Kearny Financial Corp. - Annual Report: 2019 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10‑K

(Mark One)

For the Fiscal Year Ended June 30, 2019

or

For the transition period from             to             

Commission File Number: 001-37399

KEARNY FINANCIAL CORP.

(Exact name of Registrant as specified in its Charter)

Registrant’s telephone number, including area code: (973) 244-4500

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  ☒  YES    ☐  NO

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  ☐  YES    ☒  NO

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  ☒  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 (§229.405 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 filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

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 Act).  ☐  YES    ☒  NO

The aggregate market value of the voting and non-voting common equity held by non‑affiliates of the Registrant on December 31, 2018 (the last business day of the Registrant’s most recently completed second fiscal quarter) was $1.09 billion.  Solely for purposes of this calculation, shares held by directors, executive officers and greater than 10% stockholders are treated as shares held by affiliates.

As of August 20, 2019 there were outstanding 87,767,104 shares of the Registrant’s Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

KEARNY FINANCIAL CORP.

ANNUAL REPORT ON FORM 10-K

For the Fiscal Year Ended June 30, 2019

INDEX

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PART I

Item 1. Business

Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and words of similar meaning. These forward-looking statements include, but are not limited to:

These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.  We are under no duty to and do not take any obligation to update any forward-looking statements after the date of the Annual Report on Form 10-K.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

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Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

General

Kearny Financial Corp. (the “Company,” or “Kearny Financial”), is a Maryland corporation that is the holding company for Kearny Bank (the “Bank” or “Kearny Bank”), a nonmember New Jersey stock savings bank.  The Bank converted its charter to that of a New Jersey savings bank on June 29, 2017 having previously been a federally chartered stock savings bank.

On May 18, 2015, the Company completed its second-step conversion and stock offering through which it converted from the mutual holding company structure to a fully public company.  In conjunction with that transaction, the Company sold 71,750,000 shares of its common stock at $10.00 per share, resulting in gross proceeds of $717.5 million.  The new shares issued included 3,612,500 shares sold to the Bank’s Employee Stock Ownership Plan (“ESOP”).  Concurrent with the closing of the transaction, the Company also issued an additional 500,000 shares of its common stock with an aggregate value of $5.0 million and contributed these shares with an additional $5.0 million in cash to the KearnyBank Foundation.  After adjusting for transaction costs and the value of the shares issued to the Bank’s ESOP, the Company recognized a net increase in equity capital of $670.7 million.  Each outstanding share held by the public stockholders of Kearny Financial Corp., a federal corporation, was converted into 1.3804 shares of the Company’s new common stock while the shares previously held by Kearny MHC, the former mutual holding company, were cancelled.

The Company is a unitary savings and loan holding company, regulated by the Board of Governors of the Federal Reserve Bank (“FRB”) and conducts no significant business or operations of its own.  The Bank’s deposits are federally insured by the Deposit Insurance Fund as administered by the Federal Deposit Insurance Corporation (“FDIC”) and the Bank is primarily regulated by the New Jersey Department of Banking and Insurance (“NJDBI”) and, as a nonmember bank, the FDIC.  References in this Annual Report on Form 10‑K to the Company or Kearny Financial generally refer to the Company and the Bank, unless the context indicates otherwise. References to “we”, “us”, or “our” refer to the Bank or Company, or both, as the context indicates.  

The Company’s primary business is the ownership and operation of the Bank.  The Bank is principally engaged in the business of attracting deposits from the general public in New Jersey and New York and using these deposits, together with other funds, to originate or purchase loans for its portfolio and invest in securities.  Our loan portfolio is primarily comprised of loans collateralized by commercial and residential real estate augmented by secured and unsecured loans to businesses and consumers.  We also maintain a portfolio of investment securities, primarily comprised of U.S. agency mortgage-backed securities, U.S. government and agency debentures, bank-qualified municipal obligations, corporate bonds, asset-backed securities, collateralized loan obligations and subordinated debt.

We operate from our administrative headquarters in Fairfield, New Jersey and, as of June 30, 2019, had 54 branch offices.  In April 2019, we announced the consolidation of seven of our branch offices located in northern and central New Jersey.  One such consolidation was completed in June 2019 while the remaining six were completed in July 2019, thereby reducing the number of branch offices to 48.  The Company maintains a website at www.kearnybank.com.  We make available through that website, free of charge, copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, amendments to those reports and proxy materials as soon as is reasonably practicable after the Company electronically files those materials with, or furnishes them to, the Securities and Exchange Commission.  You may access these materials by following the links under “Investor Relations” under the “Company Info” tab at the Company’s website. Information on the Company’s website is not and should not be considered a part of this Annual Report on Form 10-K.

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Acquisition of Clifton

On April 2, 2018, the Company completed its acquisition of Clifton Bancorp Inc. (“Clifton”), the parent company of Clifton Savings Bank, a federally chartered stock savings bank.  In conjunction with the acquisition, the Company acquired assets with aggregate fair values totaling $1.61 billion including loans and securities with fair values of $1.12 billion and $326.9 million, respectively.  The Company assumed liabilities with aggregate fair values totaling $1.38 billion in conjunction with the Clifton acquisition including deposits and borrowings with fair values of $949.8 million and $414.1 million, respectively.

