f10q_093019-0128.htm
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549



FORM 10-Q
(Mark One)
     
X
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
   
EXCHANGE ACT OF 1934
     
For the quarterly period ended
September 30, 2010
     
OR
     
   
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
   
EXCHANGE ACT OF 1934
     
For the transition period from
 
to
 
     
Commission File Number  000-51093
     
KEARNY FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
     
     
UNITED STATES
 
22-3803741
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification Number)
     
120 Passaic Ave., Fairfield, New Jersey
 
07004-3510
(Address of principal executive offices)
 
(Zip Code)
     
Registrant’s telephone number, including area code
 973-244-4500  
     
     
      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  [  ]  No [  ]
 
      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [  ]
Accelerated filer [X]
Non-accelerated filer [  ]
Smaller reporting company [  ]
 
      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).      Yes [  ] No  [X]
 
      The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: November 5, 2010.
     
$0.10 par value common stock  -  67,975,477 shares outstanding

 
 

 

KEARNY FINANCIAL CORP. AND SUBSIDIARIES

INDEX



   
Page
   
Number
PART I - FINANCIAL INFORMATION
   
     
Item 1:
Financial Statements
   
     
 
Consolidated Statements of Financial Condition
   
 
at September 30, 2010 and June 30, 2010 (Unaudited)
 
1
     
 
Consolidated Statements of Income for the Three Months
   
 
Ended September 30, 2010 and September 30, 2009 (Unaudited)
 
2-3
     
 
Consolidated Statements of Changes in Stockholders’ Equity for the
   
 
Three Months Ended September 30, 2010 and September 30, 2009 (Unaudited)
 
4-5
     
 
Consolidated Statements of Cash Flows for the Three
   
 
Months Ended September 30, 2010 and September 30, 2009 (Unaudited)
 
6-7
     
 
Notes to Consolidated Financial Statements (Unaudited)
 
8-29
     
Item 2:
Management’s Discussion and Analysis of
   
 
Financial Condition and Results of Operations
 
30-42
     
Item 3:
Quantitative and Qualitative Disclosure About Market Risk
 
43-50
     
Item 4:
Controls and Procedures
 
51
     
     
PART II - OTHER INFORMATION
 
52-54
     
     
SIGNATURES
 
55
     


 
 

 

KEARNY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In Thousands, Except Share and Per Share Data, Unaudited)


   
September 30,
   
June 30,
   
2010
   
2010
Assets
         
           
Cash and amounts due from depository institutions
$
           45,211
$
 
             3,286
Interest-bearing deposits in other banks
 
           73,873
   
         178,136
           
        Cash and Cash Equivalents
 
         119,084
   
         181,422
           
Securities available for sale (amortized cost $30,441 and $30,960)
 
           29,382
   
           29,497
Securities held to maturity (estimated fair value $232,063 and $256,914)
           229,976              255,000
Loans receivable, including net deferred loan costs of $351 and $564
 
         997,744
   
      1,013,713
  Less allowance for loan losses
 
            (9,377)
   
            (8,561)
           
  Net Loans Receivable
 
         988,367
   
      1,005,152
           
Mortgage-backed securities available for sale (amortized cost $815,706 and $673,414)
 
         844,042
   
         703,455
Mortgage-backed securities held to maturity (estimated fair value $1,701 and $1,754)
 
             1,625
   
             1,700
Premises and equipment
 
           34,854
   
           34,989
Federal Home Loan Bank of New York (“FHLB”) stock
 
           12,867
   
           12,867
Interest receivable
 
             8,298
   
             8,338
Goodwill
 
           82,263
   
           82,263
Bank owned life insurance
 
           19,996
   
           19,833
Other assets
 
             5,518
   
             5,297
 
         
        Total Assets
$
      2,376,272
$
 
      2,339,813
           
Liabilities and Stockholders’ Equity
         
           
Liabilities
         
           
Deposits:
         
  Non-interest-bearing
$
           49,785
$
 
           53,309
  Interest-bearing
 
      1,613,603
   
      1,569,853
           
        Total Deposits
 
      1,663,388
   
      1,623,562
           
Advances from FHLB
 
         210,000
   
         210,000
Advance payments by borrowers for taxes
 
             5,338
   
             5,699
Deferred income tax liabilities, net
 
             3,093
   
             4,391
Other liabilities
 
           10,481
   
           10,235
           
        Total Liabilities
 
      1,892,300
   
      1,853,887
           
Stockholders’ Equity
         
           
Preferred stock $0.10 par value, 25,000,000 shares authorized; none issued
         
  and outstanding
 
                    -
   
                    -
Common stock $0.10 par value, 75,000,000 shares authorized; 72,737,500 shares
         
  issued; 67,975,477 and 68,344,277 shares outstanding, respectively
 
             7,274
   
             7,274
Paid-in capital
 
         214,777
   
         213,529
Retained earnings
 
         313,379
   
         312,844
Unearned Employee Stock Ownership Plan shares; 933,464 shares
         
  and 969,828 shares, respectively
 
            (9,335)
   
            (9,698)
Treasury stock, at cost; 4,762,023 shares and 4,393,223 shares, respectively
 
          (58,054)
   
          (54,738)
Accumulated other comprehensive income
 
           15,931
   
           16,715
           
        Total Stockholders’ Equity
 
         483,972
   
         485,926
           
        Total Liabilities and Stockholders’ Equity
$
      2,376,272
$
 
      2,339,813
See notes to consolidated financial statements.

 
-1-

 

KEARNY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Data, Unaudited)

   
Three Months Ended
 
   
September 30,
 
   
2010
 
2009
 
           
Interest Income:
         
    Loans
$
        13,801
$
        14,879
 
    Mortgage-backed securities
 
          7,398
 
          7,829
 
    Securities:
         
      Taxable
 
          1,408
 
               60
 
      Tax-exempt
 
             157
 
             158
 
    Other interest-earning assets
 
             179
 
             230
 
           
        Total Interest Income
 
        22,943
 
        23,156
 
           
Interest Expense:
         
    Deposits
 
          6,323
 
          7,828
 
    Borrowings
 
          2,075
 
          2,075
 
           
        Total Interest Expense
 
          8,398
 
          9,903
 
           
Net Interest Income
 
        14,545
 
        13,253
 
           
Provision for Loan Losses
 
          1,251
 
             858
 
           
Net Interest Income after Provision
         
  for Loan Losses
 
        13,294
 
        12,395
 
           
Non-Interest Income:
         
    Fees and service charges
 
             342
 
             378
 
    Other-than-temporary security
         
      impairment:
         
      Total
 
                 -
 
           (295)
 
      Less: Portion recognized in
         
        other comprehensive income
 
                 -
 
             197
 
      Portion recognized in earnings
 
                 -
 
             (98)
 
    Miscellaneous
 
             289
 
             240
 
           
        Total Non-Interest Income
 
             631
 
             520
 
           
Non-Interest Expenses:
         
    Salaries and employee benefits
 
          6,953
 
          6,682
 
    Net occupancy expense of
         
      premises
 
          1,049
 
          1,017
 
    Equipment and systems
 
          1,177
 
          1,072
 
    Advertising and marketing
 
             246
 
             214
 
    Federal deposit insurance
         
      premium
 
             447
 
             157
 
    Directors’ compensation
 
             558
 
             556
 
    Merger-related expenses
 
               40
 
                 -
 
    Miscellaneous
 
          1,174
 
          1,319
 
           
        Total Non-Interest Expenses
$
        11,644
$
        11,017
 
 

 
 
-2-

 
KEARNY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Continued)
(In Thousands, Except Per Share Data, Unaudited)

   
Three Months Ended
   
   
 September 30,
   
   
2010
 
2009
       
                 
Income Before Income Taxes
$
          2,281
$
          1,898
       
Income Taxes
 
             946
 
             803
       
                 
Net Income
$
          1,335
$
          1,095
       
                 
Net Income per Common
               
  Share (EPS):
               
    Basic
$
0.02
$
0.02
       
    Diluted
 
0.02
 
0.02
       
                 
Weighted Average Number of
               
  Common Shares Outstanding:
               
    Basic
 
67,219
 
68,074
       
    Diluted
 
67,219
 
68,074
       
                 
Dividends Declared Per Common
               
   Share (Excluding dividends
   waived by Kearny MHC)
$
0.05
$
0.05
       

See notes to consolidated financial statements.


