UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended June 30, 2006
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 0-24040
PENNFED FINANCIAL SERVICES, INC.
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(Exact name of registrant as specified in its charter)
Maryland 22-3297339
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
622 Eagle Rock Avenue, West Orange, New Jersey 07052-2989
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (973) 669-7366
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Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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Common Stock, par value $.01 per share Nasdaq Global Market
Common Stock Purchase Rights Nasdaq Global Market
Securities Registered Pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. YES |_|. NO |X|.
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. YES |_|. NO |X|.
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
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.
(Check one):
Large accelerated filer ___. Accelerated filer X . Non-accelerated filer ___.
---
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 aggregate market value of the voting stock held by non-affiliates of
the registrant, computed by reference to the closing price of such stock on the
Nasdaq Global Market as of December 31, 2005, was $205,111,000. (The exclusion
from such amount of the market value of the shares owned by any person shall not
be deemed an admission by the registrant that such person is an affiliate of the
registrant.)
As of September 1, 2006, there were issued and outstanding 12,848,722
shares of the Registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of Form 10-K - Portions of the Proxy Statement for 2006 Annual Meeting
of Stockholders.
PennFed Financial Services, Inc. and Subsidiaries
2006 Annual Report on Form 10-K
Contents of Report
Page
Number
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PART I
ITEM 1. Business ........................................................................... 1
ITEM 1A. Risk Factors ....................................................................... 21
ITEM 1B. Unresolved Staff Comments .......................................................... 22
ITEM 2. Properties ......................................................................... 22
ITEM 3. Legal Proceedings .................................................................. 22
ITEM 4. Submission of Matters to a Vote of Security Holders ................................ 23
PART II
ITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters .......... 24
ITEM 6. Selected Financial Data ............................................................ 25
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operation 27
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk ......................... 45
ITEM 8. Financial Statements and Supplementary Data ........................................ 46
ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 80
ITEM 9A. Controls and Procedures ............................................................ 80
ITEM 9B. Other Information .................................................................. 80
PART III
ITEM 10. Directors and Executive Officers of the Registrant ................................. 81
ITEM 11. Executive Compensation ............................................................. 81
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters .................................................. 81
ITEM 13. Certain Relationships and Related Transactions ..................................... 82
ITEM 14. Principal Accountants Fees and Services ............................................ 82
PART IV
ITEM 15. Exhibits and Financial Statement Schedules ......................................... 83
PART I
Item 1. Business
General
PennFed Financial Services, Inc. ("PennFed" and with its subsidiaries, the
"Company"), a Maryland corporation, was organized in March 1994 for the purpose
of becoming the savings and loan holding company for Penn Federal Savings Bank
("Penn Federal" or the "Bank") in connection with the Bank's conversion from a
federally chartered mutual savings bank to a federally chartered stock savings
bank (the "Conversion"). PennFed owns all of the outstanding common stock of the
Bank. The Company's common stock is traded on the Nasdaq Global Market Tier of
the Nasdaq Stock Market under the symbol "PFSB."
PennFed and the Bank are subject to comprehensive regulation, examination and
supervision by the Office of Thrift Supervision of the Department of the
Treasury ("OTS") and by the Federal Deposit Insurance Corporation ("FDIC"). The
Bank is a member of the Federal Home Loan Bank ("FHLB") System. Penn Federal's
deposits are insured up to applicable limits by the FDIC.
The Company has been, and intends to continue to be, a community-oriented
financial institution offering a variety of financial services to meet the needs
of the communities it serves. The Company attracts deposits from the general
public and uses these deposits, together with borrowings and other funds, to
originate and purchase one- to four-family residential mortgage loans, and, to a
lesser extent, to originate commercial and multi-family real estate and consumer
loans. See "Originations, Purchases, Sales and Servicing of Loans." The Company
also invests in mortgage-backed securities secured by one- to four-family
residential mortgages, U.S. government agency obligations and other permissible
investments.
The Company offers many types of deposit accounts having a wide range of
interest rates and terms, which generally include savings, money market, and
checking accounts, as well as certificate accounts. The Company generally
solicits deposits in its primary market areas.
At June 30, 2006, the Company had total assets of approximately $2.3 billion,
deposits of $1.4 billion, borrowings of $748 million and stockholders' equity of
$123 million.
Penn Federal offers uninsured non-deposit investment products and through its
wholly-owned subsidiary, Penn Savings Insurance Agency, Inc., offers insurance
products to its customers. Through the Bank's wholly-owned subsidiary, PennFed
Title Service Corporation, the Bank has a 49% ownership interest in a title
insurance agency known as Eagle Rock Title Agency, LLC. See "Subsidiary
Activities."
In October 1997, Penn Federal formed Ferry Development Holding Company, a
Delaware operating subsidiary. In November 2002, Penn Federal formed Eagle Rock
Investment Corp., a New Jersey investment company. Both companies hold and
manage investment portfolios for the Bank.
The administrative offices of the Company are located at 622 Eagle Rock Avenue,
West Orange, New Jersey 07052-2989, and the telephone number at that address is
(973) 669-7366.
The Company's reports, proxy statements and other information the Company files
with the Securities and Exchange Commission (the "SEC"), as well as the
Company's news releases, are available free of charge through our Internet site
at http://www.pennfsb.com. The SEC filings can be found under "Investor
Relations" on the "Documents" page of the Company's Internet site. The Company's
Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to Section
13(a) of the Exchange Act are available as soon as reasonably practicable after
they have been filed with the SEC. Reference to the Company's Internet address
is not intended to incorporate any of the information contained on our Internet
site into this document.
1
Forward-Looking Statements
When used in this Form 10-K and in future filings by the Company with the SEC,
in the Company's press releases or other public or shareholder communications,
and in oral statements made with the approval of an authorized executive
officer, the words or phrases "will likely result," "are expected to," "will
continue," "is anticipated," "estimate," "project" or similar expressions are
intended to identify "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. These statements are subject
to certain risks and uncertainties, including, among other things, changes in
economic and competitive conditions in the Company's market area, changes in
laws and regulations and in policies by regulatory agencies, fluctuations in
interest rates and demand for loans in the Company's market area, the credit
risks of lending activities, including changes in the level and direction of
loan delinquencies and write-offs and changes in estimates of the adequacy of
the allowance for loan losses, the Company's ability to attract and retain
depositors and to obtain cost-effective funding, the relationship of short-term
interest rates to long-term interest rates and the Company's ability to manage
its interest rate risk, competition and terrorist acts that could cause actual
results to differ materially from historical earnings and those presently
anticipated or projected. The Company wishes to caution readers not to place
undue reliance on any forward-looking statements, which speak only as of the
date made. The Company wishes to advise readers that the factors listed above,
as well as other factors, could affect the Company's financial performance and
could cause the Company's actual results for future periods to differ materially
from any opinions or statements expressed with respect to future periods in any
current statements.
The Company will not undertake -- and specifically declines 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
these statements or to reflect the occurrence of anticipated or unanticipated
events.
Market Area
The Company's primary market areas are comprised of the Ironbound section of the
City of Newark and surrounding communities, the suburban Essex County area and
selected areas of central/southern New Jersey, which are serviced through 24
full service offices. Penn Federal was organized in the Ironbound section of
Newark in 1941 and the home office of the Bank remains there. The Ironbound
section of the City of Newark and immediately adjacent communities of East
Newark and Harrison are primarily urban blue collar areas with two or more
family dwellings and some manufacturing and industry. The Company entered Union
County in fiscal 2004 with the opening of a branch in the township of Union.
Deposits at Bank branches in the Ironbound section of the City of Newark and
surrounding communities and the township of Union comprised 28% of total Bank
deposits at June 30, 2006. The suburban Essex County area consists of
communities with predominantly single family homes and a white collar commuter
population. Suburban Essex County is the Bank's largest market area, accounting
for approximately 43% of total Bank deposits at June 30, 2006. Penn Federal's
central/southern New Jersey branches are located in selected areas of Middlesex,
Monmouth and northern Ocean counties. The central/southern region branches, with
29% of total Bank deposits at June 30, 2006, serve retirement populations and
expanding townhouse, multi-family and single family home developments. The Bank
also originates loans secured by properties throughout New Jersey and areas in
eastern Pennsylvania and, from time to time, purchases one-to four-family loans
secured by properties primarily located in New Jersey and other selected
Northeastern states. See "Originations, Purchases, Sales and Servicing of
Loans."
Lending Activities
General. The Company primarily originates fixed and adjustable rate, one- to
four-family first mortgage loans. The Company's policy is to originate such
loans, in general, with maturities between 10 and 30 years. The Company
underwrites mortgage loans generally using Freddie Mac and Fannie Mae
guidelines, although loan amounts may exceed agency limits. A conforming
mortgage loan is defined as a mortgage loan that meets all requirements (size,
type and age) to be eligible for purchase or securitization by federal agencies,
such as Freddie Mac and Fannie Mae. The Company has purchased loans from time to
time generally under the same guidelines under which it originates loans. See
"Loan Portfolio Composition" and "One- to Four-Family Residential Mortgage
Lending."
The Company also originates commercial and multi-family (five units or more)
real estate loans and consumer loans. These loans generally reprice more
frequently, have shorter maturities and/or have higher yields than fixed rate,
one- to four-family mortgage loans. In addition, as part of its commercial
lending activities, the Company originates loans under an accounts receivable
financing program for small and mid-sized businesses and business lines of
credit secured by non-real estate assets.
2
Residential and consumer loan applications may be approved by various officers
up to $1.5 million. Commercial and multi-family real estate loan applications
are initially considered by the Senior Vice President of the Commercial Lending
Group. Generally, commercial and multi-family real estate loans must be approved
by the Executive Loan Committee which consists of the Chief Executive Officer,
Chief Operating Officer, Chief Financial Officer, the Executive Vice President
of the Residential Lending Group and the Senior Vice President of the Commercial
Lending Group. The approval of the Bank's Board of Directors is required for all
loans or relationships above $1.5 million.
The aggregate amount of loans that the Bank is permitted to make under
applicable federal regulations to any one borrower, including related entities,
or the aggregate amount that the Bank could have lent to any one borrower is
generally 15% of unimpaired capital and surplus. See "Regulation-Federal
Regulation of Savings Associations by the OTS." At June 30, 2006, the maximum
amount which the Bank could have lent to any one borrower and the borrower's
related entities was approximately $26.2 million. The Company's current policy
is to limit such loans to a maximum of 50% of the general regulatory limit or
$10.0 million, whichever is less. Any exception to this policy requires approval
of the Board of Directors. At June 30, 2006, the Company's largest group of
loans to one borrower (and any related entities) totaled $8.1 million and
consisted of four commercial real estate loans of $5.0 million, $1.3 million,
$1.3 million and $445,000. At June 30, 2006, there were a total of 25 loans or
lender relationships in excess of $1.5 million, for a total amount of $77.7
million. At that date, all of these loans were performing in accordance with
their respective repayment terms.
Loan Portfolio Composition. The following table sets forth the composition of
the Company's loan portfolio at the dates indicated.
June 30,
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2006 2005 2004
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Amount Percent Amount Percent Amount Percent
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(Dollars in thousands)
First mortgage loans:
One- to four-family(1) .......... $ 1,302,447 77.55% $ 1,148,489 78.52% $ 996,659 77.46%
Commercial and multi-family(2) .. 172,600 10.28 169,765 11.61 172,244 13.39
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Total first mortgage loans . 1,475,047 87.83 1,318,254 90.13 1,168,903 90.85
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Other loans:
Consumer loans:
Second mortgages .............. 153,024 9.11 91,147 6.23 67,538 5.25
Home equity lines of credit ... 47,500 2.83 49,901 3.41 46,288 3.60
Other ......................... 3,922 0.23 3,375 0.23 3,862 0.30
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Total consumer loans ....... 204,446 12.17 144,423 9.87 117,688 9.15
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Total loans ................ 1,679,493 100.00% 1,462,677 100.00% 1,286,591 100.00%
====== ====== ======
Add/(less):
Unamortized premiums,
deferred loan costs, and
other, net ................. 10,619 8,853 7,131
Allowance for loan losses ....... (5,888) (6,050) (6,249)
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Total loans receivable
and loans held for sale, net .. $ 1,684,224 $ 1,465,480 $ 1,287,473
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June 30,
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2003 2002
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Amount Percent Amount Percent
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(Dollars in thousands)
First mortgage loans:
One- to four-family(1) .......... $ 946,560 77.01% $ 1,172,145 81.53%
Commercial and multi-family(2) .. 165,905 13.50 144,585 10.06
---------------------------------------------
Total first mortgage loans . 1,112,465 90.51 1,316,730 91.59
---------------------------------------------
Other loans:
Consumer loans:
Second mortgages .............. 67,290 5.47 58,671 4.08
Home equity lines of credit ... 44,308 3.61 55,247 3.85
Other ......................... 5,060 0.41 6,948 0.48
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Total consumer loans ....... 116,658 9.49 120,866 8.41
---------------------------------------------
Total loans ................ 1,229,123 100.00% 1,437,596 100.00%
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Add/(less):
Unamortized premiums,
deferred loan costs, and
other, net ................. 6,079 9,485
Allowance for loan losses ....... (6,284) (5,821)
---------------------------------------------
Total loans receivable
and loans held for sale, net .. $ 1,228,918 $ 1,441,260
=============================================
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(1) One-to four-family loans include loans held for sale of $217,000, $4.8
million, $11.5 million and $1.6 million at June 30, 2006, 2005, 2003 and
2002, respectively. There were no loans held for sale at June 30, 2004.
(2) Commercial and multi-family loans include loans under an accounts
receivable financing program for small and mid-sized businesses and
business lines of credit secured by non-real estate business assets
totaling $6.4 million, $8.6 million, $12.6 million, $12.6 million and $9.1
million at June 30, 2006, 2005, 2004, 2003 and 2002, respectively.
Loan Maturity. The following schedule sets forth the contractual maturity of the
Company's loan portfolio as of June 30, 2006. Loans that have adjustable rates
are shown as amortizing to final maturity rather than when the interest rates
are next subject to change. Loans with balloon payments are also shown as
amortizing to final maturity (i.e., when the balloon payment is due). All
balances are shown on a gross basis and, thus, do not include the allowance for
loan losses or adjustments for premiums or deferred loan costs. Savings account
loans and overdraft checking balances, included in consumer loans, which have no
stated final maturity, are reported as due within one year. The table does not
reflect the effects of possible prepayments or scheduled principal amortization.
3
After One After Three After Five After Ten
One Year Through Through Through Through After
or Less Three Years Five Years Ten Years Twenty Years Twenty Years Total
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(In thousands)
First mortgage loans:
One- to four-family ......... $ 857 $ 4,409 $ 4,241 $ 57,508 $ 373,829 $ 861,603 $1,302,447
Commercial and multi-family . 7,461 1,801 4,688 37,296 120,938 416 172,600
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Total first mortgage loans 8,318 6,210 8,929 94,804 494,767 862,019 1,475,047
Other loans:
Consumer loans .............. 2,685 3,862 8,325 34,970 113,020 41,584 204,446
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Total loans, gross ....... $ 11,003 $ 10,072 $ 17,254 $ 129,774 $ 607,787 $ 903,603 $1,679,493
===============================================================================================
Loans due after June 30, 2007, which have fixed interest rates amount to $1.2
billion, while those with adjustable rates amount to $424.5 million, detailed as
follows:
Due After June 30, 2007
------------------------------------
Fixed Adjustable Total
------------------------------------
(In thousands)
First mortgage loans:
One- to four-family ................. $1,037,502 $264,088 $1,301,590
Commercial and multi-family ......... 52,235 112,904 165,139
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Total first mortgage loans ....... 1,089,737 376,992 1,466,729
Other loans:
Consumer loans ...................... 154,283 47,478 201,761
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Total loans, gross ............... $1,244,020 $424,470 $1,668,490
====================================
One- to Four-Family Residential Mortgage Lending. At June 30, 2006, the
Company's one- to four-family residential mortgage loans totaled $1.3 billion,
or approximately 77.6% of the Company's gross loan portfolio. Residential loan
originations are generated by the Company's in-house originations staff through
marketing efforts, present customers, walk-in customers and referrals from
attorneys, accounting firms, real estate agents, mortgage brokers and builders.
The Company focuses its lending efforts primarily on the origination of loans
secured by first mortgages on owner-occupied, one- to four-family residences.
During the fiscal year ended June 30, 2006, the Company originated $327.4
million of real estate loans secured by first mortgages on one- to four-family
residential real estate. All of the Company's one- to four-family residential
mortgage originations are secured by properties located in the State of New
Jersey and areas in eastern Pennsylvania.
The Company currently originates one- to four-family residential mortgage loans
with terms of up to 30 years in amounts up to 95% of the appraised value of the
property. The Company generally requires that private mortgage insurance be
obtained in an amount sufficient to reduce the Company's exposure to 80% or less
of the loan-to-value level. Interest rates charged on loans are appropriately
priced according to market and competitive conditions.
In underwriting one- to four-family residential real estate loans, the Company
evaluates the borrower's ability to make monthly payments, past credit history
and the value of the property securing the loan. Properties securing real estate
loans made by the Company are appraised by a licensed in-house appraiser or
independent appraisers, all of whom are approved by the Board of Directors. The
Company requires borrowers to obtain title insurance in the amount of the loan.
In addition, the Company requires borrowers to obtain fire and property
insurance (including flood insurance up to a maximum available of $500,000, if
necessary) in the amount of the replacement cost. Real estate loans originated
and purchased by the Company contain a "due on sale" clause allowing the Company
to declare the unpaid principal balance due and payable upon the sale of the
property.
Commercial and Multi-Family Real Estate Lending. The Company engages in
commercial and multi-family real estate lending primarily in its market areas.
At June 30, 2006, the Company had $172.6 million of commercial and multi-family
real estate loans which represented 10.3% of the Company's gross loan portfolio.
This amount includes $1.3 million of lines of credit secured by non-real estate
business assets and $5.1 million of loans under an accounts receivable financing
program for small and mid-sized businesses. At June 30, 2006, the average per
loan balance of the Company's commercial and multi-family real estate loans
outstanding was $464,000. As of June 30, 2006, approximately 70% of the loans in
the commercial and multi-family real estate loan portfolio were adjustable rate
loans.
4
The Company's commercial and multi-family real estate loan portfolio is secured
primarily by first mortgage liens on apartment buildings, mixed-use buildings,
small office buildings, restaurants, warehouses and strip shopping centers.
Commercial and multi-family real estate loans typically have terms that do not
exceed 15 years and have a variety of rate adjustment features and other terms.
Generally, the loans are made in amounts up to 75% of the appraised value of the
property. Adjustable rate commercial and multi-family real estate loans normally
provide for a margin over various U.S. Treasury securities adjusted to a
constant maturity, with periodic adjustments, or are tied to the prime rate as
reported in the Wall Street Journal. In underwriting these loans, the Company
analyzes the current financial condition of the borrower, the borrower's credit
history, the value of the property securing the loan, and the reliability and
predictability of the cash flow generated by the property securing the loan. The
Company usually requires personal guarantees of individuals who are principals
of the borrowers. Appraisals on properties securing commercial real estate loans
originated by the Company are performed by independent appraisers approved by
the Board of Directors.
Commercial and multi-family real estate loans generally present a higher level
of risk than loans secured by one- to four-family residences. This greater risk
is due to several factors, including the concentration in a limited number of
loans and borrowers, the effect of general economic conditions on
income-producing properties and the increased difficulty of evaluating and
monitoring these types of loans. Furthermore, the repayment of loans secured by
commercial and multi-family real estate is typically dependent upon the
successful operation of the related real estate project. If the cash flow from
the project is reduced (e.g., if leases are not obtained or renewed or if a
major tenant is unable to fulfill its lease obligations), the borrower's ability
to repay the loan may be impaired.
Under the accounts receivable financing program, credit is extended to the
customer based upon the amount of receivables purchased by the Company. The
Company has actual ownership of these receivables. Remittances from the account
debtors of the customer are made directly to the Company's lockbox account. Risk
under this type of lending is further limited by the establishment of a cash
collateral reserve account used to offset any receivables that do not pay
timely. Furthermore, accounts receivable default and fraud insurance is obtained
as additional protection. The facility can be terminated at the Company's option
upon 60 days notice to the customer. Accounts receivable financing is done with
full recourse to the customer and is generally guaranteed by the principals of
the customer. In addition to the accounts receivable as collateral, the Company
typically obtains additional collateral in the form of a lien on the customer's
business assets and/or real estate.
Consumer Lending. The Company offers a variety of secured consumer loans,
including home equity lines of credit, second mortgages, automobile loans, boat
loans and loans secured by savings deposits. In addition, the Company offers
unsecured overdraft checking protection. At June 30, 2006, the Company's total
consumer loan portfolio was $204.4 million, or 12.2% of its gross loan
portfolio, of which approximately 76% were fixed rate loans and 24% were
adjustable rate loans. The Company originates nearly all of its consumer loans
throughout the State of New Jersey and areas in eastern Pennsylvania.
The Company originates adjustable rate home equity lines of credit and fixed
rate second mortgage loans. Home equity lines of credit and second mortgage
loans, together with loans secured by all prior liens, are generally limited to
80% of the appraised value of the property securing the loan. The Company also
offers 100% equity financing up to $100,000, with these loans re-underwritten
and insured through a mortgage insurance company. As of June 30, 2006, second
mortgage loans have a maximum term of up to 20 years. Home equity lines of
credit may have draw periods up to 10 years with repayment terms up to 15 years
beyond the draw period. As of June 30, 2006, second mortgage loans and home
equity lines of credit amounted to $200.5 million or 98.1% of the Company's
consumer loan portfolio.
Consumer loan terms vary according to the type and value of collateral and
length of contract. The underwriting standards employed by the Company for
consumer loans include an application, a determination of the applicant's
payment history on other debts and an assessment of the applicant's ability to
meet existing obligations and payments on the proposed loan. Although
creditworthiness of the applicant is a primary consideration, the underwriting
process also includes a comparison of the value of the security, if any, in
relation to the proposed loan amount.