Merger consideration associated with the acquisition totaled $333.9 million and primarily comprised 25.4 million shares of the Company’s common stock valued at $330.7 million that were issued to Clifton stockholders to reflect an exchange of 1.191 of Company shares for each outstanding share of Clifton common stock at the time of closing.  Merger consideration also included $3.2 million in cash distributed to eligible holders of outstanding options to purchase Clifton stock as well as cash distributed to Clifton stockholders for the settlement of fractional shares.  The amount by which merger consideration exceeded the fair value of net assets acquired resulted in the Company’s recognition of $102.3 million in goodwill associated with the Clifton acquisition.

Business Strategy

As we continue our evolution from a traditional thrift business model toward that of a full service community bank our strategy remains focused on profitably deploying capital and enhancing earnings through a variety of balance sheet growth and diversification strategies.  The key strategic initiatives of our business plan are presented below accompanied by an overview of our actions in support of those initiatives:

We plan to continue to increase our portfolio of commercial and residential mortgage loans by continuing to acquire loans through all available channels, including retail and broker originations, which may be supplemented with individual and pooled loan purchases and participations.  Additionally, we intend to continue to expand our commercial and residential mortgage lending infrastructure and resources, which will be supported by new product and pricing strategies designed to increase origination volume in a very competitive marketplace.

We plan to continue to focus our efforts on expanding our commercial business lending activities through all available channels. During fiscal 2019 we continued the realignment and expansion of our commercial business lending infrastructure.  As a result of these enhancements, we anticipate that the outstanding balance of this loan segment will increase in fiscal 2020 and thereafter.  Our business lending strategies will continue to be undertaken within a larger set of strategic initiatives designed to promote business banking services intended to increase commercial deposit balances and services and the associated increase in the level of non-interest income recognized in conjunction with those business customer relationships.

We plan to continue to grow our portfolio of construction loans and expand our construction lending resources in alignment with this goal.  During fiscal 2019 we expanded our construction lending infrastructure and as a result we anticipate the outstanding balance of this loan segment will increase in fiscal 2020 and thereafter.

We plan to continue to expand our mortgage banking infrastructure to support the continuing origination of residential mortgage loans for sale into the secondary market.  We anticipate that residential mortgage loan origination and sale activity will continue to support long-term growth in our non-interest income through the recognition of loan sale gains, while also serving to help manage the Company’s exposure to interest rate risk through the sale of longer-duration, fixed-rate loans into the secondary market.

We continue to emphasize and maintain strong asset quality as we grow and diversify our loan portfolio. Nonperforming assets increased by $2.7 million to $20.3 million, or 0.31% of total assets, at June 30, 2019 compared to $17.6 million, or 0.27% of total assets, at June 30, 2018 and $20.5 million, or 0.43% of total assets, at June 30, 2017.

We plan to continue to focus on growing and diversifying our retail deposit base with an emphasis on growth in core non-maturity deposits.  During fiscal 2019 we expanded and realigned our retail banking organizational structure, resources and product set in support of this goal.  As a result of these enhancements we anticipate that the balance of retail non-maturity deposits will increase in fiscal 2020 and thereafter.  As noted above, our business lending strategies are designed to support the growth in business banking relationships.

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At June 30, 2019, we had a total of 54 branches comprising 51 branches located in northern and central New Jersey with three additional branches located in Brooklyn and Staten Island, New York.  We plan to selectively evaluate branch network expansion opportunities, with a particular focus on contiguous markets.  Furthermore, we expect to continue placing strategic emphasis on leveraging the opportunities to increase market share and expand the depth and breadth of customer relationships within our existing branches.

As noted above, in July 2019 we completed our previously announced branch consolidations as part of our ongoing strategy to improve operating efficiency.  We plan to continue to evaluate the performance of our branch network, taking into consideration historical branch profitability, market demographic trajectory, geographic proximity to the consolidating branch and the expected impact on the Bank’s clients and communities served.

In recent years, we have diversified the composition and allocation of our investment portfolio into new asset sectors. Several of the added sectors include floating rate securities that reduce the level of interest rate risk embedded in our balance sheet.  Simultaneously, we have decreased the investment portfolio as a percentage of total assets and intend to continue to reduce the portfolio as a percentage of assets.

As a complement to our organic growth strategies, we continue to actively seek out opportunities to prudently deploy capital, diversify our balance sheet, enter new markets and enhance earnings through mergers and acquisitions with other financial institutions.  We are an experienced and disciplined acquirer, having acquired a total of six banks in the last 19 years. We expect to place the greatest emphasis on opportunities to expand within the existing markets we serve or to enter new markets that are generally contiguous to such markets.

In addition to potential acquisitions of financial institutions or their branches, we may explore additional opportunities for acquisitions or strategic partnerships to broaden our product and service offerings in the future.

The Company’s operating efficiency was enhanced as a result of the Clifton acquisition through which the Company’s primary sources of revenue, including net interest income and non-interest income, were increased proportionately greater than the increase in non-interest expenses arising from the acquisition.  Exclusive of potential future acquisitions we plan to continue to improve operating efficiency through organic means, such as the increased use of technology and the continual evaluation of branch consolidation opportunities.

