OCEANFIRST FINANCIAL CORP - Quarter Report: 2013 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

For the quarterly period ended June 30, 2013

For the transition period from                      to                     

Commission file number 001-11713

OceanFirst Financial Corp.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (732) 240-4500

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  x    NO  ¨.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x.

As of August 1, 2013, there were 17,604,117 shares of the Registrant’s Common Stock, par value $.01 per share, outstanding.

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OceanFirst Financial Corp.

INDEX TO FORM 10-Q

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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Summary

OceanFirst Financial Corp. is the holding company for OceanFirst Bank (the “Bank”), a community bank serving Ocean and Monmouth Counties in New Jersey. The term the “Company” refers to OceanFirst Financial Corp., OceanFirst Bank and all of the Bank’s subsidiaries on a consolidated basis. The Company’s results of operations are primarily dependent on net interest income, which is the difference between the interest income earned on interest-earning assets, such as loans and investments, and the interest expense on interest-bearing liabilities, such as deposits and borrowings. The Company also generates non-interest income such as income from loan sales, loan servicing, loan originations, trust and asset management services, the sale of investment products, merchant credit card services, deposit accounts, and other fees. The Company’s operating expenses primarily consist of compensation and employee benefits, occupancy and equipment, marketing, data processing, federal deposit insurance and general and administrative expenses. The Company’s results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government policies and actions of regulatory agencies.

Interest-earning assets, both loans and securities, are generally priced against longer-term indices, while interest-bearing liabilities, primarily deposits and borrowings, are generally priced against shorter-term indices. Beginning in the second half of 2011 and through the first quarter of 2013, the Company’s net interest margin has generally contracted. Due to the low interest rate environment, high loan refinance volume caused yields on loans and mortgage-backed securities to trend downward. At the same time, the Company’s asset mix has shifted as higher-yielding loans have decreased due to prepayments and the sale of newly-originated 30-year fixed-rate one-to-four family loans while lower-yielding securities have increased. Although high loan refinance volume and shifting asset mix continued into the second quarter of 2013, the Company’s net interest margin nonetheless expanded slightly as the Company invested excess liquidity and managed funding costs lower. Based upon current economic conditions, the Federal Reserve has indicated that it intends to keep short-term interest rates at current levels through mid-2015. Longer-term interest rates have recently increased, resulting in a steeper yield curve. While the impact of these factors on the Company’s financial results is difficult to predict, management anticipates further pressure on the net interest margin in subsequent quarters. In addition to the interest rate environment, the Company’s results are affected by national and local economic conditions. Recent economic indicators point to some improvement in the economy, which expanded modestly in 2012 and through the first half of 2013. Labor market conditions also improved as the national unemployment rate in the first half of 2013 decreased over prior year levels. Despite these signs, the overall economy remains weak and the unemployment rate remains at an elevated level. Additionally, housing values remain significantly below their peak levels in 2006. These economic conditions have generally had an adverse impact on the Company’s results of operations.

Highlights of the Company’s financial results for the three and six months ended June 30, 2013 were as follows:

Total assets increased to $2.306 billion at June 30, 2013, from $2.269 billion at December 31, 2012. Mortgage-backed securities available for sale increased by $58.7 million, to $392.6 million at June 30, 2013, as compared to $333.9 million at December 31, 2012. Loans receivable, net decreased $17.5 million at June 30, 2013, as compared to December 31, 2012 primarily due to prepayments and the sale of newly-originated 30-year fixed-rate one-to-four family loans. Deposits decreased by $15.9 million at June 30, 2013, as compared to December 31, 2012.

Net income for the three months ended June 30, 2013 decreased to $5.0 million, or $0.29 per diluted share, as compared to net income of $5.4 million, or $0.30 per diluted share for the corresponding prior year period due to higher operating expenses and lower net interest income, partly offset by a reduction in the provision for loan losses and higher other income.

Net interest income for the three months ended June 30, 2013 decreased to $17.5 million, as compared to $18.4 million in the same prior year period, reflecting a lower net interest margin partly offset by slightly higher interest-earning assets. The net interest margin decreased to 3.21% for the three months ended June 30, 2013, as compared to 3.39% for the corresponding prior year period and stabilized as compared to the 3.16% reported in the linked prior quarter.