Consumer loans may entail greater credit risk than residential first mortgage
loans, particularly in the case of consumer loans which are secured by rapidly
depreciable assets, such as automobiles and boats. In such cases, any
repossessed collateral from a defaulted consumer loan may not provide an
adequate source of repayment of the outstanding loan balance as a result of the
greater likelihood of damage, loss or depreciation. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be affected by adverse personal circumstances.
Furthermore, the application of various federal and state laws, including
bankruptcy and insolvency laws, may limit or eliminate the amount which can be
recovered on such loans.
5
Originations, Purchases, Sales and Servicing of Loans
For the year ended June 30, 2006, the Company originated $501.2 million of
loans, compared to $479.7 million and $528.0 million in fiscal 2005 and 2004,
respectively. Mortgage loan originations are handled by employees of the
Company.
During the year ended June 30, 2006, the Company purchased $13.4 million of one-
to four-family first mortgage loans. There were no loans purchased during the
year ended June 30, 2005. During the year ended June 30, 2004, the Company
purchased $53.0 million of one- to four-family first mortgage loans. During the
year ended June 30, 2006, loans secured by properties in New Jersey were
purchased through a correspondent relationship with a mortgage company that was
able to originate, fund and sell shorter duration one- to four-family loans to
the Bank. With a decline in mortgage refinance activity in fiscal 2006, the loan
purchases were a means to maintain the Company's loan production levels. For the
year ended June 30, 2004, the purchased loans represented large bulk loan
purchases of adjustable rate and fixed rate first mortgages secured by
properties primarily located in selected northeastern and mid-Atlantic states
(i.e., Connecticut, Delaware, Maryland, Massachusetts, Pennsylvania and
Virginia). The fiscal 2004 loan purchases were viewed as a means of investing
excess cash from the high levels of loan prepayments.
From time to time, the Company has engaged in loan sale strategies -- selling
loans to Freddie Mac and other secondary market purchasers, and to other
financial institutions, as a part of its efforts to manage interest rate risk.
During the year ended June 30, 2006, approximately $29.5 million of
predominately conforming, fixed rate one- to four-family residential mortgage
loans were sold into the secondary market and to other financial institutions,
respectively. During the year ended June 30, 2005, approximately $35.6 million
of predominately conforming, fixed rate one- to four-family residential mortgage
loans were sold into the secondary market and to other financial institutions,
respectively. During the year ended June 30, 2004, approximately $87.4 million
of predominately conforming, fixed rate one- to four-family residential mortgage
loans were sold into the secondary market and to other financial institutions,
respectively. In addition, during the year ended June 30, 2004, a $3.0 million
commercial real estate loan participation was sold as a means to reduce the
Company's credit exposure on a single commercial real estate property.
The level of loan sale activity is continuously evaluated with primary
consideration given to interest rate risk management, long-term profitability
and liquidity objectives.
When loans are sold, the Company may retain the responsibility for servicing the
loans or may sub-service the loans for a short term period. The Company receives
a fee for performing these services. The Company serviced for others primarily
one- to four-family mortgage loans with an aggregate outstanding principal
balance of $76.1 million, $69.1 million and $66.3 million at June 30, 2006, 2005
and 2004, respectively. At June 30, 2006 and 2005, the carrying value of the
Company's mortgage servicing rights was immaterial in relation to total assets
and is included in Other assets on the Company's Consolidated Statements of
Financial Condition.
6
The following table sets forth the activity in the Company's loan portfolio for
the years indicated.
Year ended June 30,
------------------------------------
2006 2005 2004
------------------------------------
(In thousands)
Net loans receivable and loans held for sale at beginning of year $1,465,480 $1,287,473 $1,228,918
Plus:
Loans originated:
One- to four-family ...................................... 327,445 350,274 409,799
Commercial and multi-family real estate .................. 42,060 38,612 43,222
Consumer ................................................. 131,729 90,808 75,002
------------------------------------
Total loans originated ................................ 501,234 479,694 528,023
------------------------------------
One- to four-family loans purchased .......................... 13,407 -- 53,034
------------------------------------
Total loans originated and purchased .................. 514,641 479,694 581,057
------------------------------------
Less:
Loans sold ................................................... 29,540 35,643 90,395
Loan principal payments and other, net ....................... 265,880 265,572 432,107
Loans transferred to real estate owned ....................... 477 472 --
------------------------------------
Net loans receivable and loans held for sale at end of year ..... $1,684,224 $1,465,480 $1,287,473
====================================
Non-Performing and Classified Assets
Generally, when a borrower fails to make a required payment on a real estate
secured loan or other secured loan, collection procedures are initiated with
the mailing of a late charge notice and the customer is contacted by telephone.
At the end of the first month, a delinquency notice is issued. In many cases,
delinquencies are cured promptly; however, if a loan secured by real estate or
other collateral has been delinquent for more than 65 days, a letter of notice
of intention to foreclose is sent and the customer is requested to make
arrangements to bring the loan current. At 95 days past due, unless satisfactory
arrangements have been made, immediate repossession commences or foreclosure
procedures are instituted. For unsecured loans, the collection procedures are
similar; however, at 90 days past due, a specific reserve or charge-off is
recommended and, subsequently, a lawsuit is filed, if necessary, to obtain a
judgement.
7
The table below sets forth the Company's amounts and categories of
non-performing assets and restructured loans. Loans are placed on non-accrual
status when the collection of principal or interest becomes delinquent more than
90 days. There are no loans delinquent more than 90 days which are still
accruing. Real estate owned represents assets acquired in the settlement of
loans (generally through foreclosure or a deed in lieu) and is shown net of
valuation allowances.
At June 30,
----------------------------------------------
2006 2005 2004 2003 2002
----------------------------------------------
(Dollars in thousands)
Non-accruing loans:
One- to four-family ................ $1,025 $1,713 $2,158 $1,451 $2,905
Commercial and multi-family ........ 731 904 -- -- --
Consumer ........................... 24 2 24 231 370
----------------------------------------------
Total non-accruing loans .......... 1,780 2,619 2,182 1,682 3,275
Real estate owned, net .............. -- -- -- 28 28
----------------------------------------------
Total non-performing assets ...... 1,780 2,619 2,182 1,710 3,303
Restructured loans .................. 61 -- -- -- --
----------------------------------------------
Total risk elements .............. $1,841 $2,619 $2,182 $1,710 $3,303
==============================================
Non-accruing loans as a percentage
of total loans .................. 0.11% 0.18% 0.17% 0.14% 0.23%
==============================================
Non-performing assets as a percentage
of total assets ................. 0.08% 0.13% 0.11% 0.09% 0.17%
==============================================
Total risk elements as a percentage
of total assets ................. 0.08% 0.13% 0.11% 0.09% 0.17%
==============================================
For the year ended June 30, 2006, gross interest income which would have been
recorded had the non-accruing loans been current in accordance with their
original terms amounted to $36,000; $1,000 of this amount was included in
interest income for the year ended June 30, 2006.
Non-Performing Assets. Non-accruing loans at June 30, 2006 were comprised of ten
one- to four-family loans aggregating $1,025,000, two commercial loans
aggregating $731,000 and three consumer loans aggregating $24,000. Non-accruing
loans at June 30, 2005 were comprised of 13 one- to four-family loans
aggregating $1,713,000, three commercial loans aggregating $904,000 and six
consumer loans aggregating $2,000.
Other Loans of Concern. As of June 30, 2006, there were $2.9 million of other
loans not included in the table or discussed above where known information about
the possible credit problems of borrowers caused management to have doubts as to
the ability of the borrower to comply with present loan repayment terms and
which may result in disclosure of such loans in the future. These loans of
concern have been considered by management in conjunction with the analysis of
the adequacy of the allowance for loan losses.
Classified Assets. Federal regulations provide for the classification of loans
and other assets such as debt and equity securities considered by the OTS to be
of lesser quality as "substandard," "doubtful" or "loss." An asset is considered
"substandard" if it is inadequately protected by the current net worth and
paying capacity of the obligor or of the collateral pledged, if any.
"Substandard" assets include those characterized by the "distinct possibility"
that the savings institution will sustain "some loss" if the deficiencies are
not corrected. Assets classified as "doubtful" have all of the weaknesses
inherent in those classified "substandard," with the added characteristic that
the weaknesses present make "collection or liquidation in full," on the basis of
currently existing facts, conditions and values, "highly questionable and
improbable." Assets classified as "loss" are those considered "uncollectible"
and of such little value that the establishment of a specific loss reserve is
warranted.
When a savings institution classifies problem assets as either substandard or
doubtful, it may establish general allowances for loan losses in an amount
deemed prudent by management. General allowances represent loss allowances which
have been established to recognize the inherent risk associated with lending
activities. When a savings institution classifies problem assets as "loss," it
is required to either establish a specific reserve equal to 100% of that portion
of the asset so classified or to charge-off such amount.
8
In connection with the filing of its periodic reports with the OTS and in
accordance with its classification of assets policy, the Bank regularly reviews
the assets in its portfolio to determine whether any assets require
classification in accordance with applicable regulations. On the basis of
management's review of its assets at June 30, 2006, the Bank's classified assets
totaled $2.3 million, of which $1.6 million were classified as substandard. At
June 30, 2006, total classified assets represented 1.83% of the Company's
stockholders' equity and 0.10% of the Company's total assets.
Allowance for Loan Losses. The allowance for loan losses is established through
charges to income based on management's evaluation of the probable credit
losses presently inherent in the Company's loan portfolio. This evaluation,
which includes a review of loans for which full collectibility may not be
reasonably assured, considers among other matters, loan classifications
discussed above, the estimated fair value of the underlying collateral, economic
conditions, historical loan loss experience, portfolio growth and composition
and other factors that warrant recognition in providing for an adequate loan
loss allowance.
Real estate properties acquired through foreclosure are recorded at the lower of
cost or estimated fair value less costs to dispose of such properties. If the
fair value at the date of foreclosure is lower than the balance of the related
loan, the difference will be charged-off to the allowance for loan losses at the
time of transfer. Valuations are periodically updated by management and if the
value declines, a specific provision for losses on real estate owned is
established by a charge to income.
Although management believes that it uses the best information available to
determine the allowances, unforeseen market conditions could result in
adjustments and earnings could be significantly affected if circumstances differ
substantially from the assumptions used in making the final determination.
Future additions to the Company's allowance will be the result of periodic loan,
property and collateral reviews and thus cannot be predicted in advance. In
addition, federal regulatory agencies, as an integral part of the examination
process, periodically review the Company's allowance for loan losses. These
agencies may require the Company to record additions to the allowance level
based upon their assessment of the information available to them at the time of
examination. See Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations "-Critical Accounting Policies."
9
The following table sets forth an analysis of the Company's allowance for loan
losses at the dates and for the periods indicated.
Year ended June 30,
-------------------------------------------------------
2006 2005 2004 2003 2002
-------------------------------------------------------
(Dollars in thousands)
Balance at beginning of year ........ $ 6,050 $ 6,249 $ 6,284 $ 5,821 $ 4,248
Charge-offs:
One- to four-family ............... (127) (165) -- (20) (20)
Commercial and multi-family ....... (4) (2) -- -- --
Consumer .......................... (31) (32) (35) (42) (32)
-------------------------------------------------------
(162) (199) (35) (62) (52)
-------------------------------------------------------
Recoveries:
One- to four-family ............... -- -- -- -- --
Commercial and multi-family ....... -- -- -- -- --
Consumer .......................... -- -- -- -- --
-------------------------------------------------------
-- -- -- -- --
-------------------------------------------------------
Net charge-offs ..................... (162) (199) (35) (62) (52)
Additions charged to operations ..... -- -- -- 525 1,625
-------------------------------------------------------
Balance at end of year .............. $ 5,888 $ 6,050 $ 6,249 $ 6,284 $ 5,821
=======================================================
Ratio of net charge-offs during the
year to average loans outstanding
during the year ................... 0.01% 0.01% 0.00% 0.00% 0.00%
=======================================================
Ratio of allowance for loan losses
to total loans at end of year ..... 0.35% 0.41% 0.48% 0.51% 0.40%
=======================================================
Ratio of allowance for loan losses to
non-accruing loans at end of year . 330.79% 231.00% 286.39% 373.60% 177.74%
=======================================================
The distribution of the Company's allowance for loan losses at the dates
indicated is summarized in the following table.
June 30,
-----------------------------------------------------------------------------------------------
2006 2005 2004 2003
----------------------------------------------------------------------------------------------
Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in
Each Each Each Each
Category Category Category Category
to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans
----------------------------------------------------------------------------------------------
(Dollars in thousands)
One- to four-family ...... $ 2,819 77.55% $ 3,006 78.52% $ 2,896 77.46% $ 2,869 77.01%
Commercial and
multi-family real estate 2,314 10.28 2,396 11.61 2,768 13.39 2,767 13.50
Consumer ................. 755 12.17 648 9.87 585 9.15 648 9.49
----------------------------------------------------------------------------------------------
Total ................ $ 5,888 100.00% $ 6,050 100.00% $ 6,249 100.00% $ 6,284 100.00%
==============================================================================================
June 30,
----------------------
2002
----------------------
Percent of
Loans in
Each
Category
to Total
Amount Loans
----------------------
(Dollars in thousands)
One- to four-family ...... $ 2,928 81.53%
Commercial and
multi-family real estate 2,040 10.06
Consumer ................. 853 8.41
--------------------
Total ................ $ 5,821 100.00%
====================
10
Investment Activities
General. The Bank maintains appropriate levels of investments for liquidity
purposes. Liquidity may increase or decrease depending upon the availability of
funds and comparative yields on investments in relation to the return on loans.
Historically, the Bank has maintained its liquid assets at a level believed
adequate to meet the requirements of normal daily activities, repayment of
maturing debt and potential deposit outflows.
At June 30, 2006, the Company had a securities portfolio consisting principally
of U.S. government agency securities and mortgage-backed securities issued by
Ginnie Mae, Freddie Mac and Fannie Mae. These investments carry a low risk
weighting for OTS risk-based capital purposes and are considered liquid assets.
See "Regulation-Regulatory Capital Requirements." The majority of investment
securities and all mortgage-backed securities were classified as held to
maturity at June 30, 2006, as the Company has a positive intent and ability to
hold these securities to maturity. All investment securities not classified as
held to maturity are classified as available for sale.
The following table sets forth the composition of the Company's investment and
mortgage-backed securities portfolios at the dates indicated.
June 30,
----------------------------------------------------------------
2006 2005
----------------------------------------------------------------
Estimated Percent Estimated Percent
Fair of Total Fair of Total
Carrying Market Carrying Carrying Market Carrying
Value Value Value Value Value Value
----------------------------------------------------------------
(Dollars in thousands)
Investment securities:
Available for sale:
Equity securities ................. $ 4,936 $ 4,936 1.04% $ 5,011 $ 5,011 1.16%
----------------------------------------------------------------
Held to maturity:
U.S. government
agency obligations ............ 406,470 386,621 85.93 371,487 371,270 85.81
Corporate bonds ................... 1,018 1,144 0.22 1,022 1,236 0.24
Trust preferred securities ........ 32,872 32,898 6.95 32,989 34,220 7.62
----------------------------------------------------------------
Total held to maturity ........ 440,360 420,663 93.10 405,498 406,726 93.67
----------------------------------------------------------------
Total investment securities ... 445,296 425,599 94.14 410,509 411,737 94.83
FHLB of New York stock ............... 27,714 27,714 5.86 22,391 22,391 5.17
----------------------------------------------------------------
Total investment securities
and FHLB of New York stock . $473,010 $453,313 100.00% $432,900 $434,128 100.00%
================================================================
Mortgage-backed securities:
Ginnie Mae .................... $ 55 $ 58 0.09% $ 151 $ 163 0.19%
Freddie Mac ................... 28,382 27,378 45.08 35,221 35,581 45.04
Fannie Mae .................... 34,413 33,444 54.65 42,529 43,204 54.38
Collateralized Mortgage
Obligations/REMICs/IOs ....... 13 13 0.02 161 161 0.21
----------------------------------------------------------------
62,863 60,893 99.84 78,062 79,109 99.82
Unamortized premiums, net ......... 100 -- 0.16 139 -- 0.18
----------------------------------------------------------------
Total mortgage-backed securities $ 62,963 $ 60,893 100.00% $ 78,201 $ 79,109 100.00%
================================================================
June 30,
------------------------------
2004
------------------------------
Estimated Percent
Fair of Total
Carrying Market Carrying
Value Value Value
------------------------------
(Dollars in thousands)
Investment securities:
Available for sale:
Equity securities ................. $ 4,720 $ 4,720 1.05%
------------------------------
Held to maturity:
U.S. government
agency obligations ............ 386,134 377,610 86.05
Corporate bonds ................... 1,026 1,276 0.23
Trust preferred securities ........ 33,100 34,329 7.37
------------------------------
Total held to maturity ........ 420,260 413,215 93.65
------------------------------
Total investment securities ... 424,980 417,935 94.70
FHLB of New York stock ............... 23,773 23,773 5.30
------------------------------
Total investment securities
and FHLB of New York stock . $448,753 $441,708 100.00%
==============================
Mortgage-backed securities:
Ginnie Mae .................... $ 249 $ 271 0.25%
Freddie Mac ................... 45,526 45,718 45.49
Fannie Mae .................... 53,860 54,430 53.82
Collateralized Mortgage
Obligations/REMICs/IOs ....... 225 225 0.22
------------------------------
99,860 100,644 99.78
Unamortized premiums, net ......... 219 -- 0.22
------------------------------
Total mortgage-backed securities $100,079 $100,644 100.00%
==============================
Investment Securities. At June 30, 2006, the Company's investment securities
(including $4.9 million of investment securities available for sale, $440.4
million of investment securities held to maturity and a $27.7 million investment
in FHLB of New York stock) totaled $473.0 million, or 20.5% of its total assets.
The Company's general policy is to purchase U.S. government securities and
federal agency obligations and other investment grade securities in accordance
with its strategic objectives, including, but not limited to, liquidity, growth,
yield and interest rate risk management and to provide collateral for
borrowings. In prior years, PennFed invested in certain non-investment grade
trust preferred securities of other financial institutions. At June 30, 2006,
PennFed held $10.9 million of such non-investment grade securities. In addition,
investment securities at June 30, 2006 included $22.0 million of investment
grade trust preferred securities.
11
OTS regulations limit investments in corporate debt and equity securities by the
Bank. See "Regulation-Federal Regulation of Savings Associations by the OTS" for
a discussion of additional restrictions on the Company's investment activities.
The following table indicates the composition of the held to maturity portion of
the investment securities portfolio based on the final maturities of each
investment. Securities in the investment portfolio in the amount of $439.3
million have call features and, thus, depending on future interest rates, may
have a much shorter life than final maturity.
June 30, 2006
---------------------------------------------------------------------------------------------------
After After
One Year Five Years After
One Year Through Through Ten
or Less Five Years Ten Years Years
---------------------------------------------------------------------------------------------------
Book Weighted Book Weighted Book Weighted Book Weighted
Value Average Yield Value Average Yield Value Average Yield Value Average Yield
---------------------------------------------------------------------------------------------------
(Dollars in thousands)
U.S. government
agency obligations .... $ -- --% $ 9,996 4.40% $76,850 5.28% $319,624 5.47%
Corporate bonds ........... -- -- 1,018 9.25 -- -- -- --
Trust preferred
securities ............ -- -- -- -- -- -- 32,872 8.00
---------------------------------------------------------------------------------------------------
Total investment securities
held to maturity ...... $ -- --% $11,014 4.85% $76,850 5.28% $352,496 5.71%
===================================================================================================
June 30, 2006
--------------------------
Total Investment
Securities Held
to Maturity
--------------------------
Book Weighted
Value Average Yield
--------------------------
(Dollars in thousands)
U.S. government
agency obligations .... $406,470 5.41%
Corporate bonds ........... 1,018 9.25
Trust preferred
securities ............ 32,872 8.00
------------------------
Total investment securities
held to maturity ...... $440,360 5.61%
========================
The Company's investment securities portfolio at June 30, 2006 did not contain
tax-exempt securities or securities of any single issuer with an aggregate book
value in excess of 10% of the Company's retained earnings, excluding those
issued by the U.S. government or its agencies.
Mortgage-Backed Securities. At June 30, 2006, mortgage-backed securities totaled
$63.0 million, or 2.7% of the Company's total assets, of which approximately
4.5% consisted of adjustable rate securities. The Company has invested primarily
in securities of Freddie Mac and Fannie Mae.
The following table indicates the composition of the mortgage-backed securities
portfolio based on the final maturities of each security.
June 30, 2006
---------------------------------------------------------------------------------------------------
After After
One Year Five Years After
One Year Through Through Ten
or Less Five Years Ten Years Years
---------------------------------------------------------------------------------------------------
Book Weighted Book Weighted Book Weighted Book Weighted
Value Average Yield Value Average Yield Value Average Yield Value Average Yield
---------------------------------------------------------------------------------------------------
(Dollars in thousands)
Ginnie Mae ................ $ 1 7.50% $ 21 8.12% $ -- --% $ 33 8.97%
Freddie Mac ............... 2 8.00 1,666 6.97 -- -- 26,716 4.96
Fannie Mae ................ -- -- 900 6.77 797 7.00 32,814 5.27
Collateralized Mortgage
Obligations/REMICs/IOs . -- -- -- -- -- -- 13 6.50
-----------------------------------------------------------------------------------------------
Total mortgage-backed
securities ............ $ 3 7.88% $2,587 6.91% $ 797 7.00% $59,576 5.13%
===============================================================================================
June 30, 2006
------------------------
Total Mortgage-Backed
Securities Held
to Maturity
------------------------
Book Weighted
Value Average Yield
------------------------
(Dollars in thousands)
Ginnie Mae ................ $ 55 8.62%
Freddie Mac ............... 28,384 5.08
Fannie Mae ................ 34,511 5.35
Collateralized Mortgage
Obligations/REMICs/IOs . 13 6.50
-----------------------
Total mortgage-backed
securities ............ $62,963 5.23%
=======================
The Ginnie Mae, Freddie Mac and Fannie Mae certificates are modified
pass-through mortgage-backed securities that represent undivided interests in
underlying pools of fixed rate, or certain types of adjustable rate,
single-family residential mortgages issued by these government-sponsored
entities. Ginnie Mae's guarantee to the certificate holder of timely payments of
principal and interest is backed by the full faith and credit of the U.S.
government. Freddie Mac and Fannie Mae provide the certificate holder a
guarantee of timely payments of interest and scheduled principal payments,
whether or not they have been collected. In accordance with Statement of
Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities" ("SFAS 140"), with
certain loan sales, the Company may record an interest-only strip ("IO"). These
IO's represent the contractual right to receive some or all of the interest due
on the mortgage loans sold.