In recognition of the ongoing evolution of our business towards online channels we have invested significant human resources and capital towards enhancing both our internal and customer-facing technology systems.  We anticipate that our technology transformation will impact nearly every area of the Company including residential and commercial lending functions, retail deposit gathering, risk management and back office operations.

Market Area. At June 30, 2019, our primary market area consisted of the counties in which we currently operate branches, including Bergen, Essex, Hudson, Middlesex, Monmouth, Morris, Ocean, Passaic and Union counties in New Jersey and Kings (Brooklyn) and Richmond (Staten Island) counties in New York.  Our lending is concentrated in these markets and our predominant sources of deposits are the communities in which our offices are located as well as the neighboring communities.

Our primary market area is largely urban and suburban with a broad economic base as is typical within the New York metropolitan area.  A downturn in the local economy could reduce the amount of funds available for deposit and the ability of borrowers to repay their loans which would adversely affect our profitability.

Competition.  We operate in a highly competitive market area with a large concentration of financial institutions and we face substantial competition in attracting deposits and in originating loans. A number of our competitors are significantly larger institutions with greater financial and technological resources and lending limits.  Our ability to compete successfully is a significant factor affecting our growth potential and profitability.

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Historically our competition for deposits and loans has come from other insured depository institutions such as commercial banks, savings institutions and credit unions located in our primary market area.  We also face competition from out-of-market depository institutions operating via online channels and from non-depository institutions including mortgage banks, finance companies, insurance companies and brokerage firms.

Lending Activities

General.  In conjunction with our strategic efforts to evolve from a traditional thrift to a full-service community bank, our lending strategies have placed increasing emphasis on the origination of commercial loans compared to one- to four-family mortgage portfolio lending.  The year-to-year trends in the composition and allocation of our loan portfolio, as reported in the table below, generally highlight those changes in business strategy.  In particular, the outstanding balance of our commercial mortgages, including loans secured by multi‑family, mixed‑use and nonresidential properties, have increased significantly over the past several years.  By comparison, the outstanding balance of our residential mortgage loans, including one- to four-family and home equity loans, remained fairly stable throughout the three years ended June 30, 2017 while increasing during the prior fiscal year ended June 30, 2018 due primarily to the Clifton acquisition.  Additionally, during the year ended June 30, 2019, the outstanding balance of one- to four-family loans has increased as a result of our continued one- to four-family mortgage origination activities coupled with an increase in the volume of purchased residential loans.

Our commercial loan offerings also include secured business loans, many of which are secured by real estate, and unsecured business loans.  Commercial loan offerings include programs offered through the SBA in which Kearny Bank participates as a Preferred Lender.  Our consumer loan offerings primarily include home equity loans and home equity lines of credit as well as account loans, overdraft lines of credit, vehicle loans and personal loans.  We also offer construction loans to builders/developers as well as individual homeowners.  We have also purchased out-of-state one- to four-family first mortgage loans to supplement our in-house originations. For more information, please see “Lending Activities (Loan Originations, Purchases, Sales, Solicitation and Processing).”  

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Loan Portfolio Composition.  The following table sets forth the composition of our loan portfolio in dollar amounts and as a percentage of the total portfolio at the dates indicated.

Loan Maturity Schedule.  The following table sets forth the maturities of our loan portfolio at June 30, 2019.  Demand loans, loans having no stated maturity and overdrafts are shown as due in one year or less.  Loans are stated in the following table at contractual maturity and actual maturities could differ due to prepayments.

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The following table shows the dollar amount of loans as of June 30, 2019 due after June 30, 2020 according to rate type and loan category:

Multi-Family and Nonresidential Real Estate Mortgage Loans.  We originate commercial mortgage loans on multi-family and nonresidential properties, including loans on apartment buildings, retail/service properties and land as well as other income-producing properties, such as mixed-use properties combining residential and commercial space.  Our continued strategic emphasis in commercial lending resulted in the origination of approximately $437.3 million of multi-family and nonresidential real estate mortgages during the year ended June 30, 2019, compared to $458.8 million during the year ended June 30, 2018.  

Our commercial mortgage acquisition strategies also included purchases of whole loans and participations totaling $68.6 million during the year ended June 30, 2019.  However, there were no such purchases during fiscal 2018.  

In total, commercial mortgage loan acquisition volume outpaced loan repayments during fiscal 2019, resulting in the reported net increase in the outstanding balance of this segment of the loan portfolio.  Our business plan continues to call for maintaining our strategic emphasis on commercial mortgage lending by increasing this segment of the portfolio on a dollar basis while maintaining its basis as a percentage of total loans.

We generally require no less than a 25% down payment or equity position for mortgage loans on multi-family and nonresidential properties.  For such loans, we generally require personal guarantees.  However, the Bank may consider multi-family and nonresidential real estate mortgages for approval on a non-personally guaranteed (non-recourse) basis when the overall strengths of a proposed loan asset sufficiently mitigates the risk of exculpating the principal owners from their personal guarantee. In such cases, the Bank generally requires borrowers to execute an indemnification agreement which personally obligates those individuals in the circumstances of fraud, negligence, environmental issues, improper conveyance, condemnation, bankruptcy or other additional provisions deemed appropriate by the Bank.