 
-3-

 

KEARNY FINANCIAL CORP. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
 
Three Months Ended September 30, 2009
 
(In Thousands, Except Per Share Data, Unaudited)
 
                               
Accumulated
     
                       
Unearned
     
Other
     
       
Common Stock
 
Paid-In
 
Retained
 
ESOP
 
Treasury
 
Comprehensive
     
       
Shares
 
Amount
 
Capital
 
Earnings
 
Shares
 
Stock
 
Income
 
Total
 
                                       
Balance - June 30, 2009
   
69,242
$
7,274
$
208,577
$
309,687
$
(11,153
)  $
(45,985
)  $
8,320
$
476,720
 
                                       
Comprehensive income:
                                   
  Net income
     
-
 
-
 
-
 
1,095
 
-
 
-
 
-
 
1,095
 
                                       
  Unrealized gain on securities available
                                 
    for sale, net of deferred income tax
                                 
    expense of $3,020
   
-
 
-
 
-
 
-
 
-
 
-
 
4,372
 
4,372
 
                                       
Non-credit related other-than-
                                 
    temporary impairment losses on
                                 
    securities held to maturity, net of
                                 
    deferred income tax benefit of $78
                         
(115
)
(115
)
                                       
  Benefit plans, net of deferred income
                                 
    tax benefit of $7
   
-
 
-
 
-
 
-
 
-
 
-
 
(10
)
(10
)
                                       
   Total Comprehensive income
                             
5,342
 
                                       
ESOP shares committed to be released
                                 
  (36 shares)
     
-
 
-
 
38
 
-
 
364
 
-
 
-
 
402
 
                                       
Dividends contributed for payment of
                                 
    ESOP loan
     
-
 
-
 
25
 
-
 
-
 
-
 
-
 
25
 
                                       
Stock option expense
   
-
 
-
 
476
 
-
 
-
 
-
 
-
 
476
 
                                       
Treasury stock purchases
   
(87
)
-
 
-
 
-
 
-
 
(968
)
-
 
(968
)
                                       
Restricted stock plan shares earned
                                 
  (63 shares)
     
-
 
-
 
771
 
-
 
-
 
-
 
-
 
771
 
                                       
Tax effect from stock based
                                 
  compensation
   
-
 
-
 
41
 
-
 
-
 
-
 
-
 
41
 
                                       
Cash dividends declared ($0.05/public share)
-
 
-
 
-
 
(852
)
-
 
-
 
-
 
(852
)
                                       
                                       
Balance - September 30, 2009
 
69,155
$
7,274
$
209,928
$
309,930
$
(10,789
)  $
(46,953
)  $
12,567
$
481,957
 
                                       
 
See notes to consolidated financial statements.

 
-4-

 

KEARNY FINANCIAL CORP. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
 
Three Months Ended September 30, 2010
 
(In Thousands, Except Per Share Data, Unaudited)
 
                               
Accumulated
     
     
 
               
Unearned
     
Other
     
       
Common Stock
 
Paid-In
 
Retained
 
ESOP
 
Treasury
 
Comprehensive
     
       
Shares
 
Amount
 
Capital
 
Earnings
 
Shares
 
Stock
 
Income
 
Total
 
                                       
Balance - June 30, 2010
   
68,344
$
7,274
$
213,529
$
312,844
$
(9,698
)  $
(54,738
)  $
16,715
$
485,926
 
                                       
Comprehensive income:
                                   
  Net income
     
-
 
-
 
-
 
1,335
 
-
 
-
 
-
 
1,335
 
                                       
  Unrealized loss on securities available
                                 
    for sale, net of deferred income tax
                                 
    benefit of $531
   
-
 
-
 
-
 
-
 
-
 
-
 
(769
)
(769
)
                                       
  Benefit plans, net of deferred income
                                 
    tax benefit of $10
   
-
 
-
 
-
 
-
 
-
 
-
 
(15
)
(15
)
                                       
   Total Comprehensive income
                             
551
 
                                       
ESOP shares committed to be released
                                 
  (36 shares)
     
-
 
-
 
(37
)
-
 
363
 
-
 
-
 
326
 
                                       
Dividends contributed for payment of
                                 
    ESOP loan
     
-
 
-
 
32
 
-
 
-
 
-
 
-
 
32
 
                                       
Stock option expense
   
-
 
-
 
477
 
-
 
-
 
-
 
-
 
477
 
                                       
Treasury stock purchases
   
(369
)
-
 
-
 
-
 
-
 
(3,316
)
-
 
(3,316
)
                                       
Restricted stock plan shares earned
                                 
  (63 shares)
     
-
 
-
 
771
 
-
 
-
 
-
 
-
 
771
 
                                       
Tax effect from stock based
                                 
  compensation
   
-
 
-
 
5
 
-
 
-
 
-
 
-
 
5
 
                                       
Cash dividends declared ($0.05/ public share)
-
 
-
 
-
 
(800
)
-
 
-
 
-
 
(800
)
                                       
Balance - September 30, 2010
 
67,975
$
7,274
$
214,777
$
313,379
$
(9,335
)  $
(58,054
)  $
15,931
$
483,972
 
                                       
 
See notes to consolidated financial statments.

 
 
-5-

 

KEARNY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands, Unaudited)

   
Three  Months Ended
 
   
September 30,
 
   
2010
 
2009
 
           
Cash Flows from Operating Activities:
         
    Net income
$
              1,335
$
             1,095
 
    Adjustments to reconcile net income to net cash provided by operating
         
      activities:
         
        Depreciation and amortization of premises and equipment
 
                 440
 
                425
 
        Net amortization of premiums, discounts and loan fees and costs
 
                 468
 
                162
 
        Deferred income taxes
 
               (756)
 
               (507)
 
        Amortization of intangible assets
 
                     -
 
                    7
 
        Amortization of benefit plans’ unrecognized net loss
 
                  17
 
                  36
 
        Provision for loan losses
 
             1,251
 
                858
 
        Loss on write-down of real estate owned
 
                 14
 
                    -
 
        Loss on other-than-temporary impairment of securities
 
                    -
 
                  98
 
        Increase in cash surrender value of bank owned life insurance
 
              (163)
 
               (140)
 
        ESOP, stock option plan and restricted stock plan expenses
 
            1,574
 
             1,649
 
        Decrease in interest receivable
 
                 40
 
                101
 
        Decrease (increase) in other assets
 
               213
 
               (232)
 
       (Decrease) increase in interest payable
 
                  (3)
 
                    4
 
        Increase (decrease) in other liabilities
 
               208
 
            (1,138)
 
           
            Net Cash Provided by Operating Activities
 
            4,638
 
              2,418
 
           
Cash Flows from Investing Activities:
         
    Proceeds from repayments of securities available for sale
 
               518
 
                126
 
    Purchase of securities held to maturity
 
        (64,975)
 
          (50,000)
 
    Proceeds from calls of securities held to maturity
 
          90,000
 
                    -
 
    Purchase of loans
 
          (1,437)
 
          (20,659)
 
    Net decrease in loans receivable
 
          16,461
 
              5,747
 
    Purchases of mortgage-backed securities available for sale
 
      (186,437)
 
        (105,098)
 
    Principal repayments on mortgage-backed securities available for sale
 
          43,732
 
           45,236
 
    Principal repayments on mortgage-backed securities held to maturity
 
                 82
 
                264
 
    Additions to premises and equipment
 
             (305)
 
               (740)
 
           
            Net Cash Used in Investing Activities
$
      (102,361)
$
        (125,124)
 

 
 
-6-

 

KEARNY FINANCIAL CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(In Thousands, Unaudited)

   
Three  Months Ended
   
September 30,
   
2010
 
2009
         
Cash Flows from Financing Activities:
       
    Net increase in deposits
$
            39,842
$
           34,801
    Decrease in advance payments by borrowers for taxes
 
               (361)
 
              (258)
    Dividends paid to stockholders of Kearny Financial Corp.
 