12
The following table sets forth the activity in the Company's mortgage-backed
securities portfolio for the years indicated.
Year ended June 30,
------------------------------
2006 2005 2004
------------------------------
(In thousands)
Mortgage-backed securities, net:
At beginning of year ....................... $ 78,201 $100,079 $ 93,632
Plus:
Securities purchased .................... -- -- 54,823
Less:
Principal repayments .................... 15,058 21,739 47,976
Amortization of premiums, net ........... 180 139 400
------------------------------
At end of year ............................. $ 62,963 $ 78,201 $100,079
==============================
Sources of Funds
General. The Company's sources of funds are deposits, borrowings, payment of
principal and interest on loans and mortgage-backed securities, interest
received on and maturities or calls of other investment securities and funds
provided from operations.
Deposits. The Company offers a variety of deposit accounts having a wide range
of interest rates and terms. The Company's deposits consist of savings, money
market and demand deposit accounts, as well as certificate accounts currently
ranging in terms up to 60 months. The Company solicits deposits primarily from
its market areas and relies on its product mix, appropriate pricing policies,
advertising, customer service and customer relationships to attract and retain
deposits. The Company also solicits short term deposits from municipalities in
its market areas. As of June 30, 2006, certificates of deposit from
municipalities totaled $6.2 million and checking accounts from municipalities
totaled $4.6 million.
The variety of deposit accounts offered by the Company has allowed it to be
competitive in obtaining funds and to respond with flexibility to changes in
consumer demand. The Company endeavors to manage the pricing of its deposits in
keeping with its asset/liability management, liquidity and profitability
objectives. In this regard, the Company has from time-to-time paid slightly
higher rates than its competitors to attract deposits. Based on its experience,
the Company believes that its savings, money market and demand deposit accounts
are relatively stable sources of deposits. However, the ability of the Company
to attract and maintain certificates of deposit and the rates paid on these
deposits has been and will continue to be significantly affected by market
conditions, including general economic conditions, changes in interest rates and
the extremely competitive New Jersey deposit market. When appropriate, the
Company has from time to time utilized brokered deposits as an alternate source
of funds. At June 30, 2006 and 2005, the Company had $65.4 million and $66.1
million, respectively, of brokered deposits. See Item 8 - Financial Statements -
Note H - Deposits - of the Notes to Consolidated Financial Statements.
The following table sets forth the deposit flows of the Company during the
periods indicated.
Year ended June 30,
---------------------------------------------
2006 2005 2004
---------------------------------------------
(Dollars in thousands)
Opening balance ............. $1,339,491 $1,188,100 $1,094,666
Net deposits ................ 36,064 123,307 69,326
Interest credited ........... 39,033 28,084 24,108
---------------------------------------------
Ending balance .............. $1,414,588 $1,339,491 $1,188,100
============================================
Net increase ................ $ 75,097 $ 151,391 $ 93,434
============================================
Percent increase ............ 5.61% 12.74% 8.54%
============================================
13
The following table indicates the amount of the Company's certificates of
deposit by time remaining until maturity as of June 30, 2006.
Maturity
---------------------------------------------------------
Over Over Over
3 Months 3 to 6 6 to 12 12
or Less Months Months Months Total
---------------------------------------------------------
(In thousands)
Certificates of deposit less than $100,000 ... $ 147,767 $ 148,187 $ 105,253 $ 147,826 $ 549,033
Certificates of deposit of $100,000 or more .. 58,954 50,322 52,001 90,179 251,456
---------------------------------------------------------
Total certificates of deposit ................ $ 206,721 $ 198,509 $ 157,254 $ 238,005 $ 800,489
=========================================================
Borrowings. Although deposits are the Company's primary source of funds, the
Company's policy has been to utilize borrowings when they are a less costly
source of funds, when the Company desires additional capacity to fund loan
demand, or to extend the life of its liabilities as a means of managing exposure
to interest rate risk.
The Company's borrowings historically have consisted of advances from the FHLB
of New York, and to a lesser extent, reverse repurchase agreements and, from
time to time, overnight repricing lines of credit. FHLB of New York advances can
be obtained pursuant to several different credit programs, each of which has its
own interest rate and range of maturities.
Junior Subordinated Deferrable Interest Debentures. In 2001, PennFed formed
PennFed Capital Trust II (the "Trust II"), which on March 28, 2001 sold $12.0
million of 10.18% cumulative trust preferred securities in a private transaction
exempt from registration under the Securities Act of 1933, as amended (the
"Act"). Trust II used the proceeds from the sale of its trust preferred
securities and from the sale of $0.4 million of its common securities to PennFed
to purchase $12.4 million of 10.18% junior subordinated deferrable interest
debentures issued by PennFed, which are the sole assets of Trust II. These
junior subordinated deferrable interest debentures mature in 2031 and are
redeemable at any time after ten years. The obligations of PennFed related to
Trust II constitute a full and unconditional guarantee by PennFed of Trust II
obligations under its trust preferred securities. PennFed used the proceeds from
the junior subordinated deferrable interest debentures for general corporate
purposes, including a $4.2 million capital contribution to the Bank to support
growth.
In 2003, PennFed formed PennFed Capital Trust III (the "Trust III"), which on
June 2, 2003 sold $30.0 million of variable rate cumulative trust preferred
securities in a private transaction exempt from registration under the Act.
Trust III used the proceeds from the sale of its trust preferred securities and
from the sale of $0.9 million of its common securities to PennFed to purchase
$30.9 million of variable rate junior subordinated deferrable interest
debentures issued by PennFed, which are the sole assets of Trust III. These
junior subordinated deferrable interest debentures mature in 2033 and are
redeemable at any time after five years. The interest rate on the $30.0 million
of trust preferred securities and the $30.9 million junior subordinated
deferrable interest debentures resets quarterly and was 8.58% and 6.66% at June
30, 2006 and 2005, respectively. The obligations of PennFed related to Trust III
constitute a full and unconditional guarantee by PennFed of Trust III
obligations under its trust preferred securities. PennFed used the proceeds from
the junior subordinated deferrable interest debentures together with available
cash to redeem $34.5 million of 8.90% cumulative trust preferred securities
issued by PennFed Capital Trust I in October 1997.
In accordance with the full adoption in fiscal 2003 of Financial Accounting
Standards Board Interpretation No. 46, "Consolidation of Variable Interest
Entities" ("FIN 46"), the Company's trust subsidiaries are not consolidated.
14
The following table sets forth the maximum month-end balance, average balance,
year-end balance and weighted average cost of FHLB of New York advances, other
borrowings and junior subordinated deferrable interest debentures for the
periods indicated.
Year ended June 30,
--------------------------------
2006 2005 2004
--------------------------------
(Dollars in thousands)
Maximum month-end balance for the year ended:
FHLB of New York advances ............................ $465,465 $435,465 $504,465
================================
Other borrowings:
Overnight repricing lines of credit ............... $136,250 $ 68,400 $ 15,200
Reverse repurchase agreements callable or maturing
within one year ................................. 88,271 22,206 34,260
Reverse repurchase agreements callable or maturing
after one year .................................. 29,986 54,461 24,986
Unsecured revolving line of credit ................ 7,772 9,586 9,892
--------------------------------
Total other borrowings ......................... $262,279 $154,653 $ 84,338
================================
Junior subordinated debentures, net ................. $ 42,126 $ 42,082 $ 42,037
================================
Average balance for the year ended:
FHLB of New York advances ............................ $440,226 $425,319 $489,699
================================
Other borrowings:
Overnight repricing lines of credit ............... $ 95,093 $ 48,820 $ 3,452
Reverse repurchase agreements callable or maturing
within one year ................................. 51,578 14,252 20,590
Reverse repurchase agreements callable or maturing
after one year .................................. 24,876 47,646 1,898
Unsecured revolving line of credit ................ 6,209 7,567 5,368
--------------------------------
Total other borrowings .......................... $177,756 $118,285 $ 31,308
================================
Junior subordinated debentures, net ................. $ 42,104 $ 42,059 $ 42,015
================================
Balance at June 30:
FHLB of New York advances ............................ $465,465 $415,465 $475,465
================================
Other borrowings:
Overnight repricing lines of credit ............... $134,150 $ 45,150 $ 7,000
Reverse repurchase agreements callable or maturing
within one year ................................. 88,271 15,000 17,468
Reverse repurchase agreements callable or maturing
after one year .................................. 10,000 39,461 24,986
Unsecured revolving line of credit ................ 7,772 8,341 9,892
--------------------------------
Total other borrowings .......................... $240,193 $107,952 $ 59,346
================================
Junior subordinated debentures, net ................. $ 42,126 $ 42,082 $ 42,037
================================
Weighted average cost of funds for the year ended:
FHLB of New York advances ............................ 5.65% 5.80% 5.76%
Other borrowings:
Overnight repricing lines of credit ............... 4.48% 2.30% 1.13%
Reverse repurchase agreements callable or maturing
within one year ................................ 3.81% 2.23% 4.38%
Reverse repurchase agreements callable or maturing
after one year ................................. 3.65% 3.32% 2.95%
Unsecured revolving line of credit ................ 5.87% 3.82% 2.66%
Junior subordinated debentures, net .................. 8.69% 7.24% 6.42%
Weighted average cost of funds at June 30:
FHLB of New York advances ............................ 5.47% 5.75% 5.70%
Other borrowings:
Overnight repricing lines of credit ............... 5.40% 3.49% 1.56%
Reverse repurchase agreements callable or maturing
within one year ................................ 4.60% 2.88% 1.21%
Reverse repurchase agreements callable or maturing
after one year ................................. 3.59% 3.42% 3.23%
Unsecured revolving line of credit ................ 6.63% 4.64% 2.63%
Junior subordinated debentures, net .................. 9.04% 7.67% 6.32%
15
Subsidiary Activities
As a federally chartered savings association, Penn Federal is permitted by OTS
regulations to invest up to 2% of its assets, or $46.0 million at June 30, 2006,
in the stock of, or loans to, service corporation subsidiaries. Penn Federal
currently has two service corporations, Penn Savings Insurance Agency, Inc.
("PSIA") and PennFed Title Service Corporation ("PTSC"). At June 30, 2006, the
net book values of Penn Federal's investments in PSIA and PTSC were $136,000 and
$39,000, respectively.
PSIA offers insurance products and the Bank offers uninsured non-deposit
investment products to the Company's customers and members of the general public
through a program known as Investment Services at Penn Federal. The sale of
securities, such as mutual funds and variable rate annuities, and securities
brokerage services are provided by an agreement with the Bank and INVEST
Financial Corporation ("INVEST"), a non-affiliated registered broker dealer,
member NASD and SIPC. Fixed annuity and insurance products are provided by an
agreement with PSIA and INVEST Financial Corporation Insurance Agency, Inc. of
Maryland ("INVEST Insurance"), a non-affiliated licensed insurance agency and a
subsidiary of INVEST. The Bank's relationship with INVEST and PSIA's
relationship with INVEST Insurance enhance the Investment Services at Penn
Federal program by giving customers a wide array of insurance and uninsured
non-deposit investment products, while offering convenient access to financial
consulting and advisory services and securities brokerage services. To a much
lesser extent, PSIA also offers homeowners insurance to Bank customers.
PTSC was formed to participate in the ownership of a title insurance agency
known as Eagle Rock Title Agency, LLC. PTSC is a joint venture partner, owning
49%, with a third party title agency owning the remainder. PTSC has no active
role in the management of the company.
In addition to investments in service corporations, federal associations are
permitted to invest an unlimited amount in operating subsidiaries engaged solely
in activities which a federal association may engage in directly. As of June 30,
2006, the Bank's investment in its operating subsidiaries, Ferry Development
Holding Company ("FDHC") and Eagle Rock Investment Corp. ("ERIC"), was $342.8
million and $157.7 million, respectively. FDHC and ERIC hold and manage
investment portfolios for the Bank.
Competition
The Company faces strong competition, both in originating real estate and other
loans and in attracting deposits. Competition in originating real estate loans
comes primarily from commercial banks, other savings associations, mortgage
banking companies and credit unions making loans secured by real estate located
in New Jersey. Competition in originating non-real estate loans comes mainly
from commercial banks and other savings associations. Commercial banks, credit
unions and finance companies provide vigorous competition in consumer lending.
The Company competes for real estate and other loans principally on the basis of
the quality of services it provides to borrowers, interest rates and loan fees
it charges, and the types of products offered.
The Company attracts substantially all of its deposits through its branches,
primarily from the communities in which those offices are located; therefore,
competition for those deposits is principally from commercial banks, savings
associations, credit unions and brokerage houses. The Company competes for these
deposits by offering a variety of deposit accounts at appropriately priced
rates, quality customer service, convenient business hours and branch locations
with interbranch deposit and withdrawal privileges.
16
REGULATION
General
Penn Federal is a federally chartered savings bank, and accordingly, the Bank is
subject to comprehensive federal regulation and oversight by the OTS extending
to all its operations. Penn Federal is a member of the FHLB of New York and
certain of its activities are subject to regulation by the Board of Governors of
the Federal Reserve System ("Federal Reserve Board"). As the savings and loan
holding company of Penn Federal, PennFed is also subject to federal regulation
and oversight by the OTS. The Bank is a member of the Deposit Insurance Fund
("DIF") and the deposits of Penn Federal are insured by the FDIC up to
applicable limits. As a result, the FDIC has regulatory and examination
authority over the Bank. For purposes of the "Regulation" discussion, the terms
"savings bank," "savings association" and "savings institution" apply to the
Bank.
Certain of these regulatory requirements and restrictions are discussed below or
elsewhere in this document.
Federal Regulation of Savings Associations by the OTS
The OTS has extensive authority over the operations of savings associations. As
part of this authority, Penn Federal is required to file periodic reports with
the OTS and is subject to periodic examinations by the OTS. The last regular OTS
examination of the Bank was as of September 2005.
The OTS, as well as the other federal banking agencies, has developed guidelines
establishing safety and soundness standards on matters such as loan
underwriting and documentation, internal controls and audit systems, asset
quality, earning standards, interest rate risk exposure and compensation and
other employee benefits.
Insurance of Accounts and Regulation by the FDIC
Penn Federal's deposits are insured by the DIF, which is administered by the
FDIC. Deposits are insured up to applicable limits by the FDIC. As insurer, the
FDIC may impose deposit insurance premiums and is authorized to conduct
examinations of, and to require reporting by, FDIC-insured institutions. The
FDIC may prohibit any FDIC-insured institution from engaging in any activity the
FDIC determines by regulation or order to pose a serious risk to the deposit
insurance funds. The FDIC also has the authority to initiate enforcement actions
against savings associations, after giving the OTS an opportunity to take such
action, and may terminate the savings association's deposit insurance if it
determines that the savings association has engaged or is engaging in unsafe or
unsound practices, or is in an unsafe or unsound condition.
Deposit Insurance Assessments
Under the Federal Deposit Insurance Reform Act of 2005, by November 5, 2006, the
Federal Deposit Insurance Corporation must promulgate new regulations on
risk-based deposit insurance assessments. The Federal Deposit Insurance
Corporation has proposed regulations that would create four Risk Categories.
Risk Category I would apply to institutions that are well capitalized and have
composite CAMELS ratings of 1 or 2. CAMELS is an acronym for the six supervisory
ratings assigned in examinations for an institution's capital adequacy, asset
quality, management, earnings, liquidity and sensitivity to market risk. Annual
base rate assessments for Risk Category I would range between 2 and 4 basis
points, applied to an institution's assessment base, which is generally its
deposits. Within Risk Category I, the precise base rate for an institution would
be determined for an institution with less than $10 billion in assets by a
formula using the institution's CAMELS ratings, certain financial ratios and
other factors. A different method would apply for institutions with assets of
$10 billion or more. Any Risk Category I institution less than 7 years old would
be assessed at the highest rate for Risk Category I. The Federal Deposit
Insurance Corporation has stated that currently, 95% of institutions it insures
would be in Risk Category I. Risk Categories II, III, and IV would apply to
institutions with progressively greater risk of loss to the deposit insurance
fund. The proposed base rates for these categories would be 7, 25 and 40 basis
points, respectively.
Under the proposed regulations, the FDIC would be able to increase the base
assessment rates by up to 5 basis points without new regulations. Any
institution insured by the FDIC on December 31, 1996, such as the Bank, which
had previously paid assessments (or its successor in a merger or consolidation)
would be eligible for a one-time credit against assessments under the new
regulations. Federal Deposit Insurance Corporation officials have indicated that
base assessment rates in the final regulations could be higher than stated in
the proposed regulations.
17
Regulatory Capital Requirements
Federally insured savings associations, such as Penn Federal, are required to
maintain a minimum level of regulatory capital. The OTS has established capital
standards, including a tangible capital requirement, a leverage ratio (or core
capital) requirement and a risk-based capital requirement. These capital
requirements must be generally as stringent as the comparable capital
requirements for national banks. The OTS is also authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of adjusted
total assets (as defined by regulation). Tangible capital generally includes
common stockholders' equity and retained earnings, and certain noncumulative
perpetual preferred stock. In addition, all intangible assets, other than
certain amounts of mortgage servicing rights, and accumulated unrealized gains
and losses on certain available for sale securities must be deducted from assets
and capital for calculating compliance with the requirements. At June 30, 2006,
Penn Federal had no intangible assets other than qualifying mortgage servicing
rights.
At June 30, 2006, Penn Federal had tangible capital of $168.7 million, or 7.33%
of adjusted total assets, which was approximately $134.2 million above the
minimum requirement of $34.5 million or 1.5% of adjusted total assets in effect
on that date.
The capital standards also require core capital equal to at least 3% of adjusted
total assets and 4% of risk-weighted assets (as described below). As a result of
the prompt corrective action provisions discussed below, however, a savings
association must maintain a ratio of core capital to adjusted total assets of
at least 4% to be considered adequately capitalized unless its supervisory
condition is such as to allow it to maintain a 3% ratio. Core capital generally
consists of tangible capital plus certain intangible assets up to 25% of
adjusted total assets. At June 30, 2006, Penn Federal did not have any
intangibles which were subject to these tests.
At June 30, 2006, Penn Federal had core capital of $168.7 million, or 7.33% of
adjusted total assets, which was approximately $76.7 million above the $92.1
million or 4% required to be considered adequately capitalized.
The OTS risk-based capital requirement requires savings associations to have
total capital of at least 8% of risk-weighted assets. Total capital consists of
core capital, as defined above, and supplementary capital. Supplementary capital
consists of selected items, such as certain permanent and maturing capital
instruments that do not qualify as core capital, allowances for loan and lease
losses up to a maximum of 1.25% of risk-weighted assets and up to 45% of pretax
unrealized gains, net of unrealized losses, on available for sale equity
securities. Supplementary capital may be used to satisfy the risk-based
requirement only to the extent of core capital. At June 30, 2006, the Bank had
no capital instruments that qualify as supplementary capital. The Bank had $5.9
million of allowances for loan and lease losses at June 30, 2006, all of which
was included as supplementary capital since it was less than 1.25% of
risk-weighted assets.
In determining the amount of risk-weighted assets, all assets, including certain
off-balance sheet items, are multiplied by a risk weight, ranging from 0% to
100% as assigned by OTS capital regulations based on the risk inherent in the
type of assets.
On June 30, 2006, Penn Federal had total risk-based capital of $174.6 million
(consisting of $168.7 million in core capital and $5.9 million in allowable
supplementary capital) and risk-weighted assets of $1.3 billion (including $45.3
million in converted off-balance sheet items primarily represented by unused
lines of credit) resulting in a risk-based capital ratio of 13.81% of
risk-weighted assets. This amount was $73.5 million above the $101.2 million or
8% required on that date.
Penn Federal met all the requirements to be considered a "well capitalized"
institution as of June 30, 2006. The OTS and the FDIC are authorized and, under
certain circumstances required, to take certain actions against savings
associations that fail to meet their capital requirements.
Limitations on Dividends and Other Capital Distributions
OTS regulations impose various restrictions or requirements on associations with
respect to their ability to pay dividends or make other distributions of
capital. OTS regulations prohibit an association from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
capital of the association would be reduced below the association's minimum
capital requirements or the amount required to be maintained for the liquidation
account established in connection with the Conversion.
18
Generally, associations may make capital distributions without OTS approval
during any calendar year equal to 100% of calendar year-to-date net income plus
retained net income for the two previous calendar years. The Bank is required to
give the OTS 30 days notice prior to declaring any dividend to PennFed on its
stock. The OTS may object to the distribution during that 30-day period based on
safety and soundness concerns. See "Regulatory Capital Requirements."
Qualified Thrift Lender Test
All savings associations, including Penn Federal, are required to meet a
qualified thrift lender ("QTL") test to avoid certain restrictions on their
operations. This test requires a savings association to have at least 65% of its
portfolio assets (as defined by regulation) in qualified thrift investments on a
monthly average for nine out of every twelve months on a rolling basis. As an
alternative, the savings association may meet the Internal Revenue Service's
Domestic Building and Loan Association test by maintaining 60% of its assets in
those assets specified in Section 7701(a)(19)(C) of the Internal Revenue Code of
1986, as amended (the "Code"). Under either test, such assets primarily consist
of residential housing related loans and investments. At June 30, 2006, the Bank
met the QTL test and has always met the test since its effective date.
Any savings association that fails to meet the QTL test must convert to a
national bank charter, unless it re-qualifies as a QTL and thereafter remains a
QTL. If an association does not re-qualify and converts to a national bank
charter, it must remain insured with the FDIC. Until such an association has
re-qualified or converted to a national bank, its new investments and activities
are limited to those permissible for both a savings association and a national
bank, and it is limited to national bank branching rights in its home state.