We generally offer fixed-rate and adjustable-rate balloon mortgage loans on multi-family and non-residential properties with final stated maturities ranging from five to twelve years and initial interest rate reset terms ranging from five to seven years, where applicable.  Our balloon mortgage loans within this category generally have payments based on amortization terms from 25 to 30 years.  We also offer fully amortizing fixed-rate and adjustable-rate mortgage loans on multi-family and non-residential properties with terms up to 25 years.  Our commercial mortgage loans are primarily secured by properties located in New Jersey and New York and, to a lesser extent, eastern Pennsylvania.

Commercial Business Loans.  We originate commercial term loans and lines of credit to a variety of professionals, sole proprietorships and small businesses in our market area.  Our business loan products include our Small Business Express Loan, which offers customers a simplified and expedited application and approval process for term loans and lines of credit up to $250,000, as well as loans originated through the SBA in which Kearny Bank participates as a Preferred Lender, as noted earlier.  We originated approximately $21.9 million of commercial business loans during the year ended June 30, 2019 compared to $25.9 million during the year ended June 30, 2018.

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Our commercial business loan acquisition strategy also included the funding of wholesale C&I loan participations totaling $2.7 million and $28.3 million during the years ended June 30, 2019 and 2018, respectively.  These participations were comprised entirely of our pro rata interest in the obligations of 13 separate commercial borrowers that were acquired through our membership in BancAlliance, a cooperative network of lending institutions that serves as a conduit for institutional investors to participate in middle-market commercial credits.  During fiscal 2018 we opted to discontinue the purchase of wholesale C&I loan participations and thus all of the wholesale C&I loans funded during fiscal 2019 were comprised of advances on previously committed lines of credit.  Our outstanding balance of wholesale C&I loan participations totaled $27.2 million and $35.3 million at June 30, 2019 and 2018, respectively.  

In total, loan repayments outpaced the volume of commercial business loans originated, purchased and acquired during fiscal 2019 resulting in the reported net decrease in the outstanding balance of this segment of the loan portfolio.  As noted earlier, we continued to realign and expand our commercial business lending infrastructure during fiscal 2019.  As a result of those enhancements, we anticipate this loan segment will increase as we continue to emphasize loans acquired through retail origination channels while diminishing the emphasis on loans and participations purchased through wholesale channels.  Through these efforts, we hope to increase this segment of the loan portfolio on both a dollar basis and as a percentage of total loans.

At June 30, 2019, approximately $38.6 million or 58.7% of our commercial business loans represent loans originated through our retail channel while the remaining $27.2 million or 41.3% comprise loans acquired through the wholesale C&I loan participation channels discussed earlier.  Of the retail originated loans, approximately $30.1 million or 78.0% are non-SBA loans consisting of secured and unsecured loans totaling $27.2 million and $2.9 million, respectively. We generally require personal guarantees on all non-SBA commercial business loans originated.  Unsecured commercial loans may take the form of overdraft checking authorization and unsecured lines of credit.  Our non-SBA commercial term loans generally have terms of up to 10 years and are mostly adjustable-rate loans.  Our commercial lines of credit have terms of up to one year and are generally floating-rate loans.

The remaining $8.5 million or 22.0% of commercial business loans originated represent the retained portion of SBA loan originations, of which approximately $374,000 is guaranteed by the SBA.  Such loans are generally secured by various forms of collateral, including real estate, business equipment and other forms of collateral.  Kearny Bank generally sells the guaranteed portion of eligible SBA loans originated, which ranges from 50% to 90% of the loan’s outstanding balance while retaining the nonguaranteed portion of such loans in portfolio.  Kearny Bank also retains both the guaranteed and non-guaranteed portion of those SBA originations that are generally ineligible for sale in the secondary market.  The Company sold $866,000 of SBA loan participations which resulted in the recognition of related sale gains totaling approximately $56,000 for the year ended June 30, 2019.  By comparison, we sold $2.8 million of SBA loan participations during fiscal 2018 which resulted in the recognition of related sale gains totaling approximately $262,000.

Construction Lending.  Our construction lending includes loans to individuals for the construction of one- to four-family residences or for major renovations or improvements to an existing dwelling.  Our construction lending also includes loans to builders and developers for commercial real estate or multi-family residential buildings.  At June 30, 2019, construction loans totaled $13.9 million.

During the year ended June 30, 2019, construction loan disbursements were $8.5 million compared to $25.2 million during the year ended June 30, 2018.  Construction loan repayments outpaced disbursements during fiscal 2019 resulting in the reported decrease in the outstanding balance of this segment of the loan portfolio.  

Construction borrowers must hold title to the land free and clear of any liens. Financing for construction loans is limited to 80% of the anticipated appraised value of the completed property. Disbursements are made in accordance with inspection reports by our approved appraisal firms.  Terms of financing are generally limited to one year with an interest rate tied to the prime rate published in the Wall Street Journal and may include a premium of one or more points.  In some cases, we convert a construction loan to a permanent mortgage loan upon completion of construction.  We have no formal limits as to the number of projects a builder has under construction or development and make a case-by-case determination on loans to builders and developers who have multiple projects under development.