               (817)
 
              (855)
    Purchase of common stock of Kearny Financial Corp. for treasury
 
            (3,316)
 
              (968)
    Dividends contributed for payment of ESOP loan
 
                  32
 
                  25
    Tax benefit from stock based compensation
 
                    5
 
                  41
         
            Net Cash Provided by Financing Activities
 
           35,385
 
           32,786
         
            Net Decrease in Cash and Cash Equivalents
 
         (62,338)
 
          (89,920)
         
Cash and Cash Equivalents – Beginning
 
         181,422
 
         211,525
         
Cash and Cash Equivalents – Ending
$
         119,084
$
         121,605
         
Supplemental Disclosures of Cash Flows Information:
       
    Cash paid during the year for:
       
        Income taxes, net of refunds
$
            2,104
$
             1,506
         
        Interest
$
            8,401
$
             9,899
         
    Non-cash investing activities:
       
        Acquisition of  real estate owned in settlement of loans
$
               449
$
               543
         

See notes to consolidated financial statements.


 
-7-

 

KEARNY FINANCIAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


1.  PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of Kearny Financial Corp. (the “Company”), its wholly-owned subsidiaries, Kearny Federal Savings Bank (the “Bank”) and Kearny Financial Securities, Inc., and the Bank’s wholly-owned subsidiaries, KFS Financial Services, Inc. and KFS Investment Corp.  The Company conducts its business principally through the Bank.  Management prepared the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, including the elimination of all significant inter-company accounts and transactions during consolidation.

2.  BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and Regulation S-X and do not include information or footnotes necessary for a complete presentation of financial condition, income, changes in stockholders’ equity and cash flows in conformity with generally accepted accounting principles (“GAAP”).  However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the consolidated financial statements have been included.  The results of operations for the three month period ended September 30, 2010, are not necessarily indicative of the results that may be expected for the entire fiscal year or any other period.

The data in the consolidated statements of financial condition for June 30, 2010 was derived from the Company’s annual report on Form 10-K.  That data, along with the interim financial information presented in the consolidated statements of financial condition, income, changes in stockholders’ equity and cash flows should be read in conjunction with the 2010 consolidated financial statements, including the notes thereto included in the Company’s annual report on Form 10-K.

3.  NET INCOME PER COMMON SHARE (“EPS”)

Basic EPS is based on the weighted average number of common shares actually outstanding including restricted stock awards (see following paragraph) adjusted for Employee Stock Ownership Plan (“ESOP”) shares not yet committed to be released.  Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as outstanding stock options, were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company.  Diluted EPS is calculated by adjusting the weighted average number of shares of common stock outstanding to include the effect of contracts or securities exercisable or which could be converted into common stock, if dilutive, using the treasury stock method.  Shares issued and reacquired during any period are weighted for the portion of the period they were outstanding.

In June 2008, the Financial Accounting Standards Board (“FASB”) issued guidance on determining whether instruments granted in share-based payment transactions are participating securities.  This guidance clarifies that all outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends participate in undistributed earnings with common shareholders.  Awards of this nature are considered participating securities and the two-class method of computing basic and diluted earnings per share must be applied.
 
 

 
-8-

 

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations:

 
Three Months Ended
   
 
September 30, 2010
   
 
Income
Shares
Per Share
       
 
(Numerator)
(Denominator)
Amount
       
 
(In Thousands, Except Per Share Data)
   
                         
Net income
$
1,335
                   
Basic earnings per share,
                       
     income available to
                       
     common stockholders
$
1,335
 
67,219
$
0.02
           
Effect of dilutive securities:
                       
     Stock options
 
-
 
-
               
                         
 
$
1,335
 
67,219
$
0.02
           


 
Three Months Ended
   
 
September 30, 2009
   
 
Income
Shares
Per Share
       
 
(Numerator)
(Denominator)
Amount
       
 
(In Thousands, Except Per Share Data)
   
                         
Net income
$
1,095
                   
Basic earnings per share,
                       
     income available to
                       
     common stockholders
$
1,095
 
68,074
$
0.02
           
Effect of dilutive securities:
                       
     Stock options
 
-
 
-
               
                         
 
$
1,095
 
68,074
$
0.02
           

4.  SUBSEQUENT EVENTS

The Company has evaluated events and transactions occurring subsequent to the statement of financial condition date of September 30, 2010, for items that should potentially be recognized or disclosed in these financial statements.  The evaluation was conducted through the date this document was filed.

5. PROPOSED ACQUISITION OF CENTRAL JERSEY BANCORP

On May 25, 2010, the Company and the Bank entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Central Jersey Bancorp (“Central Jersey”) and its wholly owned subsidiary, Central Jersey Bank, National Association (“Central Jersey Bank”), pursuant to which Central Jersey will merge with a to-be-formed subsidiary of the Company and thereby become a wholly owned subsidiary of the Company (the “Merger”). Immediately thereafter, Central Jersey Bank will merge with and into the Bank (the “Bank Merger”).  Central Jersey Bank will operate as a division of the Bank for at least 18 months after closing.  At September 30, 2010, Central Jersey Bank had $589.4 million in assets and 13 branch offices in Monmouth and Ocean Counties, New Jersey.

 
-9-

 

Under the terms of the Merger Agreement, shareholders of Central Jersey will receive $7.50 in cash (the “Merger Consideration”) for each share of Central Jersey common stock held.  The Merger Agreement also provides that all options to purchase Central Jersey stock that are outstanding and unexercised immediately prior to the closing under Central Jersey’s various stock option plans will be cancelled in exchange for a cash payment equal to the positive difference between $7.50 and the exercise price. The estimated aggregate value of the transaction is $72.3 million.

Central Jersey will use its best efforts to redeem the 11,300 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A previously issued to the U.S. Department of Treasury under the TARP Capital Purchase Plan immediately before or contemporaneously with closing.  The warrant issued to the U.S. Treasury in connection with Treasury’s preferred stock investment will be converted into the right to receive the difference between $7.50 and the warrant exercise price times the number of shares covered by the warrant.

Consummation of the Merger is subject to certain conditions, including, among others, approval of the Merger by shareholders of Central Jersey, governmental filings and regulatory approvals and expiration of applicable waiting periods, absence of litigation, accuracy of specified representations and warranties of the other party, and obtaining material permits and authorizations for the lawful consummation of the Merger and the Bank Merger.  The Merger is also conditioned upon Central Jersey’s nonperforming assets, as defined in the Merger Agreement, not exceeding $20.0 million between March 31, 2010 and the Closing Date.

The shareholders of Central Jersey approved the transaction on September 14, 2010 while the Office of Thrift Supervision issued the requisite regulatory approval on October 20, 2010.  The transaction is expected to close during the Company’s second fiscal quarter ending December 31, 2010.

6. MERGER-RELATED EXPENSES

Merger-related expenses are recorded in the Consolidated Statements of Income and include costs relating to Kearny Financial Corp.’s proposed acquisition of Central Jersey Bancorp as described above.  These charges represent one-time costs associated with acquisition activities and do not represent ongoing costs of the fully integrated combined organization.  Accounting guidance requires that acquisition-related transaction and restructuring costs incurred by the Company be charged to expense as incurred.