In addition, such an association is immediately ineligible to receive any new
FHLB of New York borrowings and is subject to national bank limits for payment
of dividends. If the association has not re-qualified or converted to a national
bank within three years after the failure, it must divest itself of all
investments and cease all activities not permissible for a national bank. In
addition, it must repay promptly any outstanding FHLB of New York borrowings,
which may result in prepayment penalties. If any association that fails the QTL
test is controlled by a holding company, then within one year after the failure,
the holding company must register as a bank holding company and become subject
to all restrictions on bank holding companies.
Community Reinvestment Act
Under the Community Reinvestment Act ("CRA"), every FDIC insured institution has
a continuing and affirmative obligation consistent with safe and sound banking
practices to help meet the credit needs of its entire community, including low
and moderate income neighborhoods. The CRA does not establish specific lending
requirements or programs for financial institutions nor does it limit an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community, consistent with CRA. The
CRA requires the OTS, in connection with the examination of Penn Federal, to
assess the institution's record of meeting the credit needs of its communities
and to take this record into account in its evaluation of certain applications,
such as a merger, by Penn Federal. A less than "satisfactory" rating may be used
by the OTS as the basis for the denial of an application.
Due to the heightened attention being given to the CRA in recent years, the Bank
has devoted additional funds for investment and lending in its local
communities. CRA compliance ratings given by the OTS include "outstanding,"
"satisfactory," "needs improvement" and "substantial noncompliance." The Bank
was last examined for CRA compliance in February 2004 and was notified in July
2004 that it received a rating of "satisfactory."
Transactions with Affiliates
Generally, transactions between a savings association or its subsidiaries and
its affiliates are required to be on terms as favorable to the association as
transactions with non-affiliates. In addition, certain of these transactions,
such as loans to affiliates, are restricted to a percentage of the association's
capital. Affiliates of Penn Federal include PennFed. Furthermore, a savings
association may not lend to any affiliate engaged in activities not permissible
for a bank holding company or acquire the securities of most affiliates. Penn
Federal's subsidiaries are not deemed affiliates; however, the OTS has the
discretion to treat subsidiaries of savings associations as affiliates on a
case-by-case basis.
19
Federal Securities Law
The common stock of PennFed is registered with the SEC under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). PennFed is subject to the
information, proxy solicitation, insider trading restrictions and other
requirements of the Exchange Act and the rules and regulations of the SEC
thereunder.
PennFed stock held by persons who are affiliates (generally executive officers,
directors and principal stockholders) of PennFed may not be resold without
registration or unless the stock is sold in accordance with certain resale
restrictions. If PennFed meets specified current public information
requirements, each affiliate of PennFed may sell in the public market, without
registration, a limited number of shares in any three-month period.
Federal Home Loan Bank System
Penn Federal is a member of the FHLB of New York, which is one of 12 regional
FHLBs that provide loans and correspondent services to its members. Each FHLB
serves as a reserve or central bank for its members within its assigned region.
It is funded primarily from proceeds derived from the sale of consolidated
obligations of the FHLB System. It makes loans to members (i.e., advances) in
accordance with policies and procedures established by the board of directors of
the FHLB, which are subject to the oversight of the Federal Housing Finance
Board. All borrowings from the FHLB are required to be fully secured by
sufficient collateral as determined by the FHLB.
As a member, Penn Federal is required to purchase and maintain stock in the FHLB
of New York. At June 30, 2006, the Bank had $27.7 million in FHLB of New York
stock, which was in compliance with this requirement. Over the past five fiscal
years, the yields earned on its FHLB of New York stock have averaged 4.01% per
annum.
Federal and State Taxation
Federal Taxation. PennFed files consolidated federal income tax returns with the
Bank and its subsidiaries. In addition to the regular income tax, corporations,
including savings associations such as the Bank, are generally subject to a
minimum tax. An alternative minimum tax is imposed at a rate of 20% on
alternative minimum taxable income, which is the sum of a corporation's regular
taxable income (with certain adjustments) and tax preference items, less any
available exemption. The alternative minimum tax is imposed to the extent it
exceeds the corporation's regular income tax. This excess amount may then be
used as a credit in a future year to offset the income tax liability calculated
under the regular income tax method. Net operating losses can offset no more
than 90% of alternative minimum taxable income.
The Bank and its consolidated subsidiaries have been audited by the Internal
Revenue Service ("IRS") with respect to its consolidated federal income tax
returns through December 31, 1991. There were no material adjustments made to
taxable income as originally reported to the IRS. In the opinion of management,
any examination of still open returns (including returns of subsidiaries and
predecessors of PennFed) would not result in a deficiency which would have a
material adverse effect on the financial condition of the Company and its
consolidated subsidiaries.
New Jersey Taxation. Earnings for the Bank are taxed at a 9% corporate tax rate.
In addition, New Jersey imposes an alternative minimum assessment. The Bank is
required to pay the greater of the regular corporate tax or the alternative
minimum assessment. The amount of alternative minimum assessment can be used in
a future year as a credit to offset the income tax liability calculated under
the regular corporate business tax. The alternative minimum assessment is based
on either 0.4% of gross receipts (less certain deductions) or 0.8% of gross
profits. PennFed and ERIC are taxed under the New Jersey Corporation Business
Tax Act (the "Tax Act"), and if they meet certain tests, will be taxed as
investment companies at an effective annual rate of 3.6% of New Jersey taxable
income (as defined in the Tax Act). If they fail to meet these tests, they will
be taxed at an annual rate of 9% of New Jersey taxable income. It is anticipated
that PennFed and ERIC will be taxed as investment companies. PSIA and PTSC are
taxed at the corporate tax rate of 9% on their New Jersey taxable income.
Delaware Taxation. FDHC, a Delaware investment company, is exempt from Delaware
corporate income tax, but is required to file an annual report with and pay
annual fees to the State of Delaware. FDHC is also subject to an annual
franchise tax imposed by the State of Delaware. As Delaware business trusts,
treated as grantor trusts for income tax purposes, PennFed Capital Trust II and
PennFed Capital Trust III are not required to pay income or franchise taxes to
the State of Delaware.
Maryland Taxation. PennFed, a Maryland corporation, currently does not pay
Maryland income taxes because it does not conduct any business in that state.
Unlike the State of Delaware, the State of Maryland does not impose a franchise
tax on corporations incorporated under its laws.
20
Executive Officers
The executive officers of PennFed are elected annually and hold office until
their respective successors have been elected and qualified or until death,
resignation or removal by the Board of Directors. The principal executive
officers of PennFed are as follows: Joseph L. LaMonica, President and Chief
Executive Officer; Jeffrey J. Carfora, Senior Executive Vice President and Chief
Operating Officer; Patrick D. McTernan, Senior Executive Vice President, General
Counsel and Secretary; and Claire M. Chadwick, Senior Executive Vice President
and Chief Financial Officer. Executive officers of PennFed do not receive any
remuneration in their capacity as PennFed executive officers.
The following table sets forth certain information regarding the executive
officers of the Bank who are not also directors.
Name Age Positions Held with the Bank
- -----------------------------------------------------------------------------------------------------------------------------
Jeffrey J. Carfora .................. 48 Senior Executive Vice President and Chief Operating Officer
Claire M. Chadwick .................. 46 Senior Executive Vice President and Chief Financial Officer
Maria F. Magurno .................... 54 Executive Vice President and Residential Lending Group Executive
Anthony V. Bilotta, Jr. ............. 45 Executive Vice President and Retail Banking Group Executive
Officers are elected annually by the Board of Directors of the Bank. The
business experience of each executive officer who is not also a director is set
forth below.
Jeffrey J. Carfora - Mr. Carfora is responsible for the daily operations of the
Bank. Mr. Carfora also assists President LaMonica in the development of
corporate policies and goals. Mr. Carfora joined Penn Federal in 1993 as Senior
Vice President and Chief Financial Officer and was appointed Executive Vice
President in 1999. He was named Senior Executive Vice President and Chief
Operating Officer in 2001. Mr. Carfora is a Certified Public Accountant.
Claire M. Chadwick - Ms. Chadwick is responsible for the financial affairs of
the Bank, which include financial and tax accounting and reporting, budgeting
and investor relations. Ms. Chadwick joined Penn Federal in 1994 and served as
the Bank's Senior Vice President and Controller since 1999. She was named
Executive Vice President and Chief Financial Officer in 2002 and Senior
Executive Vice President in 2005. Ms. Chadwick is a Certified Public Accountant.
Maria F. Magurno - Ms. Magurno joined the Bank in October 1997 as Vice President
of Residential Lending. Ms. Magurno is responsible for the Bank's residential
lending operations. She was named Senior Vice President in 1999 and Executive
Vice President in 2001.
Anthony V. Bilotta, Jr. - Mr. Bilotta joined the Bank in July 2005 as Senior
Vice President of Branch Administration. He was promoted to Executive Vice
President and Retail Banking Group Executive in July 2006. Mr. Bilotta is
responsible for the Bank's branch network, as well as the Bank's Investment
Services at Penn Federal program. Prior to joining the Bank, Mr. Bilotta had
various retail banking experience with several other banking institutions.
Employees
At June 30, 2006, the Company and its subsidiaries had a total of 272 employees,
including 58 part-time employees. The Company's employees are not represented by
any collective bargaining group.
Item 1A. Risk Factors
Rising interest rates may negatively impact the Company's results of operations.
The Company's results of operations are primarily dependent on net interest
income, which is the difference between the interest income earned on its
interest earning assets such as loans, mortgage-backed securities and investment
portfolios and the interest expense paid on interest bearing liabilities, such
as deposits and borrowings. With a further rise in short-term interest rates and
a flat or inverted yield curve, deposits and borrowings may reprice upwards
faster than the rates on loans, mortgage-backed securities and investments,
causing additional compression in the net interest margin and may have a
negative impact on the Company's results of operations. Rising interest rates
can also affect borrowers' demand for loan products as historical experience has
shown that as interest rates rise, origination levels may decline.
A downturn in the local economy can affect profitability due to the geographic
concentration of our market area. The Company gathers deposits primarily from
the communities its serves, which are the Ironbound section of the City of
Newark and surrounding areas, suburban Essex county and selected areas of
central and southern New Jersey. The
21
Company originates loans secured by properties located throughout New Jersey and
areas in eastern Pennsylvania. A downturn in the local economy in any of these
market areas may have an adverse effect on customers' demand for the Company's
products, borrowers' ability to service their debt, as well as the quality of
the Company's loan portfolio. Declining real estate values can cause loans to
become inadequately collateralized, potentially exposing the Company to a risk
of loss.
Changes in estimates of the adequacy of the allowance for loan losses. The
Company's allowance for loan losses is established based on management's
evaluation of the probable credit losses in the loan portfolio. Management
believes that they use the best information available to establish the allowance
for loan losses. However, changes in market conditions, borrowers' ability to
service their debt, real estate values, or in federal regulatory policies, which
are unforeseeable and beyond the Company's controls, may cause the allowance for
loan losses to become inadequate and earnings may be affected. See Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations "-Critical Accounting Policies."
Risks in changes in the laws and regulations of regulatory agencies. The Bank is
subject to comprehensive regulation and examination by the OTS, as the Bank's
primary regulator, and the FDIC, as its insurer of deposits. The OTS has
extensive authority over the operations of savings associations, which are
subject to periodic examinations and reporting requirements. FDIC may also
conduct examinations and require reporting by FDIC-insured institutions. In
addition, these regulatory agencies have the authority to impose restrictions on
operations. In recent years, there have been significant changes in the
legislative policies for regulation of financial institutions. Any future
changes in legislative policies, regulations or laws of regulatory agencies are
beyond the Company's control and may have a material effect on the Company's
operations.
Strong competition in originating loans and attracting deposits may have an
adverse effect on the Company's profitability. The Company operates in a highly
competitive environment in both the origination of real estate and other loans
and in attracting deposits. The Company competes based on the quality of
services offered, interest rates offered, fees charged, types of products,
quality customer service and convenient business hours and branch locations.
Competition in originating loans is primarily from commercial banks, other
savings associations, mortgage banking companies and credit unions. Competition
in attracting deposits is primarily from commercial banks, other savings
associations, credit unions and brokerage houses. In order to compete, the
Company, from time to time, may offer slightly higher rates in order to attract
deposits and stimulate loan originations. This may impact the Company's
profitability, depending on the level of interest rates offered, and may have a
negative effect on the net interest margin.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
The Company conducts its business at its operations center and the Bank's branch
offices located in its primary market areas. The total net book value of the
Company's premises and equipment (including land, building and leasehold
improvements and furniture and equipment) at June 30, 2006 was $20.4 million.
The Company believes that its current facilities are adequate to meet the
present and foreseeable needs of the Company, subject to possible future
expansion.
Item 3. Legal Proceedings
The Company is involved from time to time as plaintiff or defendant in various
legal actions arising in the normal course of its business. While the ultimate
outcome of these proceedings cannot be predicted with certainty, it is the
opinion of management at the present time, after consultation with counsel
representing the Company in the proceedings, that the resolution of these
proceedings should not have a material effect on the Company's consolidated
financial position or results of operations.
Penn Federal Savings Bank and ExxonMobil have been ordered by the New Jersey
Department of Environmental Protection to investigate and remediate soil and
ground water pollution that may have been generated at a branch location that
was formerly a gasoline service station. Penn Federal Savings Bank and
ExxonMobil have entered into a
22
cost sharing arrangement under which ExxonMobil will supervise the investigation
and remediation and the cost will be shared equally. Based on information then
available, the Company recorded a $298,000 (pretax) charge during the fourth
quarter of fiscal 2004 to accrue its share of the estimated cost. At June 30,
2006 and 2005, an environmental liability of $328,000 was included in Accounts
payable and other liabilities in the Company's Consolidated Statements of
Financial Condition. Management believes the total current liability of $328,000
represents the probable liability at this time.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders, through the solicitation
of proxies or otherwise, during the quarter ended June 30, 2006.
23
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
The Company's common stock trades on the Nasdaq Global Market tier of the Nasdaq
Stock Market under the symbol "PFSB." At September 1, 2006, there were
approximately 500 stockholders of record of the Company's common stock (not
including the number of persons or entities holding stock in nominee or street
name through various brokerage firms).
The following table sets forth the high and low closing sales prices per common
share for the periods indicated.
Fiscal 2006 Closing Price Fiscal 2005 Closing Price
---------------------------- ---------------------------
High Low High Low
---------------------------- ---------------------------
Quarter Ended:
September 30, 2005 and 2004 ................ $20.15 $16.48 $16.50 $14.84
December 31, 2005 and 2004 ................. 19.55 16.94 17.34 15.18
March 31, 2006 and 2005 .................... 19.17 17.75 16.68 14.75
June 30, 2006 and 2005 ..................... 19.15 17.75 17.12 13.20
The closing price of a common share was $18.65 at June 30, 2006 compared to
$16.88 at June 30, 2005.
The Company initiated quarterly cash dividend payments in the second quarter of
fiscal 1997 and has since then continuously paid quarterly cash dividends. The
initial quarterly cash dividend was $0.025 per share. Since the second quarter
of fiscal 2002, the Company paid quarterly cash dividends of $0.03 per share. In
the first quarter of fiscal 2003, the quarterly cash dividend was increased to
$0.05 per share. During the fourth quarter of fiscal 2005, the quarterly cash
dividend was increased to $0.07 per share.
PennFed's ability to pay cash dividends is substantially dependent on the
dividend payments it receives from the Bank. For a description of the regulatory
restrictions on the ability of the Bank to pay dividends to PennFed, see Item 1.
Business -- "Regulation - Limitations on Dividends and Other Capital
Distributions" and Note N -- Stockholders' Equity and Regulatory Capital in the
Notes to Consolidated Financial Statements.
The following table summarizes the Company's stock repurchase activity for each
month during the three months ended June 30, 2006. All shares repurchased during
the three months ended June 30, 2006 were repurchased in the open market.
Total Number Maximum Number
Total Number Average of Shares Purchased of Shares that May
of Shares Price Paid as Part of Publicly Yet Be Purchased
Repurchased Per Share Announced Plan Under the Plan
----------- --------- -------------- --------------
Repurchases for the Month
- -------------------------
April 1 - April 30, 2006 ............. 15,600 $18.18 15,600 535,100
May 1 - May 31, 2006 ................. 97,500 18.12 97,500 437,600
June 1 - June 30, 2006 ............... 22,900 18.17 22,900 414,700
-----------------------------------------
Total repurchases..................... 136,000 $18.14 136,000
=========================================
At June 30, 2006, the Company had a repurchase plan under which it had not yet
completed all approved repurchases. This repurchase plan was publicly announced
January 25, 2006 and authorized the Company to repurchase up to 5%, or 650,000,
of its outstanding shares over the following 18 months.
24
Item 6. Selected Financial Data
The following selected consolidated financial data of the Company is qualified
in its entirety by, and should be read in conjunction with, the consolidated
financial statements, including notes thereto, included elsewhere in this
document.
At June 30,
--------------------------------------------------------------
2006 2005 2004 2003 2002
--------------------------------------------------------------
(In thousands, except per share amounts)
Selected Financial Condition Data:
Total assets ................................ $2,306,510 $2,050,551 $1,902,286 $1,812,452 $1,892,427
Loans receivable and loans held for sale, net 1,684,224 1,465,480 1,287,473 1,228,918 1,441,260
Investment securities ....................... 445,296 410,509 424,980 344,239 183,785
Mortgage-backed securities .................. 62,963 78,201 100,079 93,632 169,689
Deposits .................................... 1,414,588 1,339,491 1,188,100 1,094,666 1,174,507
Total borrowings ............................ 747,784 565,499 576,848 561,114 527,779
Trust preferred securities, net ............. -- -- -- 11,621 44,537
Stockholders' equity ........................ 123,421 124,054 118,399 116,835 118,761
Book value per common share(a)(b) ........... 9.59 9.34 8.72 8.71 8.36
- -------------------
(a) The calculation of book value per share only includes ESOP shares to the
extent that they are released or committed to be released during the
fiscal year.
(b) Amounts have been restated for the effects of a 2 for 1 stock split in the
form of a 100% stock dividend paid on October 29, 2004.
Year ended June 30,
-------------------------------------------------------------------
2006 2005 2004 2003 2002
-------------------------------------------------------------------
(In thousands, except per share amounts)
Selected Operating Data:
Total interest and dividend income .............. $ 115,276 $ 104,722 $ 96,276 $ 106,371 $ 121,339
Total interest expense .......................... 77,782 61,384 58,674 62,956 72,862
-------------------------------------------------------------------
Net interest and dividend income before provision
for loan losses .............................. 37,494 43,338 37,602 43,415 48,477
Provision for loan losses ....................... -- -- -- 525 1,625
-------------------------------------------------------------------
Net interest income after provision for
loan losses .................................. 37,494 43,338 37,602 42,890 46,852
-------------------------------------------------------------------
Fees and service charges ........................ 5,670(a) 3,096 4,175 5,232 2,961
Income on Bank Owned Life Insurance ("BOLI") .... 966 690 512 -- --
Net gain on sales of loans ...................... 143 394 759 1,863 194
Net gain (loss) from real estate operations ..... (6) 156 58 3 87
Other non-interest income ....................... 740 660 925 973 975
-------------------------------------------------------------------
Total non-interest income ....................... 7,513 4,996 6,429 8,071 4,217
-------------------------------------------------------------------
Total non-interest expenses ..................... 24,198(b) 24,171 25,430(c) 29,120(d) 28,450
-------------------------------------------------------------------
Income before income taxes ...................... 20,809 24,163 18,601 21,841 22,619
Income tax expense .............................. 7,411 8,669 6,543 8,107 8,036
-------------------------------------------------------------------
Net income ...................................... $ 13,398 $ 15,494 $ 12,058 $ 13,734 $ 14,583
===================================================================
Net income per common share(e):
Basic ........................................ $ 1.03 $ 1.14 $ 0.89 $ 0.99 $ 1.01
===================================================================
Diluted ...................................... $ 1.00 $ 1.11 $ 0.83 $ 0.92 $ 0.94
===================================================================
- -----------------
(a) Includes $2,688 for a commercial loan prepayment premium.
(b) Includes $1,351 prepayment penalty on FHLB of New York advances, $372 for
acceleration of depreciation on branch automation system software and
$169 for an increase in obligations under certain long-term benefit plans.
(c) Includes $298 for recognition of a non-recurring expense associated with
an environmental liability.
(d) Includes $1,514 for recognition of a non-recurring expense associated with
the unamortized issuance costs related to the PennFed Capital Trust I
securities that were redeemed.
(e) Amounts have been restated for the effects of a 2 for 1 stock split in the
form of a 100% stock dividend paid on October 29, 2004.