We continue to evaluate lending opportunities and strategies through which we may expect to expand our construction lending activity, funding commitments and outstanding balances in the future.  If undertaken, we expect that the growth in our construction lending program will be supported by a corresponding expansion of our internal lending infrastructure and resources to support a growing number of relationships and projects with builders/borrowers.  

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One- to Four-Family First Mortgage Loans Held in Portfolio.  Our portfolio lending activities include the origination of one- to four-family first mortgage loans, of which approximately $1.22 billion or 90.7% are secured by properties located within New Jersey and New York as of June 30, 2019 with the remaining $124.9 million or 9.3% secured by properties in other states.

During the year ended June 30, 2019, Kearny Bank originated $106.9 million of one- to four-family first mortgage portfolio loans compared to $53.0 million in the year ended June 30, 2018.  To supplement portfolio loan originations, we also purchased one- to four-family first mortgages totaling $95.5 million during the year ended June 30, 2019.  By comparison, we purchased $26.3 million of one- to four-family first mortgages during the year ended June 30, 2018.

One- to four-family first mortgage loan origination volume generally outpaced loan repayments of such loans during fiscal 2019.  Our business plan generally calls for increasing the aggregate balance of residential mortgage loans, including one- to four-family first mortgage loans as well as home equity loans and home equity lines of credit discussed below, on a dollar basis while maintaining the aggregate balance of such loans as a percentage of the total loan portfolio.

We will originate a one- to four-family mortgage loan on an owner-occupied property with a principal amount of up to 95% of the lesser of the appraised value or the purchase price of the property, with private mortgage insurance required if the loan-to-value ratio exceeds 80%. At June 30, 2019, our one- to four-family mortgage loan portfolio was primarily comprised of loans secured by owner-occupied properties.  Our loan-to-value limit on a non-owner-occupied property is 75%.  Loans in excess of $2.0 million are handled on a case-by-case basis.

We offer a first-time homebuyer program for persons who have not previously owned real estate and are purchasing a one- to four-family property in our primary lending area for use as a primary residence.  This program is also available outside these areas, but only to persons who are existing deposit or loan customers of Kearny Bank and/or members of their immediate families.  The financial incentives offered under this program are a one-eighth of one percentage point rate reduction on all first mortgage loan types and the refund of the application fee at closing.

The fixed-rate residential mortgage loans that we originate for portfolio generally meet the secondary mortgage market standards of the Federal Home Loan Mortgage Corporation (“Freddie Mac”).

Substantially all of our residential mortgages include due on sale clauses, which give us the right to declare a loan immediately payable if the borrower sells or otherwise transfers an interest in the property to a third party.  Property appraisals on real estate securing our one- to four-family first mortgage loans are made by state certified or licensed independent appraisers approved by Kearny Bank’s Board of Directors.  Appraisals are performed in accordance with applicable regulations and policies.  We require title insurance policies on all first mortgage real estate loans originated.  Homeowners, liability and fire insurance and, if applicable, flood insurance, are also required.

One- to Four-Family Mortgage Loans Held for Sale.  During fiscal 2019, we further expanded and enhanced our mortgage banking infrastructure to support the continued origination of one- to four-family mortgage loans for sale into the secondary market.  As above, the loans we originate for sale generally meet the same secondary mortgage market standards as those applicable to loans originated for portfolio.  Moreover, such loans are generally originated by, and sourced from, the same resources and markets as those loans originated and held in portfolio, as discussed above.

Our mortgage banking business strategy resulted in the recognition of $524,000 in gains associated with the sale of $54.3 million of mortgage loans held for sale during the year ended June 30, 2019.  As of that date, an additional $12.3 million of loans were held and committed for sale into the secondary market.  As noted earlier, we anticipate that residential mortgage loan origination and sale activity will continue to support long-term growth in our non-interest income through the recognition of recurring loan sale gains, while also serving to help manage the Company’s exposure to interest rate risk through the sale of longer-duration, fixed-rate loans into the secondary market.  However, the volume of such originations and sales is likely to reflect variations in the levels of consumer demand for refinancing which generally moves inversely with movements in longer-term market interest rates.

Home Equity Loans and Lines of Credit.  Our home equity loans are fixed-rate loans for terms of generally up to 20 years.  We also offer fixed-rate and adjustable-rate home equity lines of credit with terms of up to 20 years.  During the year ended June 30, 2019, Kearny Bank originated $33.8 million of home equity loans and home equity lines of credit compared to $20.2 million in the year ended June 30, 2018.  However, origination volume of home equity loans and lines of credit generally outpaced repayments during fiscal 2019, resulting in a net increase in the outstanding balance of this segment of the loan portfolio.

Collateral value is determined through a property value analysis report, or full appraisal where appropriate, provided by a state certified or licensed independent appraiser.  Home equity loans and lines of credit do not require title insurance but do require homeowner, liability and fire insurance and, if applicable, flood insurance.