The provision for loan losses was $800,000 for the three months ended June 30, 2013, as compared to $1.7 million in the same prior year period due to reductions in net charge-offs and loans receivable, net. The Company’s non-performing loans increased $2.5 million, to $45.9 million at June 30, 2013, from $43.4 million at December 31, 2012. The increase was expected as it was all related to loans adversely affected by superstorm Sandy which were identified and provided for in the fourth quarter of 2012.

Other income increased to $4.7 million for the three months ended June 30, 2013 as compared to $4.5 million in the same prior year period. Trust and asset management revenue, fees and service charges and the net gain (loss) from other real estate operations improved while the net gain on sales of loans and investment securities both declined.

The Company remains well-capitalized with a tangible common equity ratio of 9.38%.

Return on average stockholders’ equity was 9.06% for the three months ended June 30, 2013, as compared to 9.79% for the corresponding prior year period.

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Analysis of Net Interest Income

Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them.

The following table sets forth certain information relating to the Company for the three months and six months ended June 30, 2013 and 2012. The yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown except where noted otherwise. Average balances are derived from average daily balances. The yields and costs include certain fees which are considered adjustments to yields.

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Comparison of Financial Condition at June 30, 2013 and December 31, 2012

Total assets increased by $36.4 million to $2.306 billion at June 30, 2013, from $2.269 billion at December 31, 2012. Cash and due from banks decreased $20.2 million, to $42.4 million, as compared to $62.5 million at December 31, 2012. Mortgage-backed securities available for sale increased by $58.7 million, to $392.6 million at June 30, 2013, as compared to $333.9 million at December 31, 2012, as excess liquidity was invested.

Loans receivable, net, decreased by $17.5 million, to $1.506 billion at June 30, 2013 from $1.523 billion at December 31, 2012, primarily due to prepayments and sale of newly-originated 30-year fixed-rate one-to-four family loans.

Deposits decreased by $15.9 million, to $1.704 billion at June 30, 2013, from $1.720 billion at December 31, 2012. The mix of deposits changed as non-interest-bearing deposits and savings deposits increased by $40.9 million and $36.5 million, respectively, while interest-bearing checking and time deposits decreased $84.0 million and $14.0 million, respectively. Securities sold under agreements to repurchase with retail customers increased by $10.3 million, to $71.0 million at June 30, 2013, from $60.8 million at December 31, 2012. Federal Home Loan Bank (“FHLB”) advances increased $44.4 million, to $269.4 million at June 30, 2013, from $225.0 million at December 31, 2012.

Stockholders’ equity decreased to $216.3 million at June 30, 2013, as compared to $219.8 million at December 31, 2012. Net income for the period was offset by an increase in accumulated other comprehensive loss of $4.9 million related to the unrealized loss on securities available for sale caused by the recent rise in interest rates, the repurchase of 314,961 shares of common stock for $4.5 million (average cost per share of $14.33) and the cash dividends on common stock of $4.2 million. At June 30, 2013, there were 519,823 shares remaining to be repurchased under the stock repurchase program adopted in the fourth quarter of 2012. Tangible stockholders’ equity per common share increased to $12.29 at June 30, 2013 as compared to $12.28 at December 31, 2012 primarily due to the reduction in shares outstanding.

Comparison of Operating Results for the Three and Six Months Ended June 30, 2013 and June 30, 2012

General

Net income for the three months ended June 30, 2013 decreased to $5.0 million, or $0.29 per diluted share, as compared to net income of $5.4 million, or $0.30 per diluted share for the corresponding prior year period, due to higher operating expenses and lower net interest income, partly offset by reductions in the provision for loan losses and higher other income. Net income for the six months ended June 30, 2013 decreased to $9.4 million, or $0.55 per diluted share, as compared to net income of $11.0 million, or $0.61 per diluted share for the corresponding prior year period due to lower net interest income, lower other income and higher operating expenses, partly offset by a reduction in the provision for loan losses.

Interest Income

Interest income for the three and six months ended June 30, 2013 was $20.2 million and $40.2 million, respectively, as compared to $22.0 million and $44.9 million for the three and six months ended June 30, 2012. The yield on interest-earning assets declined to 3.69% for both the three and six months ended June 30, 2013, as compared to 4.06% and 4.13% for the same prior year periods. Average interest-earning assets increased by $13.9 million and $8.4 million for the three and six months ended June 30, 2013, as compared to the same prior year periods. The increases in average interest-earning assets were primarily due to the increases in average investment and mortgage-backed securities available for sale, which collectively increased $87.0 million and $48.4 million, respectively, for the three and six months ended June 30, 2013. These increases were partly offset by a decrease in average loans receivable, net, of $52.1 million and $47.0 million for the three and six months ended June 30, 2013, as compared to the same prior year period.