25
At and for the year ended June 30,
---------------------------------------------------
Selected Financial Ratios and Other Data: 2006 2005 2004 2003 2002
---------------------------------------------------
Performance Ratios:
Return on average assets (ratio of net income to
average total assets) ................................... 0.62% 0.78% 0.67% 0.75% 0.79%
Return on average stockholders' equity (ratio of
net income to average stockholders' equity) ............. 10.78 12.64 10.20 11.53 12.59
Net interest rate spread during the year ................... 1.66 2.14 2.02 2.19 2.37
Net interest margin (net interest and dividend
income to average interest-earning assets) .............. 1.79 2.26 2.16 2.44 2.68
Ratio of average interest-earning assets to average
deposits and borrowings ................................. 103.46 103.87 104.21 107.00 107.88
Ratio of earnings to fixed charges(a):
Excluding interest on deposits .......................... 1.58x 1.78x 1.58x 1.73x 1.74x
Including interest on deposits .......................... 1.27x 1.39x 1.32x 1.35x 1.31x
Ratio of non-interest expenses to average total assets ..... 1.12% 1.22% 1.41% 1.58% 1.53%
Efficiency ratio (non-interest expenses, excluding
amortization of intangible assets, to net interest and
dividend income and non-interest income excluding
gains (losses) on sales and real estate operations) ..... 53.93 47.74 54.64 54.93 50.58
Dividend payout ratio ...................................... 27.18 19.30 22.47 20.30 11.39
Asset Quality Ratios:
Non-accruing loans to total loans at end of year ........... 0.11 0.18 0.17 0.14 0.23
Allowance for loan losses to non-accruing loans
at end of year .......................................... 330.79 231.00 286.39 373.60 177.74
Allowance for loan losses to total loans at end of year .... 0.35 0.41 0.48 0.51 0.40
Non-performing assets to total assets at end of year ....... 0.08 0.13 0.11 0.09 0.17
Ratio of net charge-offs during the year to average
loans outstanding during the year ....................... 0.01 0.01 0.00 0.00 0.00
Capital Ratios:
Stockholders' equity to total assets at end of year ........ 5.35 6.05 6.22 6.45 6.28
Average stockholders' equity to average total assets ....... 5.73 6.19 6.56 6.47 6.25
Tangible capital to adjusted total assets at end of year(b). 7.33 8.28 8.61 8.73 8.37
Core capital to adjusted total assets at end of year(b) .... 7.33 8.28 8.61 8.73 8.37
Risk-based capital to risk-weighted assets at end of year(b) 13.81 15.84 16.86 17.21 15.93
Other Data:
Number of branch offices at end of year .................... 24 25 24 21 21
Number of deposit accounts at end of year .................. 71,800 71,600 69,800 74,800 84,200
Cash dividends declared per common share ................... $ 0.28 $ 0.22 $ 0.20 $ 0.20 $ 0.12
- ---------------
(a) The ratio of earnings to fixed charges excluding interest on deposits is
calculated by dividing income before taxes and extraordinary items before
interest on borrowings by interest on borrowings on a pretax basis. The
ratio of earnings to fixed charges including interest on deposits is
calculated by dividing income before income taxes and extraordinary items
before interest on deposits and borrowings by interest on deposits plus
interest on borrowings on a pretax basis.
(b) Represents regulatory capital ratios for the Bank.
26
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Critical Accounting Policies
The consolidated financial statements are prepared in conformity with U.S.
generally accepted accounting principles. The preparation of the financial
statements requires management to make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes. While the
Company bases estimates on historical experience, current information and other
factors deemed to be relevant, actual results could differ from those estimates.
Management believes the following policies are both important to the reported
financial condition and results of operations and require subjective judgements
and are, therefore, considered critical accounting policies.
Allowance for Loan Losses -- The allowance for loan losses is established
through charges to income based on management's evaluation of the probable
credit losses presently inherent in the Company's loan portfolio. This
evaluation, which includes a review of loans for which full collectibility may
not be reasonably assured, considers among other matters, loan classifications,
the estimated fair value of the underlying collateral, economic conditions,
historical loan loss experience, portfolio growth and composition and other
factors that warrant recognition in providing for an adequate loan loss
allowance.
Loan losses are charged against the allowance for loan losses when management
believes that the recovery of principal is unlikely. If, as a result of loans
charged off or increases in the size or risk characteristics of the loan
portfolio, the allowance is below the level considered by management to be
adequate to absorb loan losses on existing loans, the provision for loan losses
is increased to the level considered necessary to provide an adequate allowance.
The allowance is an amount that management believes will be adequate to absorb
probable losses on existing loans that may become uncollectible, based on
evaluations of the collectibility of the loans. The evaluations take into
consideration such factors as changes in the nature and volume of the loan
portfolio, overall portfolio quality, review of specific problem loans and
current economic conditions that may affect the borrowers' ability to pay.
Economic conditions may result in the necessity to change the allowance in
order to react to deteriorating financial conditions of the Company's borrowers.
As a result, additional provisions on existing loans may be required in the
future if borrowers' financial conditions deteriorate or if real estate values
decline.
Where appropriate, reserves are allocated to individual loans that exhibit
actual or probable credit weakness. For example, reserves may be specifically
assigned for loans that are 90 days or more past due, loans where the borrower
has filed for bankruptcy or loans identified as problematic by the Company's
internal loan review process. Reserves are based upon management's estimate of
the borrower's ability to repay the loan given the availability of collateral,
other sources of cash flow and legal options available to the Company. For loans
not subject to specific reserve allocations, loss rates by loan category are
applied. A reserve is maintained to recognize the imprecision in estimating and
measuring loss when evaluating reserves for individual loans or pools of loans.
Reserves on individual loans are reviewed no less frequently than quarterly and
adjusted as appropriate.
The Company has not substantively changed any aspect of its overall approach in
its determination of the level of the allowance for loan losses. There have been
no material changes in assumptions or estimation techniques as compared to prior
periods that impacted the determination of the current period allowance.
Although management believes that it uses the best information available to
determine the allowances, unforeseen market conditions could result in
adjustments and earnings could be significantly affected if circumstances differ
substantially from the assumptions used in making the final determination.
Future additions to the Company's allowance may have to be made as a result of
periodic loan, property and collateral reviews and thus cannot be predicted in
advance. In addition, federal regulatory agencies, as an integral part of the
examination process, periodically review the Company's allowance for loan
losses. These agencies may require the Company to record additions to the
allowance level based upon their assessment of the information available to them
at the time of examination.
Accounting for Income Taxes -- In the accounting for income taxes, the Company
records amounts that represent taxes payable for the current year as well as
deferred tax assets and liabilities arising from transactions that have
differing effects for financial statements and tax returns. Judgement is
required in assessing the future tax effects of transactions that have been
recognized in the Company's consolidated financial statements or tax returns.
Fluctuations in the actual tax effects in future years could have an impact on
the Company's consolidated financial condition or results of operations.
Asset Impairment Judgments -- The Company periodically performs analyses to test
for impairment of various assets. When necessary, valuation allowances are
established to recognize impairment of assets. In addition to the impairment
27
analyses related to loans, additional impairment analysis is conducted as it
relates to the value of other than temporary declines in the value of the
investment and mortgage-backed securities portfolios.
Investments securities available for sale are carried at market value, with
unrealized gains and losses, net of taxes, reported as accumulated other
comprehensive income in stockholders' equity. Investment and mortgage-backed
securities held to maturity are carried at amortized cost as the Company has
both the ability and intent to hold the securities to maturity. The Company
conducts a periodic review and evaluation of the investment and mortgage-backed
securities portfolios to determine if the value of any security has declined
below its carrying value and whether such decline is other than temporary.
If such decline is deemed other than temporary, the carrying amount of the
security would be adjusted by writing down the security to fair market value
through a charge to current period operations. The market values of the
Company's investment and mortgage-backed securities are significantly affected
by changes in interest rates. In general, as interest rates rise, the market
value of fixed-rate securities will decrease; as interest rates fall, the market
value of fixed-rate securities will increase. With significant changes in
interest rates, the Company evaluates the intent and ability to hold the
security to maturity or for a sufficient time to recover the recorded principal
balance. Estimated fair values for securities are based on quoted dealer market
prices or subscribed pricing services.
Overview
You should read the following discussion together with our Consolidated
Financial Statements and the related Notes to Consolidated Financial Statements,
which are included elsewhere in this Form 10-K. This discussion contains
forward-looking statements and you should read the section titled
"Forward-Looking Statements" in Item 1. Business.
The Company has been, and intends to continue to be, a community-oriented
financial institution offering a variety of financial services to meet the needs
of the communities it serves. The Company currently has 24 full service branch
offices located in New Jersey. The Company attracts deposits from the general
public and uses these deposits, together with borrowings and other funds, to
originate and purchase one- to four-family residential mortgage loans, and, to a
lesser extent, to originate commercial and multi-family real estate and consumer
loans. The Company also invests in mortgage-backed securities secured by one- to
four-family residential mortgages and U.S. government agency obligations.
Through a relationship with an unaffiliated third party, the Company offers
insurance and uninsured non-deposit investment products to the Company's
customers and members of the general public. A wholly-owned subsidiary of the
Company participates in the ownership of a title insurance agency.
The Company's loan portfolio growth is dependent primarily on its ability to
provide the products and services that meet the needs of the customers in its
market area. The Company offers fixed rate, adjustable rate and balloon mortgage
loans for residential and commercial purposes, as well as home equity, consumer
loans and non-mortgage business loans, with a variety of terms. Residential
first mortgage loans are the largest part of the portfolio, representing
approximately 77.6% at June 30, 2006. The level of interest rates also has a
significant impact on the ability of the Company to originate loans and on the
amount of prepayment activity experienced by the Company. During the past fiscal
year, the Company's net loans receivable and loans held for sale increased
$218.7 million. This increase was primarily attributable to strong loan
origination levels in one- to four family residential and consumer loans and the
lower levels of prepayments when compared to prior years when market interest
rates were declining. The Company sold $29.5 million of primarily fixed rate
loans during the fiscal year as a means to assist in the management of interest
rate risk.
The retention and the recruitment of profitable deposit customers is vital to
PennFed's ability to generate liquid funds and to generate non-interest income.
The number of deposit accounts at June 30, 2006 was up slightly from June 30,
2005; and the average deposit balances per account, excluding wholesale
certificates of deposit, has increased 5.6% since June 30, 2005. The Company
offers a number of different deposit products and uses this product mix, along
with a strong focus on customer service, to attract customers and to build
depositor relationships. The level of interest rates also significantly affects
the level of the Company's deposits. During the past fiscal year, deposits
increased $75.1 million, primarily due to a $74.5 million increase in
certificates of deposit, and an $85.5 million increase in checking and money
market accounts partially offset by a decrease of $85.1 million in savings
accounts. The decrease in savings accounts since June 30, 2005 was attributable
to a rise in short term interest rates, which has shifted temporarily "parked"
savings account funds to higher yielding deposit alternatives. This shift in
temporarily "parked" savings accounts has also led to a portion of the increase
in checking and money market accounts, as these accounts are more liquid than
certificates of deposit. Overall, the increase in deposits was accomplished
through a combination of desirable product features, focused marketing campaigns
and appropriately priced products.
28
The Company's future loan and deposit growth is, to a large extent, directly
tied to the level of interest rates. If long-term interest rates rise, loan
origination levels may decline. Growth in the loan pipeline will depend on the
Company's ability to successfully seek out customers in spite of the higher cost
of borrowing for the customer and competition from other lenders. Loan growth
driven by borrower demand also will depend on the strength of the economy in the
Company's market area. With rising interest rates and/or deteriorating economic
conditions, loan origination volumes would likely be lower than recent years and
a reduction in the prepayment of loans currently in portfolio would be expected.
The Company has continued its loan sale strategy with respect to new longer
term, fixed rate residential loan product in order to assist in the management
of interest rate risk associated with keeping longer term loans on the balance
sheet. With respect to deposits, while an increase in interest rates would
increase the Company's cost of funds, it would also provide the Company with an
additional opportunity to attract depositors, some of whom may have sought
higher returns with mutual funds and other non-deposit investment products when
market rates were lower. The Company remains confident that by offering
appropriately priced products and by striving to deliver superior service, it
will be able to maintain profitable levels of loans and deposits.
Cash and cash equivalent balances were at lower levels during portions of the
fiscal year, compared to the prior year, due to a decline in accelerated
prepayments and strong loan origination levels. The average balance of
investment securities increased during the past fiscal year, compared to the
prior fiscal year, reflecting the replacement of those securities that prepaid
early, while the average balance of mortgage-backed securities decreased, as
available funds were utilized to grow the loan portfolio.
The Company's results of operations are dependent primarily on net interest
income, which is the difference between the income earned on its loan,
mortgage-backed securities and investment portfolios and its cost of funds,
consisting of the interest paid on deposits and borrowings. General economic and
competitive conditions, particularly changes in interest rates, government
policies and actions of regulatory authorities, also significantly affect the
Company's results of operations. Future changes in applicable laws, regulations
or government policies may also have a material impact on the Company.
Growth in the loan portfolio at a lower average yield, combined with a higher
cost of funds on increased deposits and other borrowings contributed to a
compression in the net interest margin, when compared to the prior fiscal year.
The lower level of prepayments and a greater amount of loan originations during
the fiscal year positively impacted the Company's interest income and
contributed to growth in the average balance of loans outstanding, when compared
to the prior year. The Company's interest income is primarily driven by interest
earned on residential first mortgage loans, which increased $7.1 million during
the fiscal year, when compared to the prior fiscal year. Higher cost of funds on
deposits and borrowings, due to the short term interest rate environment,
combined with an increase in the average balance of deposits and other
borrowings, were the primary factors responsible for an increase of $16.4
million in interest expense on deposits and other borrowings for the current
year compared to the prior year. Overall, net interest income decreased $5.8
million and the net interest margin decreased from 2.26% to 1.79% during the
fiscal year, compared to the prior fiscal year.
Non-interest income has increased this fiscal year when compared to the previous
fiscal year primarily due to fees and service charges, mainly loan fees, and
income on Bank Owned Life Insurance ("BOLI"). Fees and service charges include a
$2.7 million prepayment premium earned on the payoff of a large-balance
commercial real estate loan in the current fiscal year.
Non-interest expenses remained at relatively the same level in the current
fiscal year when compared to the level reported in the prior fiscal year.
However, the Company's non-interest expenses as a percent of average assets
decreased to 1.12% for the year ended June 30, 2006 from 1.22% for the prior
year. Fiscal 2006 non-interest expenses included a $1.4 million prepayment
penalty on certain Federal Home Loan Bank ("FHLB") of New York advances. FHLB of
New York advances of $35.0 million with a weighted average interest rate of
5.95% and a weighted average remaining term of 28 months were replaced with
$35.0 million of new FHLB of New York advances with a weighted average interest
rate of 4.20% and a weighted average remaining term of 43 months. Also included
in non-interest expenses this fiscal year was an increase in obligations under
certain long-term benefit plans and accelerated depreciation expense for branch
automation system software that is no longer used. In addition, costs associated
with regulatory burden, especially compliance with Sarbanes-Oxley Section 404 on
internal control reporting, continue to require additional compliance
expenditures. Fiscal 2005 non-interest expenses included $1.4 million of
amortization of intangible assets, which was fully amortized on March 31, 2005.
29
The Company's future earnings are inherently tied to the level of interest rates
and the relationship of short to long term rates. If interest rates increase,
the Company's interest expense on deposits and wholesale borrowings will
increase at a faster pace than the effects that will be seen in the Company's
interest income on loans, investment securities and mortgage-backed securities.
This effect on interest expense is due to the short-term repricing
characteristics of a portion of the Company's deposits and borrowings. As for
interest income, loan commitments, generally locked in at issuance, will result
in loans closed at below-market rates if rates continue to rise. As interest
rates rise, a decline in loan prepayments and in prepayments on mortgage-backed
securities will reduce cashflows available for reinvestment at higher rates. By
emphasizing the origination of adjustable rate and biweekly loan products and
continuing the sale of longer term fixed rate residential loans, while also
focusing on increasing the balance of core deposits and longer term certificates
of deposit and borrowings, the Company will endeavor to better position itself
to mitigate the effects of rising interest rates. See the section titled
"Management Strategy" for a discussion of those areas management has emphasized
as important to future growth and improved earnings.
On February 27, 2006, the Company notified its customers of its May 31, 2006
closing of its branch located at 493 Bloomfield Avenue in Montclair, New Jersey.
The decision to close the branch was principally due to economies of scale.
Deposits were transferred to a branch located less than two miles from the
branch that was closed.
Management Strategy
Management's primary goal is to enhance stockholder value, while providing our
customers with appropriate quality products and services through a continued
focus on improved earnings while managing risks, including liquidity and
interest rate risk. The Company's current strategies focus on: (i) emphasizing
lending secured by one- to four-family residential first mortgages, (ii)
increasing the commercial and multi-family and consumer loan portfolios, (iii)
maintaining asset quality, (iv) increasing core deposit balances, (v) managing
the Company's exposure to interest rate risk, (vi) improving non-interest income
and (vii) controlling non-interest expenses.
Emphasizing Lending Secured by One- to Four-Family Residential First Mortgages.
As a traditional thrift serving our market area, the Company will continue to
emphasize production of traditional one- to four-family first mortgage loans
secured by properties located primarily in New Jersey. One-to four-family loans
are generally considered to have a lower inherent risk, coupled with a lower
yield. The Company produced $340.9 million, $350.3 million and $462.8 million in
one- to four-family mortgage loans in fiscal 2006, 2005 and 2004, respectively.
Of these amounts, $327.4 million, $350.3 million and $409.8 million,
respectively, represent loan originations, with the balance representing loan
purchases. As a result of rising interest rates, refinance activity had been
significantly reduced throughout fiscal 2006. While the Company's customers
continue to favor fixed rate products, with rising interest rates, there has
been a slight increase in borrowers' preference for adjustable rate products.
The Company's interest income has been derived primarily from one- to
four-family mortgage loans, which totaled $1.3 billion, or 77.6%, of the
Company's gross loan portfolio at June 30, 2006. Interest income on one- to
four-family loans of $64.4 million represented 75.0% of total interest on loans.
Increasing the Commercial and Multi-Family and Consumer Loan Portfolios. The
Company will continue its emphasis on increasing the commercial and multi-family
and consumer loan porfolios while remaining vigilant in minimizing the risk
inherent in these products through sound underwriting. These loans generally
reprice more frequently, have shorter maturities, and/or have higher yields than
one- to four-family first mortgage loans. The Company originated $173.8 million,
$129.4 million and $118.2 million of commercial and multi-family and consumer
loans in fiscal 2006, 2005 and 2004, respectively. As of June 30, 2006, 2005 and
2004, commercial and multi-family and consumer loans represented 22.5%, 21.5%
and 22.5%, respectively, of the total gross loan portfolio. Interest income on
commercial and multi-family and consumer loans of $21.5 million represented
25.0% of total interest on loans for the year ended June 30, 2006. While
commercial and multi-family and consumer loans generally represent higher
yielding assets, the Company will continue to balance the increased income with
the risk inherent in these types of loans as compared to a first lien on a one-
to four-family home.
Maintaining Asset Quality. The majority of the Company's loan portfolio consists
of one- to four-family mortgages, which are considered to have less risk than
commercial and multi-family real estate or consumer loans. In recognition of the
Company's strong underwriting standards and aggressive collection efforts on all
loan portfolios, the Company's historical loss experience and net chargeoffs
continue to be low.
The Company's non-performing assets consist of non-accruing loans and real
estate owned. Non-performing assets as a percentage of total assets were 0.08%
at June 30, 2006, as compared to 0.13% at June 30, 2005.
30
Increasing Core Deposit Balances. The Company's primary source of funds is
deposits. The Company will continue to emphasize growth in core deposits
consisting of checking, money market and savings accounts. These deposits
provide a more stable, lower cost source of funds than other deposits and
borrowings and generate service charge income. The Company utilizes various
techniques to generate core deposits including special promotional rates and
offerings. The Company recognizes the importance of building relationship
customers. Therefore, certain higher rates have been offered on certificates of
deposit for customers who also maintain checking accounts. The Company is also
focused on growing deposits from businesses through new and enhanced business
products and sales efforts by its Business Development Team.
Managing the Company's Exposure to Interest Rate Risk. The Company has an
asset/liability committee that meets monthly to develop, implement and review
strategies and policies to manage interest rate risk. As part of its interest
rate risk strategy, the Company has emphasized core deposit growth, utilized
intermediate/longer-term borrowings and has, at select times, emphasized growth
in longer term certificates of deposit. Furthermore, the Company has endeavored
to manage its interest rate risk through the pricing and diversification of its
loan products, including focusing on the production of loans with adjustable
rate features and/or loans with shorter terms to maturity.
In an effort to manage sensitivity to changes in interest rates, the Company
periodically evaluates the sale of longer-term, fixed rate, one- to four-family
residential loan production. During the year ended June 30, 2006, approximately
$29.5 million of primarily conforming, fixed rate one- to four-family
residential mortgage loans were sold into the secondary market and to other
institutions as part of the Company's efforts to manage interest rate risk. The
level of loan sale activity continues to be actively evaluated with primary
consideration given to interest rate risk, long-term profitability and liquidity
objectives. See "-Interest Rate Sensitivity" and "-Asset/Liability Strategy."
Improving Non-Interest Income. The Company has sought and will continue to seek
additional ways of improving non-interest income. Fees and service charges,
which represent the primary source of non-interest income, reflected a $2.6
million, or 83.1%, increase for fiscal 2006 compared to fiscal 2005, primarily
due to increases in loan prepayment fees. With an anticipated leveling off of
prepayments and refinance activity expected during the next fiscal year, related
income would also not be expected to rise. Increasing core deposits will likely
result in an increase in fees and service charges.
Controlling Non-Interest Expenses. Non-interest expenses are carefully
monitored, which includes ongoing reviews of staffing levels, facilities and
operations. The Company's ratio of non-interest expenses to average total assets
was 1.12% for the year ended June 30, 2006 compared to 1.22% for the prior
fiscal year.
Interest Rate Sensitivity
Interest Rate Sensitivity Gap. The interest rate risk inherent in assets and
liabilities may be determined by analyzing the extent to which such assets and
liabilities are "interest rate sensitive" and by measuring an institution's
interest rate sensitivity "gap." An asset or liability is said to be interest
rate sensitive within a defined time period if it matures or reprices within
that period. The difference or mismatch between the amount of interest-earning
assets maturing or repricing within a defined period and the amount of
interest-bearing liabilities maturing or repricing within the same period is
defined as the interest rate sensitivity gap. An institution is considered to
have a negative gap if the amount of interest-bearing liabilities maturing or
repricing within a specified time period exceeds the amount of interest-earning
assets maturing or repricing within the same period. If more interest-earning
assets than interest-bearing liabilities mature or reprice within a specified
period, then the institution is considered to have a positive gap. Accordingly,
in a rising interest rate environment, in an institution with a negative gap,
the cost of its rate sensitive liabilities would theoretically rise at a faster
pace than the yield on its rate sensitive assets, thereby diminishing future net
interest income. In a falling interest rate environment, a negative gap would
indicate that the cost of rate sensitive liabilities would decline at a faster
pace than the yield on rate sensitive assets and improve net interest income.
For an institution with a positive gap, the reverse would be expected.