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Home equity loans and fixed-rate home equity lines of credit are generally originated in our market area and are generally made in amounts of up to 80% of value on term loans and of up to 75% of value on home equity adjustable-rate lines of credit.  We originate home equity loans secured by either a first lien or a second lien on the property.

Consumer Loans.  Our consumer loan portfolio includes unsecured overdraft lines of credit and personal loans as well as loans secured by savings accounts and certificates of deposit on deposit with Kearny Bank.  Our unsecured consumer loans at June 30, 2019 primarily include $1.9 million of loans acquired through the Company’s relationship with Lending Club, an established peer-to-peer lender.  The Company limited its original investment in Lending Club loans to approximately $25.0 million in aggregate outstanding balances and has since discontinued purchases of such loans in favor of investing in other loan alternatives.

The remaining balance of consumer loans at June 30, 2019 includes $3.7 million of loans fully secured by savings accounts or certificates of deposit held by the Bank and $194,000 of other unsecured consumer loans. We will generally lend up to 90% of the account balance on a loan secured by a savings account or certificate of deposit.

Our unsecured consumer loans generally entail greater risks compared to the other categories of loans that we originate or purchase and hold in portfolio.  Consumer loan repayment is dependent on the borrower’s continuing financial stability and is more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. The application of various federal laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on consumer loans in the event of a default.

Our underwriting standards for internally originated consumer loans include a determination of the applicant’s credit history and an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan.  The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment and any additional verifiable secondary income.

Loans to One Borrower.  New Jersey law generally limits the amount that a savings bank may lend to a single borrower and related entities to 15% of the institution’s capital funds. Accordingly, as of June 30, 2019, our loans-to-one-borrower limit was approximately $118.1 million.

Notwithstanding regulatory limitations regarding loans to one borrower, the Bank has established a more conservative set of internal thresholds that further limit our lending exposure to any single borrower or set of borrowers affiliated by common ownership.  In that regard, the Bank’s internal limits are $35.0 million for a single loan transaction and $85.0 million to a common ownership or an affiliated group of borrowers/guarantors. These limits apply irrespective of whether the obligations are on a personally guaranteed/recourse basis or non-personally guaranteed/non-recourse basis.  Exceptions to these internal limits may be considered on a case-by-case basis, subject to the review and approval of each exception by the Bank’s Board of Directors.

At June 30, 2019, our largest single borrower had an aggregate outstanding loan balance of approximately $50.6 million comprising one commercial mortgage loan and four multi-family mortgage loans. Our second largest single borrower had an aggregate outstanding loan balance of approximately $50.2 million comprising six multi-family mortgage loans.  Our third largest borrower had an aggregate outstanding loan balance of approximately $48.7 million comprising four multi-family mortgage loans.  At June 30, 2019, all of these lending relationships were current and performing in accordance with the terms of their loan agreements.  By comparison, at June 30, 2018, loans outstanding to Kearny Bank’s three largest borrowers totaled approximately $58.2 million, $56.9 million and $44.2 million, respectively.

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Loan Originations, Purchases, Sales, Solicitation and Processing.  The following table shows portfolio loans originated, purchased, acquired and repaid during the periods indicated.

Our customary sources of loan applications include loans originated by our commercial and residential loan officers, repeat customers, referrals from realtors and other professionals and walk-in customers.  These sources are supported in varying degrees by our newspaper and electronic advertising and marketing strategies.  

We have also entered into purchase agreements with a number of bank and non-bank originators to supplement our loan production pipeline.  These agreements call for our purchase of one- to four-family first mortgage loans on either a servicing released or servicing retained basis from the seller.  During the year ended June 30, 2019, we purchased one- to four-family first mortgages totaling $95.5 million.  By comparison, we purchased $26.3 million of one- to four-family first mortgages during the year ended June 30, 2018.

As of June 30, 2019, our portfolio of out-of-state residential mortgages included loans located in eight states outside of New Jersey and New York that totaled approximately $124.9 million or 9.3% of one- to four-family mortgage loans. The states with the three largest concentrations of such loans at June 30, 2019 were Massachusetts, Pennsylvania and Georgia, with outstanding principal balances totaling $115.2 million, $6.9 million and $808,000, respectively.  The aggregate outstanding balances of loans in each of the remaining five states total approximately $1.9 million and comprise approximately 1.5% of the total balance of out-of-state residential mortgage loans with aggregate balances by state ranging from $194,000 to $548,000.

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In addition to purchasing one- to four-family loans, we have also purchased commercial mortgage loans and participations originated by other banks and non-bank originators. As noted earlier, the aggregate carrying value of the loans and participations purchased from these sources during the year ended June 30, 2019 totaled approximately $68.6 million comprising loans secured primarily by multi-family and non-residential properties located in New York and New Jersey. We also purchased commercial business loans totaling $2.7 million during the year ended June 30, 2019, as discussed above.