Interest Expense

Interest expense for the three and six months ended June 30, 2013 was $2.6 million and $5.5 million, respectively, as compared to $3.7 million and $7.4 million for the three and six months ended June 30, 2012. The cost of interest-bearing liabilities decreased to 0.56% and 0.59%, respectively, for the three and six months ended June 30, 2013 as compared to 0.78% and 0.79%, respectively, in the same prior year periods. Average interest-bearing liabilities decreased by $8.4 million and $14.0 million for the three and six months ended June 30, 2013, as compared to the same prior year periods. The decreases were due to declines in average borrowed funds of $8.5 million and $20.1 million, respectively, and average time deposits of $33.2 million and $34.0 million, respectively, for the three and six months ended June 30, 2013 as compared to the same prior year periods, partly offset by an increase in average transaction deposits of $33.3 million and $40.0 million. The growth in average interest-earning assets was funded by increases in average non-interest-bearing deposits of $35.6 million and $34.8 million, respectively, for the three and six months ended June 30, 3013 as compared to the same prior year periods.

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Net Interest Income

Net interest income for the three and six months ended June 30, 2013 decreased to $17.5 million and $34.7 million, respectively, as compared to $18.4 million and $37.5 million in the same prior year periods, reflecting a lower net interest margin partly offset by slightly higher interest-earning assets. The net interest margin decreased to 3.21% and 3.19%, respectively, for the three and six months ended June 30, 2013, from 3.39% and 3.45% in the same prior year periods due to a change in the mix of average interest-earning assets from higher-yielding loans receivable into lower-yielding investment and mortgage-backed securities available for sale. High loan refinance volume also caused yields on loans and mortgage-backed securities to trend downward.

Provision for Loan Losses

For the three and six months ended June 30, 2013, the provision for loan losses was $800,000 and $1.9 million, respectively, as compared to $1.7 million and $3.4 million, respectively, for the corresponding prior year periods. The decrease for the three and six months ended June 30, 2013 was partly due to reductions of $1.8 million and $2.4 million, respectively, in net charge-offs as compared to the same prior year periods and a reduction in loans receivable, net at June 30, 2013 as compared to both December 31, 2012 and June 30, 2012. Non-performing loans increased $2.5 million at June 30, 2013 as compared to December 31, 2012, driven fully by an increase of $3.7 million in loans adversely affected by superstorm Sandy. These loans were identified at December 31, 2012 and potential losses were provided for at that time.

Other Income

Other income increased to $4.7 million for the three months ended June 30, 2013 as compared to $4.5 million in the same prior year period. For the six months ended June 30, 2013, other income decreased to $8.2 million as compared to $8.9 million in the same prior year period. For both the three and six months ended June 30, 2013 trust and asset management revenue, fees and service charges and the net gain (loss) from other real estate operations improved while the net gain on sales of loans available for sale and the net gain on the sale of investment securities available for sale declined. Effective January 1, 2013, income from the origination of reverse mortgage loans is classified as part of fees and service charges as compared to inclusion in the net gain on the sale of loans in the prior period as the Bank no longer closes these loans in its name. The amount of reverse mortgage fees included in fees and service charges for the three and six months ended June 30, 2013 was $180,000 and $345,000, respectively. For the three and six months ended June 30, 2013, trust and asset management revenue and fees and service charges, exclusive of fees on reverse mortgage loans, increased $222,000 and $206,000, respectively. Increases in trust and asset management revenue and bankcard service fees were partly offset by decreases in fees from investment services and deposit accounts. The net gain (loss) from other real estate operations improved $121,000 and $175,000, respectively, for the three and six months ended June 30, 2013, as compared to the same prior year periods. For the three and six months ended June 30, 2013, the net gain on the sale of loans decreased to $735,000 and $561,000, respectively, as compared to $947,000 and $1.9 million in the same prior year periods due to the reclassification of reverse mortgage income and a decrease in loan sale volume. Additionally, the net gain on the sale of loans for the six months ended June 30, 2013 was adversely impacted by an addition of $975,000 to the reserve for repurchased loans and loss sharing obligations as compared to an addition of $250,000 in the same prior year period. For the three months ended June 30, 2013, there was no provision for repurchased loans and loss sharing obligations as compared to $100,000 in the same prior year period. (Refer to Note 6. Reserve for Repurchased Loans and Loss Sharing Obligations.) Finally, for both the three and six months ended June 30, 2013, the net gain on sales of investment securities available for sale decreased to $42,000 from $226,000 in the same prior year periods.