In an attempt to manage its exposure to changes in interest rates, management
closely monitors the Company's exposure to interest rate risk. Management
maintains an asset/liability committee consisting of the Chief Executive
Officer, the Chief Operating Officer, the Chief Financial Officer, the
Residential Lending Group Executive, the Retail Banking Group Executive, the
Treasurer and the Customer Support/Operations Group Executive, which meets
regularly and reviews the Company's interest rate risk position and makes
recommendations for adjusting this position. In addition, the Board of
Directors reviews on a monthly basis the Company's asset/liability position,
including simulations of the effect on the Company's capital and earnings of
various interest rate scenarios and operational strategies.
31
The table following this discussion provides information about the Company's
interest sensitive financial instruments. Except for the effects of prepayments
and scheduled principal amortization on mortgage related assets, the table
presents principal cash flows and related weighted average interest rates by the
earlier of term to repricing or contractual term to maturity.
Investment securities available for sale are assumed to reprice within one year
due to the characteristics associated with the underlying assets of the mutual
fund. Callable government agency securities are assumed to be called within one
year if their stated interest rates are at or above current market rates. If the
stated interest rate is below current market rates, these callable securities
are assumed to be called at a time determined by considering the spread between
the stated interest rate and the market rate, as well as the age and structure
of the security. Some of these callable government agency securities will be
assumed to be called early, while others may extend to maturity.
Based on the Company's experience, residential fixed and adjustable rate loans
are assumed to prepay at an annualized rate between 8% and 12%. Commercial and
multi-family real estate loans are assumed to prepay at an annualized rate
between 7% and 38% while consumer loans are assumed to prepay at a 32% rate.
Fixed and adjustable rate mortgage-backed securities have annual payment
assumptions ranging from 15% to 20%. Demand loans and loans which have no
repayment schedule or stated final maturity, are assumed to be due within six
months. Loan and mortgage-backed securities balances are net of non-performing
loans and are not adjusted for unearned discounts, premiums, and deferred loan
costs.
The Company assumes that variable rate savings account balances roll-off
gradually over time. Based on the Company's historical experience, it is assumed
that 12% of these balances roll-off within one year; 10% roll-off in the second
year; 8% roll-off in the third year; and 5% roll-off each year thereafter.
During fiscal 2001 and 2002, the Bank promoted "5% Savings for Life" accounts,
which totaled $120.8 million at June 30, 2006. These deposits are assumed to
have an average life of approximately 10 years unless the 6-month U.S. treasury
bill exceeds 5%; during those times, these deposits are assumed to decay at the
same annual rates as variable rate savings accounts. At June 30, 2006, $220.8
million, or 73.5%, of savings accounts are assumed to roll-off after five years.
Transaction accounts, excluding money market accounts, are assumed to roll-off
after five years. Money market accounts are assumed to be variable accounts and
are reported as repricing within six months. No roll-off rate is applied to
certificates of deposit. Fixed maturity deposits reprice at maturity.
32
Maturing or Repricing
------------------------------------------------------
Year ending June 30,
------------------------------------------------------
2007 2008 2009 2010
------------------------------------------------------
(Dollars in thousands)
Fixed rate mortgage loans including
one- to four-family and commercial
and multi-family ......................... $ 141,451 $ 125,098 $ 115,812 $ 107,315
Average interest rate .................... 5.56% 5.53% 5.53% 5.53%
Adjustable rate mortgage loans including
one- to four-family and commercial
and multi-family ......................... $ 79,368 $ 54,284 $ 59,228 $ 66,806
Average interest rate .................... 6.27% 5.89% 5.43% 5.48%
Consumer loans including
demand loans ............................. $ 105,917 $ 38,467 $ 26,567 $ 18,499
Average interest rate .................... 6.70% 5.74% 5.74% 5.74%
Investment securities and other ............ $ 37,650 $ 1,000 $ 2,000 $ --
Average interest rate .................... 5.90% 8.90% 7.00% --%
Mortgage-backed securities excluding
unamortized premium ...................... $ 14,745 $ 10,339 $ 7,510 $ 6,810
Average interest rate .................... 5.34% 5.14% 5.19% 5.17%
Total interest-earning assets ............ $ 379,131 $ 229,188 $ 211,117 $ 199,430
======================================================
Savings deposits ........................... $ 36,030 $ 19,334 $ 11,368 $ 6,537
Average interest rate .................... 2.88% 1.98% 1.30% 1.30%
Money market and demand deposits
(transaction accounts) ................... $ 142,777 $ -- $ -- $ --
Average interest rate .................... 4.60% --% --% --%
Certificates of deposit .................... $ 562,483 $ 139,659 $ 52,219 $ 34,099
Average interest rate .................... 4.09% 4.13% 4.44% 4.23%
FHLB of New York advances .................. $ 30,465 $ 50,000 $ 75,000 $ 175,000
Average interest rate .................... 5.32% 5.21% 4.50% 5.88%
Other borrowings ........................... $ 230,193 $ 10,000 $ -- $--
Average interest rate .................... 5.17% 3.59% --% --%
Junior subordinated deferrable interest
debentures ............................... $ -- $ -- $ -- $ --
Average interest rate .................... --% --% --% --%
Total deposits and borrowings ............ $ 1,001,948 $ 218,993 $ 138,587 $ 215,636
======================================================
Interest earning assets less deposits and
borrowings (interest-rate sensitivity gap) $ (622,817) $ 10,195 $ 72,530 $ (16,206)
======================================================
Cumulative interest-rate sensitivity gap ... $ (622,817) $(612,622) $(540,092) $(556,298)
======================================================
Cumulative interest-rate sensitivity
gap as a percentage of total assets
at June 30, 2006 ......................... (27.02)% (26.58)% (23.43)% (24.14)%
======================================================
Cumulative interest-rate sensitivity gap
as a percentage of total interest-
earning assets at June 30, 2006 .......... (28.14)% (27.68)% (24.40)% (25.13)%
======================================================
Cumulative interest-earning assets as a
percentage of cumulative deposits and
borrowings at June 30, 2006 .............. 37.84% 49.82% 60.27% 64.68%
======================================================
Maturing or Repricing
------------------------------------------------------
Year ending June 30,
------------------------------------------------------
2011 Thereafter Total Fair Value
------------------------------------------------------
(Dollars in thousands)
Fixed rate mortgage loans including
one- to four-family and commercial
and multi-family ......................... $ 100,015 $ 500,042 $ 1,089,733 $ 1,049,634
Average interest rate .................... 5.53% 5.60% 5.56%
Adjustable rate mortgage loans including
one- to four-family and commercial
and multi-family ......................... $ 75,421 $ 48,451 $ 383,558 $ 362,708
Average interest rate .................... 5.21% 6.45% 5.76%
Consumer loans including
demand loans ............................. $ 13,038 $ 1,934 $ 204,422 $ 202,554
Average interest rate .................... 5.74% 5.74% 6.24%
Investment securities and other ............ $ 18,351 $ 414,009 $ 473,010 $ 453,313
Average interest rate .................... 5.21% 5.59% 5.61%
Mortgage-backed securities excluding
unamortized premium ...................... $ 6,261 $ 17,198 $ 62,863 $ 60,893
Average interest rate .................... 5.15% 5.24% 5.22%
Total interest-earning assets ............ $ 213,086 $ 981,634 $ 2,213,596 $ 2,129,102
======================================================
Savings deposits ........................... $ 6,210 $ 220,768 $ 300,247 $ 300,247
Average interest rate .................... 1.30% 3.02% 2.80%
Money market and demand deposits
(transaction accounts) ................... $ -- $ 169,712 $ 312,489 $ 312,488
Average interest rate .................... --% 0.80% 2.54%
Certificates of deposit .................... $ 12,029 $ -- $ 800,489 $ 794,163
Average interest rate .................... 4.65% --% 4.13%
FHLB of New York advances .................. $ 115,000 $ 20,000 $ 465,465 $ 464,946
Average interest rate .................... 5.69% 5.17% 5.47%
Other borrowings ........................... $ -- $ -- $ 240,193 $ 239,730
Average interest rate .................... --% --% 5.11%
Junior subordinated deferrable interest
debentures ............................... $ -- $ 43,300 $ 43,300 $ 45,372
Average interest rate .................... --% 9.04% 9.04%
Total deposits and borrowings ............ $ 133,239 $ 453,780 $ 2,162,183 $ 2,156,946
======================================================
Interest earning assets less deposits and
borrowings (interest-rate sensitivity gap) $ 79,847 $ 527,854 $ 51,403
=======================================
Cumulative interest-rate sensitivity gap ... $(476,451) $ 51,403
=======================
Cumulative interest-rate sensitivity
gap as a percentage of total assets
at June 30, 2006 ......................... (20.67)% 2.23%
=======================
Cumulative interest-rate sensitivity gap
as a percentage of total interest-
earning assets at June 30, 2006 .......... (21.52)% 2.32%
=======================
Cumulative interest-earning assets as a
percentage of cumulative deposits and
borrowings at June 30, 2006 .............. 72.11% 102.38%
=======================
At June 30, 2006, the Company's total deposits and borrowings maturing or
repricing within one year exceeded its total interest-earning assets maturing or
repricing within one year by $622.8 million, representing a one year negative
gap of 27.02% of total assets, compared to a one year negative gap of $166.8
million, or 8.13%, of total assets at June 30, 2005. See "-Asset/Liability
Strategy." The Company's negative gap position at June 30, 2006 has increased
significantly when compared to June 30, 2005. Higher market rates resulted in a
decline in loan and mortgage-backed security prepayments
33
and an extension in the projected redemption of certain callable U.S. government
agency securities, as well as a shift in balances from savings accounts to
short-term certificates of deposit and money market products. As a result, asset
cash flows lengthened while liabilities repricing within one year increased
significantly.
In evaluating the Company's exposure to interest rate risk, certain limitations
inherent in the method of interest rate gap analysis presented in the foregoing
table must be considered. For example, although certain assets and liabilities
may have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Additionally, certain assets, such as adjustable rate mortgages,
have features which restrict changes in interest rates in the short-term and
over the life of the asset. Furthermore, in the event of a change in interest
rates, prepayment and early withdrawal levels may deviate significantly from
those assumed in calculating the table. Finally, the ability of many borrowers
to service their debt may decrease in the event of an interest rate increase.
The Company considers all of these factors in monitoring its exposure to
interest rate risk.
Net Portfolio Value. The Company's interest rate sensitivity is regularly
monitored by management through additional interest rate risk ("IRR") measures,
including an IRR "Exposure Measure" or "Post-Shock" NPV ratio and a "Sensitivity
Measure." A low Post-Shock NPV ratio may indicate greater exposure to IRR.
Greater exposure can result from a high sensitivity to changes in interest
rates. The Sensitivity Measure is the change in the NPV ratio, in basis points,
caused by a 2% increase or decrease in rates, whichever produces a larger
decline. OTS guidelines would characterize an institution with a Post Shock
ratio of less than 4% to have "high" interest rate risk if the Sensitivity
Measure is greater than 2%. At least quarterly, and generally monthly,
management models the change in net portfolio value ("NPV") over a variety of
interest rate scenarios. NPV is the present value of expected cash flows from
assets, liabilities and off-balance sheet contracts. An NPV ratio, in any
interest rate scenario, is defined as the NPV in that rate scenario divided by
the market value of assets in the same scenario. Assumptions used in calculating
interest rate sensitivity are periodically reviewed and modified as appropriate.
As of June 30, 2006, the Bank's internally generated initial NPV ratio was
8.66%. Following a 2% increase in interest rates, the Bank's Post-Shock NPV
ratio was 5.02%. The change in the NPV ratio, or the Bank's Sensitivity Measure,
was negative 3.64%. Following a 2% decrease in interest rates, the Bank's
internally generated Post-Shock NPV ratio was 9.11% and the Sensitivity Measure
was positive 0.45%. As of June 30, 2006, the Company's internally generated
initial NPV ratio was 8.47%, the Post-Shock ratio was 4.34%, and the Sensitivity
Measure was negative 4.13%. As of June 30, 2005, the Bank's Post-Shock NPV ratio
and Sensitivity Measure were 8.33% and negative 1.86%, respectively, and the
Company's Post-Shock NPV ratio and Sensitivity Measure were 8.27% and negative
1.70%, respectively. At June 30, 2005, the effect of a 2% decrease in interest
rates could not be meaningfully simulated. The Post-Shock NPV ratios and
Sensitivity Measures from a simulated 2% increase in rates deteriorated from the
prior year, primarily due to a sharp increase in interest rates. The rise in
long term market rates reduced prepayment activity on certain one- to
four-family loans and mortgage-backed securities. In addition, despite continued
focus on generating one- to four-family loan growth with shorter average
durations, such as bi-weekly and adjustable rate mortgages with shorter average
durations, overall asset duration increased, principally due to a shift in the
projected redemption date of callable U.S. government agency securities to
beyond one year. Furthermore, a decline in liability duration resulted from an
increase in short-term retail deposit and wholesale borrowing balances, an
increase in the sensitivity of FHLB of New York convertible advances, and from a
reduction in savings account balances, as certain "parked" funds shifted to
shorter-term, higher-yielding deposit alternatives. Variances between the Bank's
and the Company's NPV ratios are attributable to balance sheet items which are
eliminated during consolidation, such as investments, intercompany borrowings
and capital.
Internally generated NPV measurements are based on simulations which utilize
institution specific assumptions, including discount and decay rates, and
generally result in lower levels of presumed interest rate risk than OTS
measurements indicate.
The OTS measures the Bank's IRR on a quarterly basis using data from the
quarterly Thrift Financial Reports filed by the Bank with the OTS, coupled with
non-institution specific assumptions which are based on national averages. As of
March 31, 2006 (the latest date for which information is available), the Bank's
initial NPV ratio, as measured by the OTS, was 7.17%, the Bank's Post-Shock
ratio following a 2% increase in interest rates was 2.10% and the Sensitivity
Measure was negative 5.07%.
34
In addition to monitoring NPV and gap, management also monitors the duration of
assets and liabilities and the effects on net interest income resulting from
parallel and non-parallel increases or decreases in rates.
At June 30, 2006, based on its internally generated simulation models, the
Company's consolidated net interest income projected for one year forward would
decrease 27.3% from the base case, or current market, as a result of an
immediate and sustained 2% increase in interest rates.
Asset/Liability Strategy
The primary elements of the Company's asset/liability strategy include the
following:
1. The Company has focused on managing the average life and duration of its
portfolio of one- to four-family mortgage loans by promoting one year adjustable
rate products, with initial fixed rate terms of 3 and 5 years; 15, 20 and 30
year bi-weekly mortgages; and fixed rate products with terms of 10, 15 and 20
years, which have shorter durations than 30 year fixed rate mortgage loans.
2. The Company has emphasized the origination of variable rate home equity lines
of credit and fixed rate second mortgage loans as well as variable and fixed
rate commercial and multi-family real estate loans having maturities or terms to
repricing significantly shorter than one- to four-family residential mortgage
loans.
3. The Company has periodically sold a portion of its one- to four-family
mortgage loan portfolio in an effort to shorten its average life and duration,
as well as to mitigate prepayment risk and reduce borrowings. The level of such
activity continues to be regularly evaluated with primary consideration given to
interest rate risk, long term profitability and liquidity objectives.
4. The Company has emphasized the lengthening of maturities of its liabilities
through its pricing of longer term certificates of deposit and by utilizing
intermediate- and longer-term borrowings, subject to market conditions.
5. The Company has focused on the retention and the recruitment of profitable
deposit customers in an effort to improve funding stability and earnings.
6. The Company has also emphasized growth in personal and business core deposit
accounts as these funds are relatively stable, have a longer duration and assist
in strengthening customer relationships.
During the year ended June 30, 2006, each of the strategies noted above was
employed to manage the Company's sensitivity to changes in interest rates.
Over the last year, the Federal Open Market Committee has continued the measured
increase in the targeted Federal funds rate, by raising it 2.00% from 3.25% at
June 30, 2005 to 5.25% at June 30, 2006. During this time, longer term market
yields also increased, but only approximately 1.25%. As the steepness of the
curve declined and occasionally inverted, loan origination activity remained
strong until the fourth quarter when it began to decelerate. However, shifting
of funds in retail products, particularly from savings accounts to short-term
certificates of deposit and money market accounts, accelerated due to strong
competitive pricing for short term retail deposits.
One-to four-family residential and consumer mortgage activity remained strong in
fiscal 2006, reflective of a robust housing market and competitive pricing for
most of the fiscal year. As production began to slow in the fourth quarter, the
Company added a correspondent relationship with a mortgage company that was able
to originate, fund and sell shorter duration one- to four-family loans to the
Bank. Bi-weekly and adjustable rate production dominated new volumes and helped
to manage the lengthening duration being experienced in the residential loan
portfolio. Furthermore, a large portion of the commercial and multi-family loan
production added during the fiscal year was also adjustable rate. Though loan
sale activities declined during fiscal 2006 compared to the prior year, they
included primarily lower coupon, fixed rate products with longer-terms to
maturity and supported efforts to manage interest rate risk.
Asset growth was funded through a combination of retail deposit growth and
wholesale borrowings during fiscal 2006. Significant competitive pricing
pressures made it difficult to grow retail balances at a pace sufficient to fund
loan volumes, resulting in an increase in wholesale borrowings. While efforts to
grow checking and savings accounts were only marginally successful, the Bank's
money market accounts maintained a strong market presence and helped to build
new relationships and to retain a large portion of existing customers who were
shifting their balances to higher yielding alternatives. Certificates of deposit
growth was found primarily in shorter term maturities, as depositors were
generally unwilling to place their deposits for terms longer than one year.
Wholesale funding growth included short term overnight borrowings and reverse
repurchase agreements, and longer term FHLB of New York advances.
35
By the end of fiscal 2006, the Company's NPV ratios had deteriorated, as the
overall decline in asset values surpassed the improvement in liability values.
The Sensitivity Measure also deteriorated, as asset duration lengthened and
liability duration continued to shorten.
As a result of the above activity, one- to four-family mortgage loan balances
increased $154.0 million between June 30, 2005 and June 30, 2006. Adjustable
rate one- to four-family mortgage loan balances increased $70.1 million while
fixed rate balances increased $83.9 million. Additionally, approximately 73% of
the fiscal 2006 fixed rate loan originations were for terms less than 30 years
or for bi-weekly products. Consumer loan balances increased $60.0 million. Prime
based home equity lines of credit decreased $2.4 million while other consumer
products, principally fixed rate second mortgages generally with shorter
durations than one- to four-family residential mortgages, increased $62.4
million. The commercial and multi-family real estate loan portfolio increased
$2.8 million during the current fiscal year with adjustable rate products
declining $3.9 million and fixed rate loans increasing $6.7 million.
At June 30, 2006, medium and long term certificate of deposit balances with
remaining maturities greater than one year totaled $238.0 million, including
$48.2 million of wholesale certificates of deposit, compared to $287.5 million
at June 30, 2005. There were $65.4 million of wholesale certificates of deposit
at June 30, 2006, compared to $66.1 million at June 30, 2005. Certificate of
deposit balances, excluding brokered deposits, increased $75.4 million as short
term interest rates increased during the fiscal year, while core deposit
balances increased $345,000. Savings balances decreased $85.1 million, while
checking and money market account balances increased $85.5 million. Wholesale
borrowings with remaining maturities greater than one year totaled $445.0
million at June 30, 2006, reflecting an increase of $20.1 million during the
current fiscal year. During fiscal 2006, FHLB of New York advances increased by
$50.0 million; $100.0 million was called or matured, $35.0 million was prepaid,
and $185.0 million of new advances were obtained. In addition, $40.0 million of
convertible advances from the FHLB of New York with one-time call features were
not called and subsequently were extended five years to their final maturity.
Retail certificate of deposit balances with remaining maturities of one year or
less increased $106.8 million while short-term wholesale funding balances,
including $17.2 million of wholesale certificates of deposit, increased $179.4
million between June 30, 2005 and 2006, as a portion of such borrowings shifted
to within one year of maturity. In fiscal 2006, $132.2 million of new, short
term wholesale borrowings were added, including a net increase of $89.0 million
drawn on an overnight repricing line of credit and a net decrease of $569,000 on
an unsecured revolving line of credit.
The Company emphasizes and promotes its savings, money market and demand deposit
accounts, and certificates of deposit with varying maturities through five
years, principally within its primary market areas. The balances of savings,
money market and demand deposit accounts represented 43.3% of total deposits at
June 30, 2006.
Analysis of Net Interest Income. The following table sets forth certain
information relating to the Company's Consolidated Statements of Financial
Condition and the Consolidated Statements of Income for the years ended June 30,
2006, 2005 and 2004 and reflects the average yield on assets and average cost of
liabilities for the periods indicated. Such yields and costs are derived from
average daily balances. The average balance of loans receivable includes
non-accruing loans. The yields and costs include fees, which are considered
adjustments to yields.