Loan Approval Procedures and Authority.  Senior management recommends and the Board of Directors approves our lending policies and loan approval limits.  Kearny Bank’s Loan Committee consists of the Chief Executive Officer, Chief Lending Officer, Chief Credit Officer, Director of Commercial Lending, Director of Residential Lending and Special Assets Manager.  Our Chief Lending Officer may approve residential loans up to $1.0 million.  Loan department personnel of Kearny Bank serving in the following positions may approve loans as follows: residential mortgage loan managers, mortgage/consumer loans up to $500,000; and residential mortgage loan underwriters, mortgage loans up to $350,000.  In addition to these principal amount limits, there are established limits for different levels of approval authority as to minimum credit scores and maximum loan-to-value ratios and debt-to-income ratios or debt service coverage.  Our Chief Executive Officer, Chief Lending Officer, or Chief Credit Officer have authorization to approve loans for amounts up to a limit of $1.0 million.  Non-conforming residential mortgage loans and loans over $1.0 million up to $2.0 million require the approval of the Loan Committee.  The Committee may approve individual commercial loans or an aggregate commercial lending relationship up to $5.0 million. Commercial loans or aggregate relationships in excess of $5.0 million require approval by the Board of Directors while such approval is also required for residential mortgage loans in excess of $2.0 million and commercial business loans in excess of $1.0 million.

Asset Quality

Collection Procedures on Delinquent Loans.  We regularly monitor the payment status of all loans within our portfolio and promptly initiate collection efforts on past due loans in accordance with applicable policies and procedures.  Delinquent borrowers are notified by both mail and telephone when a loan is 30 days past due. If the delinquency continues, subsequent efforts are made to contact the delinquent borrower and additional collection notices and letters are sent.  All reasonable attempts are made to collect from borrowers prior to referral to an attorney for collection.  However, when a loan is 90 days delinquent, it is our general practice to refer it to an attorney for repossession, foreclosure or other form of collection action, as appropriate.  In certain instances, we may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his or her financial affairs and we attempt to work with the borrower to establish a repayment schedule to cure the delinquency.

As to mortgage loans, if a foreclosure action is taken and the loan is not reinstated, paid in full or refinanced, the property is sold at judicial sale at which we may be the buyer if there are no adequate offers to satisfy the debt. Any property acquired as the result of foreclosure or by deed in lieu of foreclosure is classified as other real estate owned until it is sold or otherwise disposed of. When other real estate owned is acquired, it is recorded at its fair market value less estimated selling costs. The initial write-down of the property, if necessary, is charged to the allowance for loan losses. Adjustments to the carrying value of the properties that result from subsequent declines in value are charged to operations in the period in which the declines are identified.

Past Due Loans.  A loan’s past due status is generally determined based upon its principal and interest payment (“P&I”) delinquency status in conjunction with its past maturity status, where applicable.  A loan’s P&I delinquency status is based upon the number of calendar days between the date of the earliest P&I payment due and the as of measurement date.  A loan’s past maturity status, where applicable, is based upon the number of calendar days between a loan’s contractual maturity date and the as of measurement date.  Based upon the larger of these criteria, loans are categorized into the following past due tiers for financial statement reporting and disclosure purposes: Current (including 1-29 days), 30-59 days, 60-89 days and 90 or more days.

Nonaccrual 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 P&I payments owed substantially in accordance with the terms of the loan agreement, regardless of past due status.  Loans that become 90 day 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.

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Nonperforming Assets.  The following table provides information regarding our nonperforming assets which are comprised of nonaccrual loans, accruing loans 90 days or more past due and other real estate owned.

Total nonperforming assets increased by $2.7 million to $20.3 million at June 30, 2019 from $17.6 million at June 30, 2018.  The increase was due to a net increase in nonperforming loans of $3.4 million partially offset by a net decrease in other real estate owned of $725,000.  For those same comparative periods, the number of nonperforming loans decreased to 77 loans from 80 loans while there were no properties in other real estate owned at June 30, 2019 compared to four at June 30, 2018.

At June 30, 2019, nonperforming loans comprised $20.2 million of nonaccrual loans and $22,000 of loans being reported as accruing loans over 90 days and over past due.  By comparison, at June 30, 2018, nonperforming loans comprised $16.8 million of nonaccrual loans and $60,000 of loans being reported as accruing loans over 90 days past due.

Nonperforming one- to four-family mortgage loans at June 30, 2019 include 40 nonaccrual loans totaling $9.9 million whose net outstanding balances range from $11,000 to $766,000, with an average balance of approximately $249,000 as of that date.  The loans are in various stages of collection, workout or foreclosure.  Of these loans, 37 are secured by New Jersey properties while two loans are secured by a properties located in New York and one loan is secured by a property located in Georgia.  We have identified approximately $31,000 of specific impairment relating to one of the nonperforming loans for which a valuation allowance was maintained in the allowance for loan losses at June 30, 2019.

Nonperforming commercial real estate loans, including multi-family and nonresidential mortgage loans, include 16 nonaccrual loans totaling $9.0 million.  At June 30, 2019, the outstanding balances of these loans range from $14,000 to $2.8 million with an average balance of approximately $561,000 as of that date.  The loans are in various stages of collection, workout or foreclosure and are secured by 15 properties located in New Jersey and one property located in New York.  There was no specific impairment identified relating to these nonperforming loans at June 30, 2019.