Operating Expenses

Operating expenses increased to $13.7 million and $26.4 million, respectively, for the three and six months ended June 30, 2013, as compared to $12.9 million and $25.8 million for the corresponding prior year periods. Compensation and employee benefits expense for the three and six months ended June 30, 2013 was adversely impacted by recruiting costs and by the decrease in mortgage loan closings from the prior year levels. Lower loan closings in the current periods decreased deferred loan expense, net of sales commissions to mortgage loan representatives, which is reflected as an increase in compensation expense. Compensation and employee benefits expense benefited from a reduction in incentive plan expense of $226,000 and $605,000, respectively, for the three and six months ended June 30, 2013 as compared to the same prior year periods. Professional fees for the three and six months ended June 30, 2013 were adversely impacted by $175,000 in non-recurring professional fees.

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Provision for Income Taxes

Income tax expense was $2.8 million and $5.2 million, respectively, for the three and six months ended June 30, 2013, as compared to $3.0 million and $6.1 million for the same prior year periods. The effective tax rate was 35.7% and 35.4% for the three and six months ended June 30, 2013 as compared to 35.8% and 35.7%, respectively, in the same prior year periods.

Liquidity and Capital Resources

The Company’s primary sources of funds are deposits, principal and interest payments on loans and mortgage-backed securities, proceeds from the sale of loans, FHLB and other borrowings and, to a lesser extent, investment maturities. While scheduled amortization of loans is a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by interest rates, economic conditions and competition. The Company has other sources of liquidity if a need for additional funds arises, including various lines of credit.

At June 30, 2013, the Company had $80.4 million of overnight borrowings from the FHLB compared to none at December 31, 2012. The Company periodically utilizes overnight borrowings to fund short-term liquidity needs. The Company had total FHLB borrowings of $269.4 million and $225.0 million, respectively, at June 30, 2013 and December 31, 2012.

The Company’s cash needs for the six months ended June 30, 2013 were primarily satisfied by principal payments on loans and mortgage-backed securities, proceeds from the sale of mortgage loans held for sale, proceeds from maturities of investment securities and short-term borrowings. The cash was principally utilized for loan originations, the purchase of investment and mortgage-backed securities and to fund deposit outflows. The Company’s cash needs for the six months ended June 30, 2012 were primarily satisfied by principal payments on loans and mortgage-backed securities, proceeds from the sale of mortgage loans held for sale and proceeds from maturities of investment securities. The cash was principally utilized for loan originations, the purchase of investment and mortgage-backed securities and to reduce FHLB borrowings.

In the normal course of business, the Company routinely enters into various off-balance-sheet commitments, primarily relating to the origination and sale of loans. At June 30, 2013, outstanding commitments to originate loans totaled $106.8 million; outstanding unused lines of credit totaled $244.4 million; and outstanding commitments to sell loans totaled $7.5 million. The Company expects to have sufficient funds available to meet current commitments arising in the normal course of business.

Time deposits scheduled to mature in one year or less totaled $130.2 million at June 30, 2013. Based upon historical experience management estimates that a significant portion of such deposits will remain with the Company.

The Company has a detailed contingency funding plan and comprehensive reporting of funding trends on a monthly and quarterly basis which is reviewed by management. Management also monitors cash on a daily basis to determine the liquidity needs of the Bank. Additionally, management performs multiple liquidity stress test scenarios on a quarterly basis. The Bank continues to maintain significant liquidity under all stress scenarios.

Under the Company’s stock repurchase program, shares of OceanFirst Financial Corp. common stock may be purchased in the open market and through other privately-negotiated transactions, from time-to-time, depending on market conditions. The repurchased shares are held as treasury stock for general corporate purposes. For the six months ended June 30, 2013, the Company repurchased 314,961 shares of common stock at a total cost of $4.5 million compared with repurchases of 513,737 shares at a cost of $7.3 million for the six months ended June 30, 2012. At June 30, 2013, there were 519,823 shares remaining to be repurchased under the existing stock repurchase program.