36
Year ended June 30,
----------------------------------------------------------------------
2006 2005
----------------------------------------------------------------------
Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
Balance Paid Rate Balance Paid Rate
----------------------------------------------------------------------
(Dollars in thousands)
Interest-earning assets:
One- to four-family mortgage
loans ....................... $1,227,499 $ 64,447 5.25% $1,082,952 $ 57,358 5.30%
Commercial and multi-family real
estate loans ................ 167,083 11,522 6.90 168,556 11,638 6.90
Consumer loans .................. 170,601 9,953 5.83 127,020 6,834 5.38
---------- ---------- ---------- ----------
Total loans receivable ...... 1,565,183 85,922 5.49 1,378,528 75,830 5.50
Federal funds sold .............. -- -- -- -- -- --
Investment securities and other . 461,033 25,794 5.59 446,903 24,384 5.46
Mortgage-backed securities ...... 69,804 3,560 5.10 88,286 4,508 5.11
---------- ---------- ---------- ----------
Total interest-earning assets 2,096,020 $ 115,276 5.50 1,913,717 $ 104,722 5.47
========== ==========
Non-interest earning assets ........ 73,125 67,373
---------- ----------
Total assets ................ $2,169,145 $1,981,090
========== ==========
Deposits and borrowings:
Money market and demand
deposits .................... $ 261,404 $ 4,748 1.82% $ 191,747 $ 1,144 0.60%
Savings deposits ................ 339,864 8,911 2.62 420,852 9,901 2.35
Certificates of deposit ......... 764,537 28,107 3.68 644,112 19,311 3.00
--------- --------- ---------- ----------
Total deposits .............. 1,365,805 41,766 3.06 1,256,711 30,356 2.42
FHLB of New York advances ....... 440,226 24,863 5.65 425,319 24,668 5.80
Other borrowings ................ 177,756 7,496 4.22 118,285 3,313 2.80
Junior subordinated debentures .. 42,104 3,657 8.69 42,059 3,047 7.24
---------- ---------- ---------- ----------
Total deposits and borrowings 2,025,891 $ 77,782 3.84 1,842,374 $ 61,384 3.33
========== ==========
Other liabilities .................. 18,917 16,095
---------- ----------
Total liabilities ........... 2,044,808 1,858,469
Stockholders' equity ............... 124,337 122,621
---------- ----------
Total liabilities and
stockholders' equity ..... $2,169,145 $1,981,090
========== ==========
Net interest income and net interest
rate spread ..................... $ 37,494 1.66% $ 43,338 2.14%
========== ====== ========== ======
Net interest-earning assets and net
interest margin ................. $ 70,129 1.79% $ 71,343 2.26%
========== ====== ========== ======
Ratio of interest-earning assets to
deposits and borrowings ......... 103.46% 103.87%
====== ======
Year ended June 30,
-----------------------------------
2004
-----------------------------------
Average Interest
Outstanding Earned/ Yield/
Balance Paid Rate
-----------------------------------
(Dollars in thousands)
Interest-earning assets:
One- to four-family mortgage
loans ....................... $ 915,316 $ 49,831 5.44%
Commercial and multi-family real
estate loans ................ 162,855 12,029 7.39
Consumer loans .................. 115,793 6,353 5.49
---------- ----------
Total loans receivable ...... 1,193,964 68,213 5.71
Federal funds sold .............. 17,918 178 0.99
Investment securities and other . 428,104 22,816 5.33
Mortgage-backed securities ...... 98,828 5,069 5.13
---------- ----------
Total interest-earning assets 1,738,814 $ 96,276 5.54
==========
Non-interest earning assets ........ 63,978
----------
Total assets ................ $1,802,792
==========
Deposits and borrowings:
Money market and demand
deposits .................... $ 167,569 $ 315 0.19%
Savings deposits ................ 388,552 9,931 2.56
Certificates of deposit ......... 549,480 16,388 2.98
---------- ----------
Total deposits .............. 1,105,601 26,634 2.41
FHLB of New York advances ....... 489,699 28,203 5.76
Other borrowings ................ 31,308 1,139 3.64
Junior subordinated debentures .. 42,015 2,698 6.42
---------- ----------
Total deposits and borrowings 1,668,623 $ 58,674 3.52
==========
Other liabilities .................. 15,899
----------
Total liabilities ........... 1,684,522
Stockholders' equity ............... 118,270
----------
Total liabilities and
stockholders' equity ..... $1,802,792
==========
Net interest income and net interest
rate spread ..................... $ 37,602 2.02%
========== ======
Net interest-earning assets and net
interest margin ................. $ 70,191 2.16%
========== ======
Ratio of interest-earning assets to
deposits and borrowings ......... 104.21%
======
37
Rate/Volume Analysis. The following table presents the extent to which changes
in interest rates and changes in the volume of interest-earning assets and
deposits and borrowings have affected the Company's interest income and interest
expense during the periods indicated. Information is provided in each category
with respect to (1) changes attributable to changes in volume (changes in volume
multiplied by prior rate), (2) changes attributable to changes in rate (changes
in rate multiplied by prior volume), (3) changes attributable to changes in
rate/volume (changes in rate multiplied by changes in volume) and (4) the net
change.
Year ended June 30,
---------------------------------------------------------------------------------------------
2006 vs. 2005 2005 vs. 2004
--------------------------------------------- ----------------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
--------------------------------------------- ----------------------------------------------
Total Total
Rate/ Increase Rate/ Increase
Volume Rate Volume (Decrease) Volume Rate Volume (Decrease)
---------------------------------------------------------------------------------------------
(In thousands)
Interest-earning assets:
One- to four-family
mortgage loans ................ $ 7,656 $ (500) $ (67) $ 7,089 $ 9,127 $ (1,352) $ (248) $ 7,527
Commercial and multi-family
real estate loans ............. (102) (14) -- (116) 421 (785) (27) (391)
Consumer loans .................. 2,345 576 198 3,119 616 (123) (12) 481
---------------------------------------------------------------------------------------------
Total loans receivable ........ 9,899 62 131 10,092 10,164 (2,260) (287) 7,617
Federal funds sold .............. -- -- -- -- (178) (178) 178 (178)
Investment securities and other . 771 619 20 1,410 1,002 542 24 1,568
Mortgage-backed securities ...... (944) (5) 1 (948) (540) (23) 2 (561)
---------------------------------------------------------------------------------------------
Total interest-earning assets . $ 9,726 $ 676 $ 152 $ 10,554 $ 10,448 $ (1,919) $ (83) $ 8,446
=============================================================================================
Deposits and borrowings:
Money market and demand
deposits ...................... $ 416 $ 2,338 $ 850 $ 3,604 $ 45 $ 685 $ 99 $ 829
Savings deposits ................ (1,905) 1,133 (218) (990) 826 (790) (66) (30)
Certificates of deposit ......... 3,610 4,369 817 8,796 2,822 86 15 2,923
---------------------------------------------------------------------------------------------
Total deposits ................ 2,121 7,840 1,449 11,410 3,693 (19) 48 3,722
FHLB of New York advances ....... 865 (647) (23) 195 (3,708) 199 (26) (3,535)
Other borrowings ................ 1,666 1,675 842 4,183 3,164 (262) (728) 2,174
Junior subordinated debentures .. 3 606 1 610 3 346 -- 349
---------------------------------------------------------------------------------------------
Total deposits and borrowings . $ 4,655 $ 9,474 $ 2,269 $ 16,398 $ 3,152 $ 264 $ (706) $ 2,710
=============================================================================================
Net change in net interest income $ 5,071 $ (8,798) $ (2,117) $ (5,844) $ 7,296 $ (2,183) $ 623 $ 5,736
=============================================================================================
Financial Condition
Comparison of Financial Condition at June 30, 2006 and June 30, 2005
Assets. Total assets increased $256.0 million to $2.307 billion at June 30, 2006
from total assets of $2.051 billion at June 30, 2005. The increase at June 30,
2006 was primarily due to a $223.4 million increase in net loans receivable and
a $34.9 million increase in investment securities held to maturity partially
offset by a $15.2 million decrease in mortgage-backed securities held to
maturity. The increase in total assets at June 30, 2006 was also partially due
to an $8.0 million increase in the investment in BOLI.
The increase in net loans receivable was reflective of strong loan origination
levels and the lower levels of loan prepayment activity due to rising interest
rates. Loan sales in fiscal 2006 were $29.5 million, compared to $35.6 million
in fiscal 2005, as originations of long term, fixed rate conforming balance
loans were at reduced levels in fiscal 2006
38
when compared to fiscal 2005. Loan purchases in fiscal 2006 were $13.4 million.
There were no loan purchases for the year ended June 30, 2005. The interest rate
environment during the fiscal year allowed the Company to utilize available
funds for the purchase of investment securities and the origination of loans at
higher rates of return than would have been achieved by re-investing in
mortgage-backed securities, as these securities rolled off during the fiscal
year.
Liabilities. Deposits increased $75.1 million to $1.415 billion at June 30, 2006
from $1.339 billion at June 30, 2005. The increase was attributable to an
increase in certificates of deposit of $74.5 million and an increase of $85.5
million in checking and money market accounts partially offset by a decrease of
$85.1 million in savings accounts since June 30, 2005. The decrease in savings
accounts since June 30, 2005 was attributable to a rise in short term interest
rates, which has shifted temporarily "parked" savings account funds to higher
yielding deposit alternatives. This shift in temporarily "parked" savings
accounts has also led to a portion of the increase in checking and money market
accounts, as these accounts are more liquid than certificates of deposit. At
June 30, 2006, FHLB of New York advances and other borrowings totaled $705.7
million, reflecting a $182.2 million increase from $523.4 million at June 30,
2005. Throughout fiscal 2006, wholesale borrowings have been an alternate, lower
costing source of funds when compared to the highly competitive pricing of
retail deposits.
Stockholders' Equity. Stockholders' equity at June 30, 2006 totaled $123.4
million compared to $124.1 million at June 30, 2005. The change in equity
reflects the repurchase of 626,300 shares of the Company's outstanding stock at
an average price of $18.57 per share, the declaration of cash dividends and
unrealized holding losses on investment securities available for sale, net of
taxes, partially offset by the net income recorded for the year ended June 30,
2006 and the exercise of stock options, including the related tax effect.
Results of Operations
Comparison of Operating Results for the Years Ended June 30, 2006 and June 30,
2005
General. For the year ended June 30, 2006, net income was $13.4 million, or
$1.00 per diluted share, compared to net income of $15.5 million, or $1.11 per
diluted share, for the year ended June 30, 2005.
Interest and Dividend Income. Interest and dividend income for the year ended
June 30, 2006 increased to $115.3 million from $104.7 million for the year ended
June 30, 2005. In general, the increase in interest and dividend income reflects
a higher level of interest-earning assets due to strong loan originations of
one- to four-family residential and consumer loans and the lower levels of
prepayments in the Company's loan and mortgage-backed securities portfolios
during fiscal 2006. Average interest-earning assets were $2.096 billion for the
year ended June 30, 2006, compared to $1.914 billion for the prior year. The
average yield earned on interest-earning assets increased to 5.50% for the year
ended June 30, 2006 from 5.47% for the year ended June 30, 2005, primarily
reflective of the increase in the yield earned on consumer loans and investment
securities.
Interest income on residential one- to four-family mortgage loans for the year
ended June 30, 2006 increased $7.1 million when compared to the prior year. The
increase in interest income on residential one- to four-family mortgage loans
was due to an increase in the average balance of residential one- to four-family
mortgage loans outstanding of $144.5 million to $1.227 billion for the year
ended June 30, 2006, compared to $1.083 billion for the prior year, primarily as
a result of strong loan origination levels and the lower levels of prepayments.
Somewhat offsetting the increase in the average balance of residential one- to
four-family mortgage loans was a decrease in the average yield earned on this
loan portfolio to 5.25% for the year ended June 30, 2006 from 5.30% for the
prior year period, reflecting the payoff or refinance of higher yielding loans
and the origination of lower yielding loans over the last twelve months. At June
30, 2006, one- to four- family mortgage loans represented 77.6% of the total
loan portfolio and 75.0% of interest income on loans for the fiscal year.
Interest income on commercial and multi-family real estate loans decreased
$116,000 for the year ended June 30, 2006, when compared to the year ended June
30, 2005. The decrease in interest income on commercial and multi-family real
estate loans was partially attributable to a decrease in the average outstanding
balance on these loans. With loan payoffs exceeding loan originations, the
average balance outstanding of commercial and multi-family real estate loans
decreased $1.5 million for the year ended June 30, 2006, when compared to the
year ended June 30, 2005. The average yield earned on this loan portfolio
remained unchanged at 6.90% for fiscal 2006, compared to fiscal 2005.
Interest income on consumer loans increased $3.1 million for the year ended June
30, 2006, when compared to the year ended June 30, 2005. The increase in
interest income on consumer loans for the year ended June 30, 2006 was partially
attributable to an increase in the average outstanding balance of this loan
portfolio of $43.6 million, when compared to the year ended
39
June 30, 2005, due primarily to higher origination levels and reduced
prepayments. Also contributing to the increase in interest income on consumer
loans for the year ended June 30, 2006 was an increase in the average yield
earned on these loans to 5.83% from 5.38% for the prior year due to fourth
quarter originations at higher market interest rates.
Interest income on investment securities and other interest-earning assets
increased $1.4 million for the year ended June 30, 2006, when compared to the
prior year. The increase in interest income on these securities was partially
attributable to a $14.1 million increase in the average balance outstanding for
the year ended June 30, 2006, when compared to the prior year, as available
funds were utilized to purchase additional investment securities and due to the
absence of callable securities being called before maturity as a result of the
increase in interest rates. In addition, the increase in interest income on
investment securities and other interest-earning assets was also partially
attributable to an increase in the average yield earned on these securities to
5.59% for the year ended June 30, 2006, compared to 5.46% for the year ended
June 30,2005.
Interest income on the mortgage-backed securities portfolio decreased $948,000
for the year ended June 30, 2006 compared to the prior year. The decrease in
interest income on mortgage-backed securities for the year ended June 30, 2006
was partially due to a decrease in the average balance outstanding of $18.5
million for the year ended June 30, 2006, when compared to the prior year. In
addition, the decrease in interest income on mortgage-backed securities was due
to a slight decrease in the average yield earned on this portfolio to 5.10% for
the year ended June 30, 2006 from 5.11% for the year ended June 30, 2005.
Interest Expense. Interest expense increased to $77.8 million for the year ended
June 30, 2006 from $61.4 million for the year ended June 30, 2005. A significant
rise in short term interest rates coupled with an increase in the average
balance of deposits, FHLB of New York advances and other borrowings, were the
primary factors responsible for the increase in interest expense for the year
ended June 30, 2006, when compared to the year ended June 30, 2005. The average
rate on deposits and borrowings was 3.84% for the year ended June 30, 2006, an
increase from 3.33% for the year ended June 30, 2005. Total average deposits and
borrowings increased $183.5 million for fiscal 2006, when compared to the prior
year.
The average rate paid on deposits increased to 3.06% for the year ended June 30,
2006 from 2.42% for the year ended June 30, 2005, reflecting the effect of the
rise in short term market interest rates and the highly competitive New Jersey
market. Average deposit balances increased $109.1 million to $1.366 billion for
the year ended June 30, 2006 from $1.257 billion for the prior year.
The average cost of FHLB of New York advances decreased to 5.65% for the year
ended June 30, 2006 from 5.80% for the prior year, due to the addition of lower
costing advances and the first quarter of fiscal 2006 prepayment of $35.0
million of advances that had an average rate of 5.95% and their replacement with
$35.0 million of advances with an average rate of 4.20%. The average balance of
FHLB of New York advances increased $14.9 million for the year ended June 30,
2006, when compared to the year ended June 30, 2005. To offset the slower loan
prepayment cashflows and to take advantage of favorable rates on other
borrowings as compared to rates on deposits, the average balance of other
borrowings increased $59.5 million for the year ended June 30, 2006, when
compared to the prior year. The average rate paid on other borrowings increased
to 4.22% for the year ended June 30, 2006 from 2.80% for the year ended June 30,
2005, as a result of higher market interest rates. During fiscal 2006, the vast
majority of other borrowings had maturities within one year; thus, the cost of
these borrowings reflected the higher levels of short term interest rates
experienced during the year, when compared to fiscal 2005.
Interest expense on junior subordinated debentures increased $610,000 for the
year ended June 30, 2006, when compared to the prior year. The increase in
interest expense was primarily due to an increase in the average cost of these
borrowings to 8.69% for the year ended June 30, 2006 from 7.24% for the year
ended June 30, 2005. The average balance of junior subordinated debentures
increased $45,000 during the fiscal year ended June 30, 2006, when compared to
the prior fiscal year.
Net Interest and Dividend Income. Net interest and dividend income before
provision for loan losses for the year ended June 30, 2006 was $37.5 million
compared to $43.3 million recorded in the prior year. Average net
interest-earning assets decreased $1.2 million for the year ended June 30, 2006,
when compared to the prior year. The net interest rate spread and net interest
margin for fiscal 2006 were 1.66% and 1.79%, respectively, a decrease from 2.14%
and 2.26% for the year ended June 30, 2005. The decline in the net interest
margin during fiscal 2006 has been the result of the flattening yield curve,
with longer term interest rates reflecting minimal movement but with continual
increases in shorter term rates. As a result, the Company's deposit and
borrowing costs continued to rise at a significantly faster pace than interest
rates offered on real estate mortgage loans within the Company's lending market.
40
Provision for Loan Losses. There was no provision for loan losses recorded for
the years ended June 30, 2006 and 2005, reflecting the Company's historically
low levels of non-accruing loans and loan chargeoffs. Management believes that
the allowance for loan losses at both dates was adequate to absorb probable
losses on existing loans that may become uncollectible. The allowance for loan
losses at June 30, 2006 was $5.9 million compared to $6.1 million at June 30,
2005. The allowance for loan losses as a percentage of non-accruing loans was
330.79% at June 30, 2006, compared to 231.00% at June 30, 2005. Non-accruing
loans were $1.8 million at June 30, 2006 compared to $2.6 million at June 30,
2005. The allowance for loan losses as a percentage of total loans at June 30,
2006 was 0.35% compared to 0.41% at June 30, 2005, primarily due to the increase
in the balance of the overall loan portfolio. See Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations
"-Critical Accounting Policies".
Non-Interest Income. For the year ended June 30, 2006, non-interest income was
$7.5 million compared to $5.0 million for the prior year. The increase in
non-interest income for fiscal 2006 was primarily due to an increase in fees and
service charges when compared to the year ended June 30, 2005.
Fees and service charges for the year ended June 30, 2006 was $5.7 million,
reflecting an increase of $2.6 million from the $3.1 million recorded for the
prior year. This increase for fiscal 2006 was primarily due to a $2.7 million
prepayment premium earned on the payoff of a large-balance commercial real
estate loan.
During the year ended June 30, 2006, the net gain on sales of loans was $143,000
compared to $394,000 for the year ended June 30, 2005. Approximately $6.1
million of conforming, fixed rate one- to four-family residential mortgage loans
were sold into the secondary market during the 2006 fiscal year. In addition,
during the year ended June 30, 2006, the Company sold approximately $23.4
million of primarily fixed rate one- to four-family residential mortgage loans
to other financial institutions. For the year ended June 30, 2005, there were
$11.0 million and $24.6 million of such sales into the secondary market and to
other financial institutions, respectively. The reduction in loan sales for the
year ended June 30, 2006, when compared to the prior year, can be partially
attributed to a reduction in the origination of longer term fixed rate products,
as borrowers have shown increased interest in adjustable rate and bi-weekly
loans, which are retained in portfolio.
Income on BOLI increased $277,000 to $967,000 for the year ended June 30, 2006
from $690,000 for the year ended June 30, 2005. The fiscal 2006 increase was
primarily due to a $7.0 million additional BOLI purchase.
Non-Interest Expenses. Non-interest expenses for the year ended June 30, 2006
were $24.2 million, which was relatively unchanged from the $24.2 million
recorded for the prior year. The Company's non-interest expenses as a percent of
average assets decreased to 1.12% for the year ended June 30, 2006 from 1.22%
for the prior year. Fiscal 2006 non-interest expenses included a $1.4 million
prepayment penalty on certain FHLB of New York advances, a $169,000 increase in
obligations under certain long-term benefit plans and $372,000 of accelerated
depreciation expense for branch automation system software that is no longer
used. The opening of a new branch in February 2005 also added to fiscal 2006
non-interest expenses. Fiscal 2005 non-interest expenses included $1.4 million
of the amortization of intangible assets, which were fully amortized on March
31, 2005.
Income Tax Expense. Income tax expense for the year ended June 30, 2006 was $7.4
million compared to $8.7 million for the year ended June 30, 2005. The effective
tax rate for the year ended June 30, 2006 was 35.6% compared to 35.9% for the
prior year.
Comparison of Operating Results for the Years Ended June 30, 2005 and June 30,
2004
General. For the year ended June 30, 2005, net income was $15.5 million, or
$1.11 per diluted share, compared to net income of $12.1 million, or $0.83 per
diluted share, for the year ended June 30, 2004. As a result of additional
Sarbanes-Oxley Section 404 ("SOX 404") compliance costs, the Company recorded
approximately $300,000 (pretax) of costs associated with SOX 404 in fiscal 2005,
including a $208,000 (pretax) charge during the fourth quarter of fiscal 2005.
As a result of an environmental liability, as explained in Item 3. Legal
Proceedings, the Company recorded a $298,000 (pretax) charge during the fourth
quarter of fiscal 2004. Earnings per share amounts reflect the effect of the
100% stock dividend described in Item 8 - Financial Statements - Note N -
Stockholders' Equity and Regulatory Capital - of the Notes to Consolidated
Financial Statements.
Interest and Dividend Income. Interest and dividend income for the year ended
June 30, 2005 increased to $104.7 million from $96.3 million for the year ended
June 30, 2004. In general, the increase in interest and dividend income reflects
a
41
higher level of interest-earning assets due to strong loan originations and the
slowdown in prepayments in the Company's loan and mortgage-backed securities
portfolios during fiscal 2005. The effect of the increase was slightly offset by
a lower average yield earned on assets which was the result of prepayments of
higher yielding loans and the origination of loans at lower market interest
rates during the year ended June 30, 2005. Average interest-earning assets were
$1.914 billion for the year ended June 30, 2005 compared to $1.739 billion for
the prior year. The average yield earned on interest-earning assets decreased to
5.47% for the year ended June 30, 2005 from 5.54% for the year ended June 30,
2004.
Interest income on residential one- to four-family mortgage loans for the year
ended June 30, 2005 increased $7.5 million when compared to the prior year. The
increase in interest income on residential one- to four-family mortgage loans
was due to an increase in the average balance of residential one- to four-family
mortgage loans outstanding of $167.6 million for the year ended June 30, 2005,
when compared to the prior year, as a result of strong loan origination levels
and a slowdown in prepayments. Somewhat offsetting the increase in the average
balance of residential one- to four-family mortgage loans was a decrease in the
average yield earned on this loan portfolio to 5.30% for the year ended June 30,
2005 from 5.44% for the prior year period, reflecting the payoff or refinance of
higher yielding loans and the origination of lower yielding loans over the year
ended June 30, 2005. At June 30, 2005, one- to four- family mortgage loans
represented 78.5% of the total loan portfolio and 75.6% of interest income on
loans.