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Nonperforming commercial business loans at June 30, 2019 include six nonaccrual loans totaling $469,000.  At June 30, 2019, the outstanding balances of these loans range from $5,000 to $219,000 with an average balance of approximately $78,000 as of that date.  The loans are in various stages of collection, workout or foreclosure and are primarily secured by New Jersey and New York properties and, to a lesser extent, other forms of collateral. There was no specific impairment identified relating to these nonperforming loans at June 30, 2019.

Home equity loans and home equity lines of credit that are reported as nonperforming at June 30, 2019 include 14 nonaccrual loans totaling $866,000.  At June 30, 2019, the outstanding balances of these loans range from $4,000 to $383,000 with an average balance of approximately $62,000 as of that date.  The loans are in various stages of collection, workout or foreclosure and are primarily secured by New Jersey properties.  There was no specific impairment identified relating to these nonperforming loans at June 30, 2019.

Other consumer loans that are reported as nonperforming at June 30, 2019 included three unsecured loans totaling $22,000 reported as accruing loans over 90 days past due.

There were no nonperforming construction loans in nonaccrual status at June 30, 2019.  

At June 30, 2019, 2018, and 2017, Kearny Bank had loans with aggregate outstanding balances totaling $15.1 million, $10.2 million and $11.0 million, respectively, reported as troubled debt restructurings.

Loan Review System.  We maintain a loan review system consisting of several related functions including, but not limited to, classification of assets, calculation of the allowance for loan losses, independent credit file review as well as internal audit and lending compliance reviews.  We utilize both internal and external resources, where appropriate, to perform the various loan review functions.  For example, we have engaged the services of a third party firm specializing in loan review and analysis to perform several loan review functions.  The firm reviews the loan portfolio in accordance with the scope and frequency determined by senior management and the Audit and Compliance Committee of the Board of Directors.  The third party loan review firm assists senior management and the Board of Directors in identifying potential credit weaknesses; in reviewing and confirming risk ratings or adverse classifications internally ascribed to loans by management; in identifying relevant trends that affect the collectability of the portfolio and identifying segments of the portfolio that are potential problem areas; in verifying the appropriateness of the allowance for loan losses; in evaluating the activities of lending personnel including compliance with lending policies and the quality of their loan approval, monitoring and risk assessment; and by providing an objective assessment of the overall quality of the loan portfolio. Currently, independent loan reviews are being conducted quarterly and include non-performing loans as well as samples of performing loans of varying types within our portfolio.

Our loan review system also includes the internal audit and compliance functions, which operate in accordance with a scope determined by the Audit and Compliance Committee of the Board of Directors.  Internal audit resources assess the adequacy of, and adherence to, internal credit policies and loan administration procedures.  Similarly, our compliance resources monitor adherence to relevant lending-related and consumer protection-related laws and regulations.  As noted, the loan review system also comprises our policies and procedures relating to the regulatory classification of assets and the allowance for loan loss functions each of which are described in greater detail below.

Classification of Assets.  In compliance with the regulatory guidelines, our loan review system includes an evaluation process through which certain loans exhibiting adverse credit quality characteristics are classified as Special Mention, Substandard, Doubtful or Loss.  An asset is classified as Substandard if it is inadequately protected by the paying capacity and net worth of the obligor or the collateral pledged, if any.  Substandard assets include those characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all of the weaknesses inherent in those classified 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. Assets, or portions thereof, classified as Loss are considered uncollectible or of so little value that their continuance as assets is not warranted.  Assets which do not currently expose us to a sufficient degree of risk to warrant an adverse classification but have some credit deficiencies or other potential weaknesses are designated as Special Mention by management.  Adversely classified assets, together with those rated as Special Mention are generally referred to as Classified Assets.  Non-classified assets are internally rated within one of four Pass categories or as Watch with the latter denoting a potential deficiency or concern that warrants increased oversight or tracking by management until remediated.

Additional information about our classification of assets is presented in Note 8 to the audited consolidated financial statements.

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The following table discloses our designation of certain loans as special mention or adversely classified during each of the five years presented:

At June 30, 2019, 17 loans were classified as Special Mention and 125 loans were classified as Substandard.  As of that same date, four loans were classified as Doubtful.  

Allowance for Loan Losses.  Our allowance for loan losses is maintained at a level necessary to absorb loan losses that are both probable and reasonably estimable.  The allowance for loan losses as of June 30, 2019, is maintained at a level that represents management’s best estimate of losses inherent in the loan portfolio.  Although we believe that our allowance for loans losses is established in accordance with management’s best estimate, actual losses are dependent upon future events and, as such, further additions to the level of loan loss allowances may be necessary.  

Additional information about our allowance for loan losses is presented in Note 1 to the audited consolidated financial statements.

The following table sets forth information with respect to activity in the allowance for loan losses for the periods indicated:

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Allocation of Allowance for Loan Losses.  The following table sets forth the allocation of the total allowance for loan losses by loan category and segment and the percent of loans in each category’s segment to total net loans receivable at the dates indicated.  The portion of the loan loss allowance allocated to each loan segment does not represent the total available for future losses which may occur within a particular loan segment since the total loan loss allowance is a valuation reserve applicable to the entire loan portfolio.