7.  RECENT ACCOUNTING PRONOUNCEMENTS

In June 2009, the FASB issued guidance concerning accounting for transfers of financial assets, an amendment to previous guidance on the topic.  This statement prescribes the information that a reporting entity must provide in its financial reports about a transfer of financial assets; the effects of a transfer on its financial position, financial performance and cash flows; and a transferor’s continuing involvement in transferred financial assets.  Specifically, among other aspects, this guidance amends previous guidance concerning accounting for transfers and servicing of financial assets and extinguishments of liabilities by removing the concept of a qualifying special-purpose entity from previous guidance on transfers and servicing and removes the exception from applying previous guidance on transfers and servicing to variable interest entities that are qualifying special-purpose entities.  It also modifies the financial-components approach used in previous guidance.  This guidance is effective for fiscal years beginning after November 15, 2009.  The implementation of this standard did not have a material impact on the Company’s consolidated financial position or results of operations.

In June 2009, the FASB issued guidance concerning consolidation of variable interest entities to require an enterprise to determine whether its variable interest or interests give it a controlling financial

 
-10-

 
interest in a variable interest entity.  The primary beneficiary of a variable interest entity is the enterprise that has both (1) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity.  This guidance also amends previous guidance to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity.  This guidance is effective for fiscal years beginning after November 15, 2009.  The implementation of this standard did not have a material impact on the Company’s consolidated financial position or results of operations.

In October 2009, the FASB issued guidance concerning accounting for own-share lending arrangements in contemplation of convertible debt issuance or other financing.  The guidance amends earlier guidance and provides direction for accounting and reporting for own-share lending arrangements issued in contemplation of a convertible debt issuance.  At the date of issuance, a share-lending arrangement entered into on an entity’s own shares should be measured at fair value in accordance with the guidance on fair value measurements and disclosures and recognized as an issuance cost, with an offset to additional paid-in capital.  Loaned shares are excluded from basic and diluted earnings per share unless default of the share-lending arrangement occurs.  The amendments also require several disclosures including a description and the terms of the arrangement and the reason for entering into the arrangement.  The effective dates of the amendments are dependent upon the date the share-lending arrangement was entered into and include retrospective application for arrangements outstanding as of the beginning of fiscal years beginning on or after December 15, 2009.  The implementation of this standard did not have a material impact on the Company’s consolidated financial position or results of operations.

In January 2010, the FASB issued guidance concerning fair value measurement and disclosures.  The guidance mandates additional disclosure requiring that a reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers while also requiring that in the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuances, and settlements (that is, on a gross basis rather than as one net number).  The guidance clarifies existing fair value disclosure requirements such that a reporting entity should provide fair value measurement disclosures for each class of assets and liabilities. A class is often a subset of assets or liabilities within a line item in the statement of financial position. A reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities.  Moreover, a reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. Those disclosures are required for fair value measurements that fall in either Level 2 or Level 3.  This guidance also includes conforming amendments regarding employers' disclosures about postretirement benefit plan assets.  The conforming amendments change the terminology from “major categories” of assets to “classes” of assets and provide a cross reference to the guidance in Subtopic 820-10 on how to determine appropriate classes to present fair value disclosures.  The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years.  The implementation of the new pronouncement during the quarter ended March 31, 2010 did not have a material impact on the Company’s consolidated financial position or results of operations.  The Company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements for those disclosures that go into effect during fiscal 2012.
 

 
-11-

 

In April, 2010, the FASB issued amended guidance that codifies the consensus reached regarding the effect of a loan modification when the loan is part of a pool that is accounted for as a single asset.  The amendments to the Codification provide that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if expected cash flows for the pool change. The amended guidance does not affect the accounting for loans under the scope of Subtopic 310-30 that are not accounted for within pools. Loans accounted for individually under Subtopic 310-30 continue to be subject to the troubled debt restructuring accounting provisions within Subtopic 310-40.  The amended guidance is effective prospectively for modifications of loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. Upon initial adoption of ASU 2010-18, an entity may make a one-time election to terminate accounting for loans as a pool under Subtopic 310-30. This election may be applied on a pool-by-pool basis and does not preclude an entity from applying pool accounting to subsequent acquisitions of loans with credit deterioration.  The implementation of this standard did not have a material impact on the Company’s consolidated financial position or results of operations.

In July, 2010, the FASB issued guidance concerning disclosures about the credit quality of financing receivables and the allowance for credit losses that will help investors assess the credit risk of a company’s receivables portfolio and the adequacy of its allowance for credit losses held against the portfolios by expanding credit risk disclosures.  This guidance requires more information about the credit quality of financing receivables in the disclosures to financial statements, such as aging information and credit quality indicators.  Both new and existing disclosures must be disaggregated by portfolio segment or class.  The disaggregation of information is based on how a company develops its allowance for credit losses and how it manages its credit exposure.  The amendments in this guidance apply to all public and nonpublic entities with financing receivables.  Financing receivables include loans and trade accounts receivable.  However, short-term trade accounts receivable, receivables measured at fair value or lower of cost or fair value, and debt securities are exempt from these disclosure amendments.  The effective date of the guidance differs for public and nonpublic companies.  For public companies, the amendments that require disclosures as of the end of a reporting period are effective for periods ending on or after December 15, 2010.  The amendments that require disclosures about activity that occurs during a reporting period are effective for periods beginning on or after December 15, 2010.  For nonpublic companies, the amendments are effective for annual reporting periods ending on or after December 15, 2011.  The Company is currently evaluating the potential impact the new pronouncement will have on its consolidated financial statements.

8.  STOCK REPURCHASE PLANS
 
On May 26, 2010, the Company announced that the Board of Directors authorized a stock repurchase plan to acquire up to 889,506 shares, or 5% of the Company’s outstanding stock held by persons other than Kearny MHC.  In accordance with that plan, during the three months ended September 30, 2010, the Company purchased in the open market 368,800 shares at a cost of $3,316,000 and at an average cost per share of $8.99.  Through September 30, 2010, the Company has repurchased a total of 730,900 shares in accordance with this repurchase plan at a total cost of $6,600,000 and at an average cost per share of $9.03.
 
9.  DIVIDEND WAIVER

During the three months ended September 30, 2010, Kearny MHC, the federally chartered mutual holding company of the Company waived its right, in accordance with the non-objection previously

 
-12-

 

granted by the Office of Thrift Supervision (“OTS”), to receive cash dividends of approximately $2.5 million declared on the 50,916,250 shares of Company common stock it owns.

10.  SECURITIES AVAILABLE FOR SALE

The amortized cost, gross unrealized gains and losses, estimated fair value and stratification by contractual maturity of securities available for sale at September 30, 2010 and June 30, 2010 are presented below:
 
 
At September 30, 2010
   
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Carrying
Value
 
(In Thousands)
Securities:
               
  Debt securities:
               
    Trust preferred securities
$
8,857
$
-
$
2,125
$
6,732
    U.S. agency securities
 
3,460
 
1
 
12
 
3,449
    Obligations of state and political
               
      subdivisions
 
18,124
 
1,077
 
-
 
19,201
                 
          Total securities
 
30,441
 
1,078
 
2,137
 
29,382
                 
Mortgage-backed securities:
               
  Mortgage pass-through securities:
               
    Government National Mortgage
               
      Association
 
14,097
 
948
 
29
 
15,016
    Federal Home Loan Mortgage
               
      Corporation
 
308,969
 
10,044
 
69
 
318,944
    Federal National Mortgage Association
 
492,640
 
17,556
 
114
 
510,082
                 
          Total mortgage-backed securities
 
815,706
 
28,548
 
212
 
844,042
                 
          Total securities available for sale
$
846,147
$
29,626
$
2,349
$
873,424

 
 
At September 30, 2010
       
   
Amortized
Cost
 
Carrying
Value
       
 
(In Thousands)
       
Debt securities:
               
    Due in one year or less
$
-
$
-
       
    Due after one year through five years
 
6,306
 
6,653
       
    Due after five years through ten years
 
12,135
 
12,867
       
    Due after ten years
 
12,000
 
9,862
       
                 
          Total
$
30,441
$
29,382
       







 
-13-

 


 
At June 30, 2010
   
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Carrying
Value
 
(In Thousands)
Securities:
               
  Debt securities:
               
    Trust preferred securities
$
8,855
$
-
$
2,255
$
6,600
    U.S. agency securities
 
3,980
 
1
 
39
 
3,942
    Obligations of state and political
               
      subdivisions
 
18,125
 
830
 
-
 
18,955
                 
          Total securities
 
30,960
 
831
 
2,294
 
29,497
                 
Mortgage-backed securities:
               
  Mortgage pass-through  securities:
               
    Government National Mortgage
               
      Association
 
14,660
 
999
 
31
 
15,628
    Federal Home Loan Mortgage
               
      Corporation
 
263,481
 
10,267
 
44
 
273,704
    Federal National Mortgage Association
 
395,273
 
18,884
 
34
 
414,123
                 
          Total mortgage-backed securities
 
673,414
 
30,150
 
109
 
703,455
                 
          Total securities available for sale
$
704,374
$
30,981
$
2,403
$
732,952

There were no sales of securities from the available for sale portfolio during the three months ended September 30, 2010 and September 30, 2009.
 
