in deposit balances reflected a$38.2 million increase in interest-bearing deposits coupled with a$3.0 million increase in non-interest-bearing deposits. Borrowings from the FHLB ofNew York and other sources are generally available to supplement the Bank's liquidity position and, to the extent that maturing deposits do not remain with us, management may replace such funds with borrowings. As ofDecember 31, 2019 , the Bank's outstanding balance of FHLB advances, excluding fair value adjustments, totaled$1.26 billion . In addition to FHLB advances, we have other borrowings totaling$6.1 million atDecember 31, 2019 representing collateralized overnight sweep account balances linked to customer demand deposits and$15.0 million in other overnight borrowings. We have the capacity to borrow additional funds from the FHLB, through a line of credit or by taking short-term or long-term advances. Such borrowings are an option available to management if funding needs change or to modify the effective duration of liabilities. As ofDecember 31, 2019 , the Bank's borrowing potential at the FHLB ofNew York was$1.58 billion without pledging additional collateral. We also have the capacity to borrow additional funds, on an unsecured basis, via lines of credit we have established with a variety of other financial institutions. As ofDecember 31, 2019 , the available borrowing capacity under those lines of credit totaled$655.0 million .
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
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The following table sets forth the Bank's capital position at December 31, 2019
and June 30, 2019 , as compared to the minimum regulatory capital requirements
that were in effect as of those dates:
At December 31, 2019
To Be Well Capitalized
Under Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
Amount Ratio Amount Ratio Amount Ratio
(Dollars in Thousands)
Total capital (to risk-weighted
assets) $ 797,058 21.07 % $ 302,656 8.00 % $ 378,320 10.00 %
Tier 1 capital (to risk-weighted
assets) 766,121 20.25 % 226,992 6.00 % 302,656 8.00 %
Common equity tier 1 capital (to
risk-weighted assets) 766,121 20.25 % 170,244 4.50 % 245,908 6.50 %
Tier 1 capital (to adjusted total
assets) 766,121 12.01 % 255,165 4.00 % 318,956 5.00 %
At June 30, 2019
To Be Well Capitalized
Under Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
Amount Ratio Amount Ratio Amount Ratio
(Dollars in Thousands)
Total capital (to risk-weighted
assets) $ 787,219 19.50 % $ 322,974 8.00 % $ 403,718 10.00 %
Tier 1 capital (to risk-weighted
assets) 753,945 18.68 % 242,231 6.00 % 322,974 8.00 %
Common equity tier 1 capital (to
risk-weighted assets) 753,945 18.68 % 181,673 4.50 % 262,417 6.50 %
Tier 1 capital (to adjusted total
assets) 753,945 11.78 % 256,116 4.00 % 320,145 5.00 %
The following table sets forth the Company's capital position at
At December 31, 2019
For Capital
Actual Adequacy Purposes
Amount Ratio Amount Ratio
(Dollars in Thousands)
Total capital (to risk-weighted assets) $ 902,243 23.74 % $ 304,025 8.00 %
Tier 1 capital (to risk-weighted assets) 871,306 22.93 % 228,019 6.00 %
Common equity tier 1 capital (to
risk-weighted assets) 871,306 22.93 % 171,014 4.50 %
Tier 1 capital (to adjusted total assets) 871,306 13.62 % 255,951 4.00 %
At June 30, 2019
For Capital
Actual Adequacy Purposes
Amount Ratio Amount Ratio
(Dollars in Thousands)
Total capital (to risk-weighted assets) $ 941,319 23.22 % $ 324,246 8.00 %
Tier 1 capital (to risk-weighted assets) 908,045 22.40 % 243,184 6.00 %
Common equity tier 1 capital (to
risk-weighted assets) 908,045 22.40 % 182,388 4.50 % Tier 1 capital (to adjusted total assets) 908,045 14.14 % 256,856 4.00 %
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As a result of the recently enacted Economic Growth, Regulatory Relief, and
Consumer Protection Act, the federal banking agencies proposed a rule to
establish for institutions with assets of less than $10 billion that meet other
specified criteria a "community bank leverage ratio" (the ratio of a bank's
tangible equity capital to average total consolidated assets) of 9% that such
institutions may elect to utilize in lieu of the generally applicable leverage
and risk-based capital requirements noted above. A "qualifying community bank"
with capital exceeding 9% will be considered compliant with all applicable
regulatory capital and leverage requirements, including the requirement to be
"well capitalized." The rule has been adopted in final form and the framework
will first be available for use in the Bank's March 31, 2020 Call Report.
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 ofDecember 31, 2019 .
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 7 to the unaudited consolidated financial statements.
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