Cash dividends on common stock declared and paid during the first six months of 2013 were $4.2 million, as compared to $4.3 million in the same prior year period. On July 17, 2013, the Board of Directors declared a quarterly cash dividend of twelve cents ($0.12) per common share. The dividend is payable on August 9, 2013, to stockholders of record at the close of business on July 29, 2013.

The primary sources of liquidity specifically available to OceanFirst Financial Corp., the holding company of OceanFirst Bank, are capital distributions from the banking subsidiary and the issuance of preferred and common stock and long-term debt. For the six months ended June 30, 2013, the Company received a dividend payment of $8.0 million from the Bank. At June 30, 2013, the Company had received notice from the Federal Reserve Bank of Philadelphia that it does not object to the payment of $4.0 million in dividends from the Bank to the Holding Company over the next quarter, although the Federal Reserve Bank reserved the right to revoke the approval at any time if a safety and soundness concern arises during the period. The Company’s ability to continue to pay dividends will be largely dependent upon capital distributions from the Bank, which may be adversely affected by capital constraints imposed by the applicable regulations. The Company cannot predict whether the Bank will be permitted under applicable regulations to pay a dividend to the Company. If the Bank is unable to pay dividends to the Company, the Company may not have the liquidity necessary to pay a dividend in the future or pay a dividend at the same rate as historically paid, or be able to meet current debt obligations. At June 30, 2013, OceanFirst Financial Corp. held $17.1 million in cash and $6.9 million in investment securities available for sale.

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As of June 30, 2013, the Bank exceeded all regulatory capital requirements as follows (in thousands):

The Bank is considered a “well-capitalized” institution under the Prompt Corrective Action Regulations.

In July 2013 the Federal banking agencies adopted a new capital rule which implements higher minimum capital requirements for all banking institutions. The rule becomes effective on January 1, 2015 with a transition period through January 1, 2019. The Bank is currently in compliance with the new capital requirements.

At June 30, 2013, the Company maintained tangible common equity of $216.3 million, for a tangible common equity to assets ratio of 9.38%.

Off-Balance-Sheet Arrangements and Contractual Obligations

In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in the financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used for general corporate purposes or for customer needs. Corporate purpose transactions are used to help manage credit, interest rate and liquidity risk or to optimize capital. Customer transactions are used to manage customers’ requests for funding. These financial instruments and commitments include unused lines of credit and commitments to extend credit. The Company also has outstanding commitments to sell loans amounting to $7.5 million.

The following table shows the contractual obligations of the Company by expected payment period as of June 30, 2013 (in thousands):

Commitments to originate loans and commitments to fund unused lines of 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. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company’s exposure to credit risk is represented by the contractual amount of the instruments.

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Non-Performing Assets

The following table sets forth information regarding the Company’s non-performing assets consisting of non-performing loans and Other Real Estate Owned (“OREO”). It is the policy of the Company to cease accruing interest on loans 90 days or more past due or in the process of foreclosure.

The Company’s non-performing loans increased $2.5 million at June 30, 2013, as compared to December 31, 2012 due to the impact of superstorm Sandy which has caused substantial disruption in the Bank’s market area since October 29, 2012. The Bank increased its allowance for loan losses at December 31, 2012 by $1.8 million in expectation of potential losses from increasing levels of non-performing loans for borrowers impacted by superstorm Sandy. The Bank previously identified loans totaling $30.1 million which were adversely impacted by the storm, of which $3.7 million were 90 days or more delinquent at June 30, 2013.

Included in the non-performing loan total at June 30, 2013 was $19.5 million of troubled debt restructured loans, as compared to $18.2 million of troubled debt restructured loans at December 31, 2012. Non-performing loans are concentrated in one-to-four family loans which comprise 62.0% of the total. At June 30, 2013, the average weighted loan-to-value ratio of non-performing one-to-four family loans, after any related charge-offs, was 60% using appraisal values at time of origination and 79% using updated appraisal values. Appraisals are updated for all non-performing residential loans secured by real estate and subsequently updated annually if the loan remains delinquent for an extended period. At June 30, 2013, the average weighted loan-to-value ratio of the total one-to-four family loan portfolio was 56% using appraisal values at time of origination. The Company’s non-performing loans remain at elevated levels partly due to the extended foreclosure process in the State of New Jersey. The protracted foreclosure process delays the Company’s ability to resolve non-performing loans through the sale of the underlying collateral.