At September 30, 2010 and June 30, 2010, securities available for sale with carrying value of approximately $247.9 million and $243.7 million, respectively, were utilized as collateral for borrowings via repurchase agreements through the FHLB of New York.  As of those same dates, securities available for sale with carrying values of approximately $1.7 million and $1.4 million, respectively, were pledged to secure public funds on deposit.
 
At September 30, 2010 and June 30, 2010, all obligations of states and political subdivisions were guaranteed by insurance policies issued by various insurance companies.
 
The Company’s available for sale mortgage-backed securities are generally secured by residential mortgage loans with original contractual maturities of ten to thirty years.  However, the effective lives of those securities are generally shorter than their contractual maturities due to principal amortization and prepayment of the mortgage loans comprised within those securities.  Investors in mortgage pass-through securities generally share in the receipt of principal repayments on a pro-rata basis as paid by the borrowers.
 

 
-14-

 

11.  SECURITIES HELD TO MATURITY

The amortized cost, gross unrealized gains and losses, estimated fair value and stratification by contractual maturity of securities held to maturity at September 30, 2010 and June 30, 2010 are as follows:
 
 
At September 30, 2010
   
Carrying
Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In Thousands)
Securities:
               
  Debt securities:
               
    U.S. agency securities
$
229,976
$
2,087
$
-
$
232,063
                 
          Total securities
 
229,976
 
2,087
 
-
 
232,063
                 
Mortgage-backed securities:
               
                 
  Collateralized mortgage obligations:
               
    Federal Home Loan Mortgage
               
      Corporation
 
91
 
12
 
-
 
103
    Federal National Mortgage Association
 
732
 
89
 
-
 
821
    Non-agency securities
 
299
 
3
 
39
 
263
                 
          Total collateralized mortgage
               
            obligations
 
1,122
 
104
 
39
 
1,187
                 
  Mortgage pass-through securities:
               
    Federal Home Loan Mortgage
               
      Corporation
 
163
 
5
 
-
 
168
    Federal National Mortgage Association
 
340
 
7
 
1
 
346
                 
          Total mortgage pass-through securities
 
 
503
 
 
12
 
 
1
 
 
514
                 
          Total mortgage-backed
               
            securities
 
1,625
 
116
 
40
 
1,701
                 
          Total securities held to maturity
$
231,601
$
2,203
$
40
$
233,764


 
At September 30, 2010
       
   
Carrying
Value
 
Fair
Value
       
 
(In Thousands)
       
Debt securities:
               
    Due in one year or less
$
-
$
-
       
    Due after one year through five years
 
160,000
 
161,678
       
    Due after five years through ten years
 
20,000
 
20,102
       
    Due after ten years
 
49,976
 
50,283
       
                 
          Total
$
229,976
$
232,063
       


 
-15-

 



 
At June 30, 2010
   
Carrying
Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In Thousands)
Securities:
               
  Debt securities:
               
    U.S. agency securities
$
255,000
$
1,914
$
-
$
256,914
                 
          Total securities
 
255,000
 
1,914
 
-
 
256,914
                 
Mortgage-backed securities:
               
                 
  Collateralized mortgage obligations:
               
    Federal Home Loan Mortgage
               
      Corporation
 
99
 
12
 
-
 
111
    Federal National Mortgage Association
 
767
 
71
 
1
 
837
    Non-agency securities
 
310
 
2
 
43
 
269
                 
          Total collateralized mortgage
               
            obligations
 
1,176
 
85
 
44
 
1,217
                 
  Mortgage pass-through securities:
               
    Federal Home Loan Mortgage
               
      Corporation
 
168
 
5
 
-
 
173
    Federal National Mortgage Association
 
356
 
9
 
1
 
364
                 
          Total mortgage pass-through securities
 
 
524
 
 
14
 
 
1
 
 
537
                 
          Total mortgage-backed
               
            securities
 
1,700
 
99
 
45
 
1,754
                 
          Total securities held to maturity
$
256,700
$
2,013
$
45
$
258,668


There were no sales of securities from the held to maturity portfolio during the three months ended September 30, 2010 and September 30, 2009.  Held to maturity securities were not utilized as collateral for borrowings nor pledged to secure public funds on deposit during the three months ended September 30, 2010.
 
The Company’s held to maturity collateralized mortgage obligations and mortgage pass-through securities are generally secured by residential mortgage loans with original contractual maturities of ten to thirty years.  However, the effective lives of those securities are generally shorter than their contractual maturities due to principal amortization and prepayment of the mortgage loans comprised within those securities.  Investors in mortgage pass-though securities generally share in the receipt of principal repayments on a pro-rata basis as paid by the borrowers.  In addition to mortgage pass-through securities, the held to maturity portfolio also contains collateralized mortgage obligations.  Such securities generally represent individual tranches within a larger investment vehicle that is designed to distribute cash flows received on securitized mortgage loans to investors in a manner determined by the overall terms and structure of the investment vehicle and those applying to the individual tranches within that structure.
 

 
-16-

 
 
12.  IMPAIRMENT OF SECURITIES

The following three tables summarize the fair values and gross unrealized losses within the available for sale and held to maturity portfolios at September 30, 2010 and June 30, 2010.  The gross unrealized losses, presented by security type, represent temporary impairments of value within each portfolio as of the dates presented.  Temporary impairments within the available for sale portfolio have been recognized through other comprehensive income as reductions in stockholders’ equity on a tax-effected basis.
 
The tables are followed by a discussion that summarizes the Company’s rationale for recognizing the certain impairments as “temporary” versus those identified as “other-than-temporary”.  Such rationale is presented by investment type and generally applies consistently to both the available for sale and held to maturity portfolios, except where specifically noted.  As noted earlier, the Company’s mortgage-backed securities held in the available for sale and held to maturity portfolios are generally secured by residential mortgage loans.

 
Less than 12 Months
 
12 Months or More
 
Total
   
Fair
Value
 
Unrealized Losses
   
Fair
Value
 
Unrealized Losses
   
Fair
Value
 
Unrealized Losses
 
(In Thousands)
Securities Available for Sale:
                           
 
At September 30, 2010:
                           
  Trust preferred securities
$
-
$
-
 
$
5,731
$
2,125
 
$
5,731
$
2,125
  U.S. agency securities
 
-
 
-
   
3,130
 
12
   
3,130
 
12
  Mortgage pass-through securities
 
 
95,239
 
 
115
   
 
815
 
 
97
   
 
96,054
 
 
212
                             
          Total
$
95,239
$
115
 
$
9,676
$
2,234
 
$
104,915
$
2,349

At June 30, 2010:
                           
  Trust preferred securities
$
-
$
-
 
$
5,600
$
2,255
 
$
5,600
$
2,255
  U.S. agency securities
 
-
 
-
   
3,667
 
39
   
3,667
 
39
  Mortgage pass-through securities
 
 
559
 
 
4
   
 
906
 
 
105
   
 
1,465
 
 
109
                             
          Total
$
559
$
4
 
$
10,173
$
2,399
 
$
10,732
$
2,403


The number of available for sale securities with unrealized losses at September 30, 2010 totaled 33 comprising four trust preferred securities, five U.S. agency securities and 24 mortgage pass-through securities.  The number of available for sale securities with unrealized losses at June 30, 2010 totaled 28 comprising four trust preferred securities, six U.S. agency securities and 18 mortgage pass-through securities.

 
-17-

 


 
Less than 12 Months
 
12 Months or More
 
Total
   
Fair
Value
 
Unrealized Losses
   
Fair
Value
 
Unrealized Losses
   
Fair
Value
 
Unrealized Losses
 
(In Thousands)
Securities Held to Maturity:
                           
 
At September 30, 2010:
                           
  Collateralized mortgage
                           
    obligations
$
10
$
2
 
$
198
$
37
 
$
208
$
39
  Mortgage pass-through securities
 
 
63
 
 
1
   
 
-
 
 
-
   
 
63
 
 
1
                             
          Total
$
73
$
3
 
$
198
$
37
 
$
271
$
40

At June 30, 2010:
                           
  Collateralized mortgage
                           
    obligations
$
76
$
3
 
$
218
$
41
 
$
294
$
44
  Mortgage pass-through securities
 
 
66
 
 
1
   
 
-
 
 
-
   
 
66
 
 
1
                             
          Total
$
142
$
4
 
$
218
$
41
 
$
360
$
45

The number of held to maturity securities with unrealized losses at September 30, 2010 totaled 20 comprising 19 collateralized mortgage obligations and one mortgage pass-through security. The number of held to maturity securities with unrealized losses at June 30, 2010 totaled 23 comprising 22 collateralized mortgage obligations and one mortgage pass-through security.
 
U.S. Agency Mortgage-backed Securities.  The carrying value of the Company’s agency mortgage-backed securities totaled $845.4 million at September 30, 2010 and comprised 76.5% of total investments and 35.6% of total assets as of that date.  This category of securities generally includes mortgage pass-through securities and collateralized mortgage obligations issued by U.S. government-sponsored entities such as Ginnie Mae, Fannie Mae and Freddie Mac who guarantee the contractual cash flows associated with those securities.  Those guarantees were strengthened during the 2008-2009 financial crisis during which time Fannie Mae and Freddie Mac were placed into receivership by the federal government.  Through those actions, the U.S. government effectively reinforced the guarantees of their agencies thereby assuring the creditworthiness of the mortgage-backed securities issued by those agencies.
 
With credit risk being reduced to negligible levels due to the U.S. government’s support of these agencies, the unrealized losses on the Company’s investment in U.S. agency mortgage-backed securities are due largely to the combined effects of several market-related factors.  First, movements in market interest rates significantly impact the average lives of mortgage-backed securities by influencing the rate of principal prepayment attributable to refinancing activity.  Changes in the expected average lives of such securities significantly impact their fair values due to the extension or contraction of the cash flows that an investor expects to receive over the life of the security.
 
Generally, lower market interest rates prompt greater refinancing activity thereby shortening the average lives of mortgage-backed securities and vice-versa.  The historically low mortgage rates currently prevalent in the marketplace have created significant refinancing incentive for qualified borrowers.  However, prepayment rates are also influenced by fluctuating real estate values and the overall availability of credit in the marketplace which significantly impacts the ability of borrowers to qualify for
 

 
-18-

 

refinancing.  The deteriorating real estate market values and reduced availability of credit that have characterized the residential real estate marketplace in recent years have stifled demand for residential real estate while reducing the ability of certain borrowers to qualify for the refinancing of existing loans.  To some extent, these factors have offset the effects of historically low interest rates on mortgage-backed security prepayment rates.
 
The market price of mortgage-backed securities, being the key measure of the fair value to an investor in such securities, is also influenced by the overall supply and demand for such securities in the marketplace.  Absent other factors, an increase in the demand for, or a decrease in the supply of a security increases its price.  Conversely, a decrease in the demand for, or an increase in the supply of a security decreases its price.  During fiscal 2008 and fiscal 2009, the volatility and uncertainty in the marketplace had reduced the overall level of demand for mortgage-backed securities which generally had an adverse impact on their prices in the open market.  This was further exacerbated by many larger institutions shedding mortgage-related assets to shrink their balance sheets for capital adequacy purposes thereby increasing the supply of such securities.
 
During fiscal 2010, however, institutional demand for mortgage-backed securities increased reflecting greater stability and liquidity in the financial markets coupled with the intervention of the Federal Reserve as a buyer/holder of such securities.  Moreover, many financial institutions, including the Bank, are experiencing the concurrent effects of strong deposit growth and diminished loan origination volume resulting in increased institutional demand for mortgage-backed securities as investment alternatives to loans.  These factors have continued into fiscal 2011 with market prices of agency mortgage-backed securities generally reflecting the increased institutional demand for such securities.

In sum, the factors influencing the fair value of the Company’s U.S. agency mortgage-backed securities, as described above, generally result from movements in market interest rates and changing real estate and financial market conditions which affect the supply and demand for such securities.  Inasmuch as such market conditions fluctuate over time, the impairments of value arising from these changing market conditions are both “noncredit-related” and “temporary” in nature.
 
The Company has the stated ability and intent to “hold to maturity” those securities so designated.  Moreover, the Company has both the ability and intent, as of the periods presented, to hold the temporarily impaired available for sale securities until the fair value of the securities recovers to a level equal to or greater than the Company’s amortized cost.  As such,  the Company has not decided to sell the securities as of September 30, 2010 and has further concluded that the possibility of being required to sell the securities prior to their anticipated recovery is unlikely based upon its strong liquidity, asset quality and capital position as of that date.  Moreover, the Company purchased these securities at either par or nominal premiums.  Accordingly, the Company expects that the securities will not be settled for a price less than its amortized cost.
 
In light of the factors noted above, the Company does not consider its U.S. agency mortgage-backed securities with unrealized losses at September 30, 2010 to be “other-than-temporarily” impaired as of that date.
 
Non-agency Mortgage-backed Securities. The carrying value of the Company’s non-agency mortgage-backed securities totaled $299,000 at September 30, 2010 and comprised less than one percent of total investments and total assets as of that date.
 
Unlike agency mortgage-backed securities, non-agency collateralized mortgage obligations are not explicitly guaranteed by a U.S. government sponsored entity.  Rather, such securities generally utilize the structure of the larger investment vehicle to reallocate credit risk among the individual tranches
 

 
-19-

 

comprised within that vehicle.  Through this process, investors in different tranches are subject to varying degrees of risk that the cash flows of their tranche will be adversely impacted by borrowers defaulting on the underlying mortgage loans.  The creditworthiness of certain tranches may also be further enhanced by additional credit insurance protection embedded within the terms of the total investment vehicle.
 
The Company monitors the general level of credit risk for each of its non-agency mortgage-backed securities based upon the ratings assigned to its specific tranches by one or more credit rating agencies.  The level of such ratings, and changes thereto, is one of several factors considered by the Company in identifying those securities that may be other-than-temporarily impaired.  For example, all impaired non-agency mortgage-backed securities that are rated below investment grade are reviewed individually to determine if such impairment is other-than-temporary.
 
Additional factors considered by the Company in identifying its other-than-temporarily impaired securities include, but are not limited to, the severity and duration of the impairment, the payment performance of the underlying mortgage loans and trends relating thereto, the original terms of the underlying loans regarding credit quality (ex. Prime, Alt-A), the geographic distribution of the real estate collateral supporting those loans and any current or anticipated declines in associated collateral values, as well as the degree of protection against credit losses afforded to the Company’s security through the structural characteristics of the larger  investment vehicle as noted above.  Based upon these additional factors, the impairment of certain investment grade securities may also be reviewed for other-than-temporary impairment.
 