The largest non-performing loan relationship consists of several credits to a single borrower operating a marina, with an aggregate balance of $6.2 million. The loans are criticized due to weak, but improving, operating results. The loans are collateralized by commercial and residential real estate, all business assets and also carry a personal guarantee. An appraisal of the commercial real estate performed in May 2011 values the collateral at $9.3 million. In November 2011, the Company entered into a troubled debt restructuring with the borrower which reduced the interest rate in exchange for additional collateral. The loan was renewed in December 2012 at comparable terms. The borrower is current as to payments under the restructured terms but remains classified as a non-accrual loan due to continued uncertainty about the borrower’s ability to service the debt.

The Company classifies loans and other assets in accordance with regulatory guidelines as follows (in thousands):

The largest Special Mention loan at June 30, 2013 is a commercial real estate mortgage to a local builder for $1.7 million which was current as to payments. The loan is well collateralized by residential property and several vacant lots. The largest Substandard loan relationship is the marina credit for $6.2 million noted above. The largest Doubtful asset with a balance of

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$901,000 is a portion of a commercial real estate loan to a self-storage facility. The remaining balance of $1.3 million is rated Substandard. In September 2011, the Company entered into a troubled debt restructuring with the borrower which reduced the interest rate and extended the payment term. All scheduled payments under the restructured terms have been made since that date. In addition to loan classifications, the Company previously classified select investment securities as Substandard, representing the amount with a credit rating below investment grade from one of the internationally-recognized credit rating services. These securities have consistently remained current as to principal and interest payments. During the first quarter of 2013, the Company performed, with the assistance of an independent expert, a detailed analysis relating to the collectability of these securities. The analysis concluded that the issuers of these securities have an adequate capacity to meet financial commitments as originally agreed for the projected life of the security, the risk of default is low and the full and timely repayment of principal and interest is expected.

Critical Accounting Policies

Note 1 to the Company’s Audited Consolidated Financial Statements for the year ended December 31, 2012 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (the “2012 Form 10-K”), as supplemented by this report, contains a summary of significant accounting policies. Various elements of these accounting policies, by their nature, are inherently subject to estimation techniques, valuation assumptions and other subjective assessments. Certain assets are carried in the consolidated statements of financial condition at fair value or the lower of cost or fair value. Policies with respect to the methodologies used to determine the allowance for loan losses, the reserve for repurchased loans and the valuation of Mortgage Servicing Rights and judgments regarding securities impairment are the most critical accounting policies because they are important to the presentation of the Company’s financial condition and results of operations. These judgments and policies involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. The use of different judgments, assumptions and estimates could result in material differences in the results of operations or financial condition. These critical accounting policies and their application are reviewed periodically and, at least annually, with the Audit Committee of the Board of Directors.

Private Securities Litigation Reform Act Safe Harbor Statement

In addition to historical information, this quarterly report contains certain forward-looking statements within the meaning of the Private Securities Reform Act of 1995 which are based on certain assumptions and describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “will,” “should,” “may,” “view,” “opportunity,” “potential,” or similar expressions or expressions of confidence. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, general economic conditions, levels of unemployment in the Bank’s lending area, real estate market values in the Bank’s lending area, the level of prepayments on loans and mortgage-backed securities, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government including policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area and accounting principles and guidelines. These risks and uncertainties are further discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 and subsequent securities filings and should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. The Company does not undertake - and specifically disclaims any obligation - to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Further description of the risks and uncertainties to the business are included in Item 1, Business and Item 1A, Risk Factors of the Company’s 2012 Form 10-K and Item 1A of this Form 10-Q.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company’s interest rate sensitivity is monitored through the use of an interest rate risk (“IRR”) model. The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at June 30, 2013, which were anticipated by the Company, based upon certain assumptions, to reprice or mature in each of the future time periods shown.

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At June 30, 2013, the Company’s one-year gap was negative 3.89% as compared to positive 0.90% at December 31, 2012. The change from December 31, 2012 was due to the investment of excess short-term liquidity, a temporary increase in short-term funding through FHLB advances, and an expected slowdown in prepayments from loans and mortgage-backed securities.

Additionally, the table below sets forth the Company’s exposure to interest rate risk as measured by the change in net portfolio value (“NPV”) and net interest income under varying rate shocks as of June 30, 2013 and December 31, 2012. All methods used to measure interest rate sensitivity involve the use of assumptions, which may tend to oversimplify the manner in which actual yields and costs respond to changes in market interest rates. The Company’s interest rate sensitivity should be reviewed in conjunction with the financial statements and notes thereto contained in the 2012 Form 10-K.