Securities determined to be potentially other-than-temporarily impaired are individually analyzed to determine the “credit-related” and “noncredit-related” portions of the impairment.  As noted earlier, a credit-related impairment generally represents the amount by which the present value of the cash flows that are expected to be collected on an other-than-temporarily impaired security fall below its amortized cost.  Projected cash flows for the Company’s non-agency mortgage-backed securities are modeled using an automated securities analytics system that is commonly used by institutional investors and the broker/dealer community.  The system generates an individual tranche’s projected cash flows based upon several input assumptions regarding the payment performance of the mortgage loans underlying the larger investment vehicle of which the Company’s tranche is a part.  Such assumptions include, but may not be limited to, loan prepayment rates, loan default rates, and the severity of actual losses on defaulting loans.  The Company generally bases the input values for these assumptions on historical data reported by the analytics system.  The Company then calculates the present value of those cash flows based upon the appropriate discount rate required by the applicable accounting guidance.
 
The impairments of those securities whose cash flows, when present valued, fall below the Company’s amortized cost due to expected principal losses are identified as other-than-temporary.  The amount by which the present value of the expected cash flows falls below the Company’s amortized cost of the security is identified as the credit-related portion of the other-than-temporary impairment.  The remaining portion, where applicable, is identified as noncredit-related, other-than-temporary impairment.
 
The impairments of those individually analyzed securities whose cash flows, when present valued, exceed the Company’s amortized cost or otherwise reflect no expected principal losses, are generally identified as temporary.  Similarly, the impairments associated with those securities that have generally retained their investment-grade credit rating and whose additional factors, as noted above, are not characterized by potentially adverse attributes, are also generally identified as temporary.  In such cases, the Company attributes the unrealized losses to the same fluctuating market-related factors as those affecting agency mortgage-backed securities, noting, in particular, the comparatively greater temporary adverse effect on fair value arising from the general illiquidity of non-agency, investment grade
 

 
-20-

 

mortgage-backed securities in the marketplace compared to agency-guaranteed mortgage-backed securities.  In light of these factors, the related impairments are defined as “temporary”.
 
The classification of impairment as “temporary” is generally reinforced by the Company’s stated intent and ability to “hold to maturity” all of its non-agency mortgage-backed securities which allows for an adequate timeframe during which the fair values of the impaired securities are expected to recover to the level of their amortized cost.  However, in the event of a severe deterioration of a security’s credit characteristics – including, but not limited to, a reduction in credit rating from investment grade to below investment grade and/or the recognition of credit-related impairment resulting from actual or expected deterioration of cash flows - the Company may re-evaluate and restate its intent to hold an impaired security until the expected recovery of its amortized cost.

For example, during the fourth quarter of fiscal 2010, the Company re-evaluated its intent regarding the retention or sale of its impaired, nonagency collateralized mortgage obligations whose credit-ratings had fallen below investment grade.  The Company considered the combined effects of the severe deterioration of the securities’ credit-ratings since their acquisition as investment grade securities and the actual and anticipated cash flow losses that characterized most of the securities.  Based on these factors, the Company modified its intent regarding these impaired securities during the quarter ended June 30, 2010 from “hold to recovery of amortized cost” to “sell” and sold such securities prior to the end of that same quarter.

At September 30, 2010, the Company's remaining portfolio of non-agency CMOs totaled 20 held-to-maturity securities all of which are rated as investment grade at September 30, 2010.  As such,  the Company has not decided to sell the securities as of September 30, 2010 and has further concluded that the possibility of being required to sell the securities prior to their anticipated recovery is unlikely based upon its strong liquidity, asset quality and capital position as of that date.

In light of the factors noted above, the Company does not consider its balance of non-agency mortgage-backed securities with unrealized losses at September 30, 2010 to be “other-than-temporarily” impaired as of that date.
 
U.S. Agency Securities.  The carrying value of the Company’s U.S. agency debt securities totaled $233.4 million at September 30, 2010 and comprised 21.1% of total investments and 9.8% of total assets as of that date.  Such securities are comprised of $230.0 million of U.S. agency debentures and $3.4 million of securitized pools of loans issued and fully guaranteed by the Small Business Administration (“SBA”), a U.S. government sponsored entity.
 
At September 30, 2010, the fair value of the Company’s SBA securities included a combination of unrealized gains and losses.  As of that same date, the fair value of the Company’s portfolio of U.S. agency debentures reflected no unrealized losses.   With credit risk being reduced to negligible levels due to the issuer’s guarantee, the unrealized losses on the Company’s investment in U.S. agency debt securities are due largely to the combined effects of several market-related factors including movements in market interest rates and general level of liquidity of such securities in the marketplace based on supply and demand.
 
With regard to interest rates, the Company’s SBA securities are variable rate investments whose interest coupons are generally based on the Prime index minus a margin.  Based upon the historically low level of short term market interest rates, of which the Prime index is one measure, the current yields on these securities are comparatively low.  Consequently, the fair value of the SBA securities, as determined based upon the market price of these securities, reflects the adverse effects of the historically low short term, market interest rates at September 30, 2010.
 

 
-21-

 

Like the mortgage-backed securities described earlier, the currently diminished fair value of the Company’s SBA securities also reflects the extended average lives of the underlying loans resulting from loan prepayment prohibitions that may be embedded in the underlying loans coupled with the generally reduced availability of credit in the marketplace reducing borrower refinancing opportunities.  Such influences extend the timeframe over which an investor would anticipate holding the security at a “below market” yield.  Similarly, the price of securitized SBA loan pools also reflects fluctuating supply and demand in the marketplace attributable to similar factors as those applying to mortgage-backed securities, as presented above.
 
Unlike its SBA securities, the Company’s U.S. agency debentures are fixed rate investments whose fair values over time reflect movements in comparatively longer term market interest rates.  While there were no unrealized losses in the agency debenture portfolio at September 30, 2010, fluctuation in the fair value of such securities are generally attributable to movements in longer term market interest rates since their acquisition by the Company.
 
In sum, the factors influencing the fair value of the Company’s U.S. agency securities, as described above, generally result from movements in market interest rates and changing market conditions which affect the supply and demand for such securities.  Inasmuch as such market conditions fluctuate over time, the “noncredit-related” impairments of value arising from these changing market conditions are “temporary” in nature.
 
The Company has the stated ability and intent to “hold to maturity” those securities so designated.  Moreover, the Company has both the ability and intent, as of the periods presented, to hold the temporarily impaired available for sale securities until the fair value of the securities recovers to a level equal to or greater than the Company’s amortized cost.  As such,  the Company has not decided to sell the securities as of September 30, 2010 and has further concluded that the possibility of being required to sell the securities prior to their anticipated recovery is unlikely based upon its strong liquidity, asset quality and capital position as of that date.  Moreover, the Company purchased these securities at either par or nominal premiums.  Accordingly, the Company expects that the securities will not be settled for a price less than its amortized cost.
 
In light of the factors noted above, the Company does not consider its balance of U.S. agency securities with unrealized losses at September 30, 2010 to be “other-than-temporarily” impaired as of that date.
 
Trust Preferred Securities. The outstanding balance of the Company’s trust preferred securities totaled $6.7 million at September 30, 2010 and comprised less than one percent of total investments and total assets as of that date.  The category comprises a total of five “single-issuer” (i.e. non-pooled) trust preferred securities, four of which are impaired as of September 30, 2010, that were originally issued by four separate financial institutions.  As a result of bank mergers involving the issuers of these securities, the Company’s five trust preferred securities currently represent the de-facto obligations of three separate financial institutions.
 
The Company generally evaluates the level of credit risk for each of its trust preferred securities based upon ratings assigned by one or more credit rating agencies where such ratings are available.  For those trust preferred securities that are impaired, the Company uses such ratings as a practical expedient to identify those securities whose impairments are potentially “credit-related” versus “noncredit-related”.
 
Specifically, impairments associated with investment-grade trust preferred securities are generally categorized as “noncredit-related” given the nominal level of credit losses that would be expected based upon such ratings.  At September 30, 2010, the Company owned two securities at an amortized cost of
 

 
-22-

 

$2.9 million that were consistently rated as investment grade by Moody’s and Standard & Poor’s Financial Services (“S&P”).  The securities were originally issued through Chase Capital II and currently represent de-facto obligations of JPMorgan Chase & Co.
 
The Company has attributed the unrealized losses on these securities to the combined effects of several market-related factors including movements in market interest rates and general level of liquidity of such securities in the marketplace based on overall supply and demand.
 
With regard to interest rates, the Company’s impaired trust preferred securities are variable rate securities whose interest rates generally float with three month Libor plus a margin.  Based upon the historically low level of short term market interest rates, the current yield on these securities is comparatively low.  Consequently, the fair value of the securities, as determined based upon their market price, reflects the adverse effects of the historically low market interest rates at September 30, 2010.
 
More significantly, the market prices of the impaired trust preferred securities also currently reflect the effect of reduced demand for such securities given the increasingly credit risk-averse nature of financial institutions in the current marketplace.  Additionally, such prices reflect the effects of increased supply arising from financial institutions selling such investments and reducing assets for capital adequacy purposes, as noted earlier.
 
In sum, the factors influencing the fair value of the Company’s investment-grade trust preferred securities, as described above, generally result from movements in market interest rates and changing market conditions which affect the supply and demand for such securities.  Inasmuch as such market conditions fluctuate over time, the “noncredit-related” impairments of value arising from these changing market conditions are “temporary” in nature.
 
The impairments of the Company’s trust preferred securities with one or more non-investment grade ratings are further evaluated to determine if such impairments are “credit-related”.  Factors considered in this evaluation include, but may not be limited to, the financial strength and viability of the issuer and its parent company, the security’s historical performance through prior business and economic cycles, rating consistency or variability among rating companies, the security’s current and anticipated status regarding payment default or deferral of contractual payments to investors and the impact of these factors on the present value of the security’s expected future cash flows in relation to its amortized cost basis.
 
At September 30, 2010, the Company owned two securities at an amortized cost of $4.9 million that were rated as investment grade by Moody’s, but below investment grade by S&P.  The securities were originally issued through BankBoston Capital Trust IV and MBNA Capital B and currently represent de-facto obligations of Bank of America Corporation.
 
In evaluating the impairment associated with these securities, the Company noted the overall financial strength and continuing expected viability of the issuing entity’s parent, particularly given their systemically critical role in the marketplace.  The Company noted the security’s absence of historical defaults or payment deferrals throughout prior business cycles including the recent fiscal crisis that triggered the current economic weaknesses prevalent in the marketplace.  The Company also noted the disparity between investment-grade and non-investment grade ratings for the securities among rating companies which demonstrates the current level of uncertainty regarding credit-risk in the marketplace.  Given these factors, the Company had no basis upon which to estimate an adverse change in the expected cash flows over the securities’ remaining terms to maturity.
 

 
-23-

 

While all of its trust preferred securities are classified as available for sale, the Company has both the ability and intent, as of the periods presented, to hold the impaired securities until their fair values recover to a level equal to or greater than the Company’s amortized cost.  As such,  the Company has not decided to sell the securities as of September 30, 2010 and has further concluded that the possibility of being required to sell the securities prior to their anticipated recovery is unlikely based upon its strong liquidity, asset quality and capital position as of that date.  Moreover, the Company purchased these securities at nominal discounts.  Accordingly, the Company expects that the securities will not be settled for a price less than its amortized cost.
 
In light of the factors noted above, the Company does not consider its investments in trust preferred securities with unrealized losses at September 30, 2010 to be “other-than-temporarily” impaired as of that date.
 
The following table presents roll forwards of OTTI recognized in earnings due to credit-related losses on securities still held at the end of each reporting period.

     
Activity in credit-related other-than-temporary impairment
(“OTTI”) recognized through earnings
   
   
Cumulative balance of
credit-
related
OTTI
recognized
in earnings - beginning
 
Additions
for
newly
identified
credit-
related
OTTI
 
Additions to existing
OTTI for
further
credit-
related
declines in
fair value
 
Reductions
in credit-
related
OTTI for
security sale
 
Reductions
in credit-
related OTTI
due to
accretion of impairment
into interest income
 
Cumulative balance of
credit-
related
OTTI
recognized
in earnings - ending
 
(In Thousands)
Collateralized mortgage
                       
  obligations:
                       
    Non-agency securities:
 
Three months ended
   September 30, 2010
$
-
$
-
$
-
$
-
$
-
$
-
 
        Three months ended
    September 30, 2009
$
434
$
7
$
90
$
-
$
13
$
518

 


 
-24-

 

13.  BENEFIT PLANS – COMPONENTS OF NET PERIODIC EXPENSE

The following table sets forth the aggregate net periodic benefit expense for the Bank’s Benefit Equalization Plan, Postretirement Welfare Plan and Directors’ Consultation and Retirement Plan:

   
Three Months
       
     Ended September 30,        
   
2010
 
2009
       
     (In Thousands)        
                 
Service cost
$
40
$
           38
       
Interest cost
 
83
 
           90
       
Amortization of unrecognized past service
               
   liability
 
18
 
           17
       
Amortization of unrecognized net actuarial
               
   (gain) loss
 
(1)
 
           18
       
                 
Net periodic benefit expense
$
140
$
         163
       


14.  FAIR VALUE OF FINANCIAL INSTRUMENTS

The guidance on fair value measurement establishes a hierarchy that prioritizes the inputs to valuation techniques used to measure fair value.  The hierarchy describes three levels of inputs that may be used to measure fair value:

 
Level 1:
Quoted prices in active markets for identical assets or liabilities.
     
 
Level 2:
Observable inputs other than Level 1 prices, such as quoted for similar assets or liabilities; quoted prices in markets that are not active; or inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
     
 
Level 3:
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

In addition, the guidance requires the Company to disclose the fair value for assets and liabilities on both a recurring and non-recurring basis.


 
-25-

 

Those assets and liabilities measured at fair value on a recurring basis are summarized below:

 
Fair Value Measurements Using
   
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
Balance
 
(In Thousands)
At September 30, 2010:
                             
  Securities available for
                             
 
sale
 
$
-
   
$
28,382
   
$
1,000
   
$
29,382
  Mortgage-backed
                             
 
securities available
                             
 
for sale
   
-
     
844,042
     
-
     
844,042
                               
At June 30, 2010:
                             
  Securities available for
                             
 
sale
 
$
-
   
$
 28,497
   
$
 1,000
   
$
 29,497
  Mortgage-backed
                             
 
securities available
                             
 
for sale
   
-
     
703,455
     
-
     
703,455

The fair values of securities available for sale (carried at fair value) or held to maturity (carried at amortized cost) are primarily determined by obtaining matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

The Company holds a trust preferred security with a par value of $1.0 million, a de-facto obligation of Mercantil Commercebank Florida Bancorp, Inc., whose fair value has been determined by using Level 3 inputs.  It is a part of a $40.0 million private placement with a coupon of 8.90% issued in 1998 and maturing in 2028.  Generally management has been unable to obtain a market quote due to a lack of trading activity for this security.  Consequently, the security’s fair value as reported at September 30, 2010 and June 30, 2010 is based upon the present value of its expected future cash flows assuming the security continues to meet all its payment obligations and utilizing a discount rate based upon the security’s contractual interest rate.  For the three months ended September 30, 2010, there were no purchases, sales, issuances, or settlements of assets or liabilities whose fair values are determined based upon Level 3 inputs on a recurring basis.


 
-26-

 


 
Those assets and liabilities measured at fair value on a non-recurring basis are summarized below:

 
Fair Value Measurements Using
   
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
Balance
 
(In Thousands)
At September 30, 2010
                             
Impaired loans
 
$
        -
   
$
        -
   
$
9,969
   
$
9,969
Real estate owned
   
        -
     
        -
     
581
     
581
                               
At June 30, 2010
                             
Impaired loans
 
$
        -
   
$
        -
   
$
9,781
   
$
9,781
Real estate owned