Interest income on commercial and multi-family real estate loans decreased
$391,000 for the year ended June 30, 2005, when compared to the year ended June
30, 2004. The decrease in interest income on commercial and multi-family real
estate loans was attributable to a decrease in the average yield earned on these
loans. The average yield on commercial and multi-family real estate loans
decreased to 6.90% for the year ended June 30, 2005 compared to 7.39% for the
year ended June 30, 2004. As with other loans, the payoff of higher yielding
loans and the origination of loans at lower market interest rates resulted in a
decline in the yield on the commercial and multi-family real estate loan
portfolio. The decrease in interest income for this portfolio was partially
offset by an increase in the average outstanding balance of commercial and
multi-family real estate loans of $5.7 million for the year ended June 30, 2005,
when compared to the prior year.
Interest income on consumer loans increased $481,000 for the year ended June 30,
2005, when compared to the year ended June 30, 2004. The increase in interest
income on consumer loans for the year ended June 30, 2005 was due to an increase
in the average balance outstanding of this loan portfolio of $11.2 million, when
compared to the year ended June 30, 2004. The increase in interest income from
the larger portfolio of consumer loans for the year ended June 30, 2005 was
partially offset by a decrease in the average yield to 5.38% from 5.49% for the
prior year.
Interest income on investment securities and other interest-earning assets
increased $1.6 million for the year ended June 30, 2005 compared to the prior
year. The increase in interest income on these securities was attributable to an
$18.8 million increase in the average balance outstanding for the year ended
June 30, 2005, when compared to the prior year. The average yield increased to
5.46% for the year ended June 30, 2005 compared to 5.33% for the year ended June
30, 2004.
Interest income on the mortgage-backed securities portfolio decreased $561,000
for the year ended June 30, 2005 compared to the prior year. The decrease in
interest income on mortgage-backed securities for the year ended June 30, 2005
was primarily due to a decrease in the average balance outstanding of $10.5
million for the year ended June 30, 2005, when compared to the prior year. In
addition, the decrease in interest income on mortgage-backed securities was due
to a decrease in the average yield earned on this portfolio to 5.11% from 5.13%
for the year ended June 30, 2004.
Interest Expense. Interest expense increased $2.7 million for the year ended
June 30, 2005 from the year ended June 30, 2004. While the Company's cost of
funds decreased, total average deposits and borrowings increased. The average
rate on deposits and borrowings decreased to 3.33% for the year ended June 30,
2005 from 3.52% for the prior year, as a result of lower market interest rates
on other borrowings and only a slight increase in the cost of deposits. The
decrease in the cost of funds for the year ended June 30, 2005 was offset by an
increase in total average deposits and borrowings of $173.8 million, when
compared to the year ended June 30, 2004.
The average rate paid on deposits increased slightly to 2.42% for the year ended
June 30, 2005 from 2.41% for the year ended June 30, 2004. Average deposit
balances increased $151.1 million to $1.257 billion for the year ended June 30,
2005 from $1.106 billion for the prior year. The growth in deposits was
partially reflective of the addition of the four new branches opened since
September 2003 and the addition of wholesale certificates of deposit. In
addition, deposit growth reflected the offering of attractive and competitive
deposit products, which were promoted through various marketing strategies.
42
The average cost of FHLB of New York advances increased to 5.80% for the year
ended June 30, 2005 from 5.76% for the prior year, due to the maturity of lower
costing advances. The average balance of FHLB of New York advances decreased
$64.4 million for the year ended June 30, 2005, when compared to the year ended
June 30, 2004. As a funding source to replace maturing FHLB of New York advances
and because of the slowdown in prepayments on loans, the average balance of
other borrowings for the year ended June 30, 2005 increased $87.0 million, when
compared to the prior year. The average rate paid on other borrowings decreased
to 2.80% for fiscal 2005 from 3.64% for fiscal 2004. During fiscal 2005, the
vast majority of other borrowings were borrowings with maturities within one
year; thus, the cost of these borrowings reflected the lower levels of short
term interest rates experienced during the year, when compared to fiscal 2004.
Interest expense on junior subordinated debentures increased $349,000 for the
year ended June 30, 2005, when compared to the prior year. The increase in
interest expense was due to an increase in the average cost of these borrowings
to 7.24% for the year ended June 30, 2005 from 6.42% for the year ended June 30,
2004. The average balance of junior subordinated debentures increased $44,000
during the fiscal year ended June 30, 2005.
Net Interest and Dividend Income. Net interest and dividend income before
provision for loan losses for the year ended June 30, 2005 was $43.3 million
compared to $37.6 million recorded in the prior year. Average net
interest-earning assets increased $1.2 million for the year ended June 30, 2005,
when compared to the prior year. The net interest rate spread and net interest
margin for fiscal 2005 were 2.14% and 2.26%, respectively, an increase from
2.02% and 2.16% for the year ended June 30, 2004. The net interest margin
expanded during fiscal 2005 when compared to the prior year principally due to
a slowdown in loan prepayments, growth in the loan portfolio and the repricing
of certain deposits and other borrowings.
Provision for Loan Losses. There was no provision for loan losses recorded for
the years ended June 30, 2005 and 2004, which was consistent with the
maintenance of the Company's historically low levels of non-accruing loans and
loan chargeoffs. Management believes that the allowance for loan losses at both
dates was adequate to absorb probable losses on existing loans that may have
become uncollectible. The allowance for loan losses at June 30, 2005 of $6.1
million was relatively unchanged from the $6.2 million at June 30, 2004. The
allowance for loan losses as a percentage of non-accruing loans was 231.00% at
June 30, 2005, compared to 286.39% at June 30, 2004. Non-accruing loans were
$2.6 million at June 30, 2005 compared to $2.2 million at June 30, 2004. The
allowance for loan losses as a percentage of total loans at June 30, 2005 was
0.41% compared to 0.48% at June 30, 2004, primarily due to the increase in the
balance of the overall loan portfolio. See Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations "-Critical Accounting
Policies".
Non-Interest Income. For the year ended June 30, 2005, non-interest income was
$5.0 million compared to $6.4 million for the prior year. The decrease in
non-interest income for fiscal 2005 was primarily due to decreases in fees and
service charges and net gain on sales of loans when compared to the year ended
June 30, 2004.
Fees and service charges for the year ended June 30, 2005 was $3.1 million
compared to $4.2 million recorded for the prior year. The decline in fees and
service charges for the year ended June 30, 2005 was primarily due to a decline
in fees associated with various loan prepayments and/or modifications.
During the year ended June 30, 2005, the net gain on sales of loans was $394,000
compared to $759,000 for the year ended June 30, 2004. Approximately $11.0
million of conforming, fixed rate one- to four-family residential mortgage loans
were sold into the secondary market during the 2005 fiscal year. In addition,
during the year ended June 30, 2005, the Company sold approximately $24.6
million of fixed rate one- to four-family residential mortgage loans to other
financial institutions. For the year ended June 30, 2004, there were $48.4
million and $39.0 million of such sales into the secondary market and to other
financial institutions, respectively. Furthermore, during the year ended June
30, 2004, a $3.0 million commercial real estate loan participation was sold as a
means to reduce the Company's credit exposure on a large commercial real estate
loan relationship, realizing a net gain of approximately $183,000. The
reduction in loan sales for the year ended June 30, 2005 was attributed to a
reduction in the origination of longer-term fixed rate products, as borrowers
showed increased interest in adjustable rate and bi-weekly loans, which were
retained in portfolio.
Non-Interest Expenses. Non-interest expenses for the year ended June 30, 2005
were $24.2 million compared to $25.4 million for the prior year. The Company's
non-interest expenses as a percent of average assets decreased to 1.22% for the
year ended June 30, 2005 from 1.41% for the prior year. While fiscal 2005
expense levels reflected the end of costs associated with funding the Company's
Employee Stock Ownership Plan ("ESOP"), expenses in fiscal 2005 included a much
less expensive replacement benefit plan for the ESOP, increased advertising
expense and costs associated with the
43
four branches opened since September 2003. In addition, costs associated with
regulatory burden, especially compliance with SOX 404, required significant
additional expenditures and were expected to remain high into fiscal 2006. The
opening of a new branch in February 2005 will also add to future non-interest
expense, particularly in the net occupancy and advertising expense categories.
For the year ended June 30, 2004, the Company recorded a $298,000 (pretax)
non-recurring charge for an additional environmental accrual, as discussed in
Item 3. Legal Proceedings.
Income Tax Expense. Income tax expense for the year ended June 30, 2005 was $8.7
million compared to $6.5 million for the year ended June 30, 2004. The effective
tax rate for the year ended June 30, 2005 was 35.9% compared to 35.2% for the
prior year. The higher effective tax rate in fiscal 2005 was primarily due to
adjustment in the first quarter of fiscal 2005 in valuation allowances
established against state deferred tax assets.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, principal and interest
payments on loans and mortgage-backed securities, and borrowings from the FHLB
of New York. While scheduled loan repayments and maturing investments are
relatively predictable, deposit flows and early loan repayments are more
influenced by interest rates, general economic conditions and competition. The
Company sets rates on deposit products for selected terms and, when necessary,
has supplemented deposits with longer-term or less expensive alternative sources
of funds.
The Bank maintains appropriate levels of liquid assets. The Company's most
liquid assets are cash and cash equivalents, U.S. government agency securities
and mortgage-backed securities. The levels of these assets are dependent on the
Bank's operating, financing, lending and investing activities during any given
period.
In the event that the Company should require funds beyond its ability to
generate them internally, additional sources of funds are available through the
use of FHLB of New York advances and reverse repurchase agreements. In addition,
the Company may access funds, if necessary, through the use of a $100.0 million
overnight repricing line of credit and a $100.0 million variable rate one-month
overnight repricing line of credit from the FHLB of New York, both of which
expire in July 2006. The Company expects to renew these lines of credit after
expiration on an annual basis. Furthermore, the Company has $120.0 million of
overnight variable repricing lines of credit available from other correspondent
banks. The Company also has a $12.0 million unsecured revolving line of credit.
The Company uses its liquid resources principally to fund maturing certificates
of deposit and deposit withdrawals, to purchase loans and securities, to fund
existing and future loan commitments, and to meet operating expenses. At June
30, 2006, the Company had outstanding commitments to extend credit which
amounted to $121.0 million (including $90.7 million in available lines of
credit). The actual extension of credit would result in a use of liquidity.
Management believes that loan repayments and other sources of funds will be
adequate to meet the Company's foreseeable liquidity needs. Future liquidity
requirements are not expected to be significantly different from historical
experience.
During fiscal 2006, the Company's cash inflows included $29.8 million of
proceeds from the sale of loans, a $74.9 million increase in deposits (net of
accrued interest payable), a $332.2 million increase in FHLB of New York
advances and other borrowings, including short term borrowings, and principal
repayments of loans and mortgage-backed securities. During the year ended June
30, 2006, the cash provided was used to repay $150.0 million of maturing FHLB of
New York advances and other borrowings and to fund investing activities, which
included the origination and purchase of loans, the purchase of $35.0 million of
investment securities, the purchase of $5.3 million of FHLB of New York stock
and the funding of a $7.0 million investment in BOLI. In addition, the cash
provided was used to repurchase $10.6 million of outstanding common shares, net
of reissuances, and to pay cash dividends of $3.6 million.
The Company's cash inflows for the year ended June 30, 2005 included $36.0
million of proceeds from the sale of loans, $44.7 million of proceeds from
maturities of investment securities, principal repayments of loans and
mortgage-backed securities, a $151.4 million increase in deposits (net of
accrued interest payable) and a $48.6 million increase in other borrowings,
including short term borrowings. During the year ended June 30, 2005, the cash
provided was used to fund investing activities, which included the origination
of loans, the purchase of $30.2 million of investment securities and to fund a
$10.0 million investment in BOLI. In addition, the cash provided was used to
repay $60.0 million of maturing FHLB of New York advances and other borrowings,
to repurchase $9.9 million of outstanding common shares, net of reissuances, and
to pay cash dividends of $2.9 million.
During the year ended June 30, 2004, the Company's cash inflows included $91.4
million of proceeds from the sale of loans, $96.3 million of proceeds from
maturities of investment securities, principal repayments of loans and
mortgage-backed securities and a $93.6 million increase in deposits (net of
accrued interest payable). Additionally, the Company's cash inflows for the year
ended June 30, 2004 included a $52.1 million increase in other borrowings,
including short term
44
borrowings. During fiscal 2004, the cash provided was used to fund investing
activities, which included the origination and purchase of loans and the
purchase of $232.2 million of investment and mortgage-backed securities, as well
as for the repayment of $48.4 million of FHLB of New York advances and other
borrowings. Additionally, during the year ended June 30, 2004, the cash provided
was used to fund a $12.0 million investment in BOLI, to repurchase $11.0 million
of outstanding common shares, net of reissuances, and to pay cash dividends of
$2.7 million.
Total dividends paid for the years ended June 30, 2006, 2005 and 2004 were $0.28
per share, $0.22 per share and $0.20 per share, respectively. The declaration
and payment of dividends are subject to, among other things, PennFed's financial
condition and results of operations, regulatory capital requirements, tax
considerations, industry standards, economic conditions, regulatory
restrictions, general business practices and other factors.
Off-Balance Sheet Arrangements and Contractual Obligations
In the normal course of operation, the Company engages in a variety of financial
transactions that, in accordance with U.S. generally accepted accounting
principles, are not recorded in the consolidated financial statements, or are
recorded in amounts that differ from the notional amounts. 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 consumer lines of credit and commitments to extend
credit and are discussed in Item 8 - Financial Statements - Note M - of the
Notes to Consolidated Financial Statements.
The following table shows the contractual obligations of the Company by expected
payment period as of June 30, 2006 (in thousands). Further discussion of these
commitments is included in Item 8 - Financial Statements - Notes I and M - of
the Notes to Consolidated Financial Statements.
Less than 1 Year 3 Years More than
Contractual obligations: Total One Year to 3 Years to 5 Years 5 Years
---------------------------------------------------------------
Debt obligations ......... $ 794,575 $ 148,244 $ 185,817 $ 323,264 $ 137,250
Operating lease and other
contractual obligations 5,916 1,179 2,034 764 1,939
---------------------------------------------------------------
$ 800,491 $ 149,423 $ 187,851 $ 324,028 $ 139,189
===============================================================
Debt obligations include borrowings from the FHLB of New York, reverse
repurchase agreements and junior subordinated deferrable interest debentures.
The borrowings have defined terms and, under certain circumstances, are callable
at the option of the lender.
Operating leases and other contractual obligations include lease arrangements
entered into by the Company for the use of land and premises and a loan
sub-servicing contract. The Company's leases generally have escalation terms
based upon certain defined indexes.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information required by this item is set forth in Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations
"-Interest Rate Sensitivity" and "-Asset/Liability Strategy."
45
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
PennFed Financial Services, Inc. and Subsidiaries
We have audited the accompanying consolidated statements of financial condition
of PennFed Financial Services, Inc. and Subsidiaries (the "Company") as of June
30, 2006 and 2005, and the related consolidated statements of income,
comprehensive income, changes in stockholders' equity, and cash flows for the
years then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of PennFed Financial
Services, Inc. and Subsidiaries as of June 30, 2006 and 2005, and the results of
their operations and their cash flows for the years then ended in conformity
with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of PennFed
Financial Services, Inc. and Subsidiaries' internal control over financial
reporting as of June 30, 2006, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission, and our report dated September 11,
2006 expressed an unqualified opinion on management's assessment of, and the
effective operation of, internal control over financial reporting.
/s/ KPMG LLP
Short Hills, New Jersey
September 11, 2006
46
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
PennFed Financial Services, Inc. and Subsidiaries
West Orange, New Jersey
We have audited the accompanying consolidated statements of income,
comprehensive income, changes in stockholders' equity and cash flows for the
year ended June 30, 2004 of PennFed Financial Services, Inc. and Subsidiaries
(the "Company"). These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion such consolidated financial statements present fairly, in all
material respects, the results of operations and cash flows of PennFed Financial
Services, Inc. and Subsidiaries for the year ended June 30, 2004 in conformity
with accounting principles generally accepted in the United States of America.
As discussed in Note U to the consolidated financial statements, the
consolidated statements of cash flows for the year ended June 30, 2004 has been
restated.
/s/ Deloitte & Touche LLP
Parsippany, New Jersey
August 27, 2004
(September 12, 2005 as to Note U)
47
Report of Independent Registered Public Accounting Firm on Internal Control Over
Financial Reporting
The Board of Directors and Stockholders
PennFed Financial Services, Inc. and Subsidiaries
We have audited management's assessment, included in the accompanying Report of
Management on Internal Control Over Financial Reporting, that PennFed Financial
Services, Inc. and Subsidiaries (the "Company") maintained effective internal
control over financial reporting as of June 30, 2006, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Management of the Company
is responsible for maintaining effective internal control over financial
reporting and for its assessment of the effectiveness of internal control over
financial reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that PennFed Financial Services, Inc.
and Subsidiaries maintained effective internal control over financial reporting
as of June 30, 2006, is fairly stated, in all material respects, based on
criteria established in Internal Control--Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Also, in our
opinion, PennFed Financial Services, Inc. and Subsidiaries maintained, in all
material respects, effective internal control over financial reporting as of
June 30, 2006, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated statement of
financial condition of PennFed Financial Services, Inc. and Subsidiaries as of
June 30, 2006 and 2005, and the related consolidated statements of income,
comprehensive income, changes in stockholders' equity, and cash flows for the
years then ended, and our report dated September 11, 2006 expressed an
unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Short Hills, New Jersey
September 11, 2006
48
Report of Management on Internal Control Over Financial Reporting
The management of PennFed Financial Services, Inc. and Subsidiaries (the
"Company") is responsible for establishing and maintaining adequate internal
control over financial reporting.
The Company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with U.S. generally accepted accounting principles. The Company's internal
control over financial reporting includes policies and procedures that (i)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect transactions and dispositions of the assets of the Company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with U.S. generally
accepted accounting principles, and that receipts and expenditures of the
Company are being made only in accordance with authorizations of management and
the directors of the Company; (iii) and provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use or disposition
of the Company's assets that could have a material effect on the financial
statements.
Because of inherent limitations, internal control over financial reporting may
not prevent or detect misstatements. All internal control systems, no matter how
well designed, have inherent limitations, including the possibility of human
error and the circumvention of overriding controls. Therefore, even effective
internal control over financial reporting can provide only reasonable assurance
with respect to financial statement preparation and presentation. Also,
projections of any evaluation of effectiveness to future periods are subject to
the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may
deteriorate.
The Company's management assessed the effectiveness of the Company's internal
control over financial reporting as of June 30, 2006, based on the criteria set
forth by the Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control--Integrated Framework. Based on our assessment we concluded
that, as of June 30, 2006, the Company's internal control over financial
reporting is effective based on those criteria.
The Company's independent registered public accounting firm that audited the
June 30, 2006 consolidated financial statements has issued a report on our
assessment of, and the effective operation of, the Company's internal control
over financial reporting as of June 30, 2006. This report appears on page 48.
/s/ Joseph L. LaMonica /s/ Claire M. Chadwick
Joseph L. LaMonica Claire M. Chadwick
President and Senior Executive Vice President and
Chief Executive Officer Chief Financial Officer
September 11, 2006
49
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Consolidated Statements of Financial Condition
June 30,
------------------------
2006 2005
------------------------
(Dollars in thousands)
Assets
Cash and cash equivalents ......................................................... $ 16,614 $ 15,220
Investment securities available for sale, at market value, amortized cost of
$5,053 and $4,849 at June 30, 2006 and 2005 ................................... 4,936 5,011
Investment securities held to maturity, at amortized cost, market value of
$420,663 and $406,726 at June 30, 2006 and 2005 ............................... 440,360 405,498
Mortgage-backed securities held to maturity, at amortized cost, market value of
$60,893 and $79,109 at June 30, 2006 and 2005 ................................. 62,963 78,201
Loans held for sale ............................................................... 217 4,826
Loans receivable, net of allowance for loan losses of
$5,888 and $6,050 at June 30, 2006 and 2005 ................................... 1,684,007 1,460,654
Premises and equipment, net ....................................................... 20,415 20,903
Federal Home Loan Bank of New York stock, at cost ................................. 27,714 22,391
Accrued interest receivable, net .................................................. 11,145 9,808
Bank owned life insurance ("BOLI") ................................................ 31,168 23,202
Other assets ...................................................................... 6,971 4,837
------------------------
$ 2,306,510 $2,050,551
========================
Liabilities and Stockholders' Equity
Liabilities:
Deposits ...................................................................... $ 1,414,588 $1,339,491
Federal Home Loan Bank of New York advances ................................... 465,465 415,465
Other borrowings .............................................................. 240,193 107,952
Junior Subordinated Deferrable Interest Debentures,
net of unamortized issuance expenses of $1,174 and $1,218 at June 30, 2006
and 2005 .................................................................. 42,126 42,082
Mortgage escrow funds ......................................................... 11,877 10,398
Accounts payable and other liabilities ........................................ 8,840 11,109
------------------------
Total liabilities ............................................................. 2,183,089 1,926,497
------------------------
Commitments and Contingencies
Stockholders' Equity:
Serial preferred stock, $.01 par value,
7,000,000 shares authorized, no shares issued ............................. -- --
Common stock, $.01 par value, 15,000,000 shares authorized, 12,864,047 and
13,280,038 shares issued and outstanding at June 30, 2006 and 2005 ........ 129 133
Additional paid-in capital .................................................... 38,325 39,092
Retained earnings ............................................................. 85,036 84,734
Accumulated other comprehensive income (loss), net of taxes ................... (69) 95
------------------------
Total stockholders' equity .................................................... 123,421 124,054
------------------------
$ 2,306,510 $2,050,551
========================
See notes to consolidated financial statements.
50
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Consolidated Statements of Income
For the years ended June 30,
------------------------------------------------
2006 2005 2004
------------------------------------------------
(Dollars in thousands, except per share amounts)
Interest and Dividend Income:
Interest and fees on loans ........................ $ 85,922 $ 75,830 $ 68,213
Interest on federal funds sold .................... -- -- 178
Interest and dividends on investment securities ... 25,794 24,384 22,816
Interest on mortgage-backed securities ............ 3,560 4,508 5,069
------------------------------------------------
115,276 104,722 96,276
------------------------------------------------
Interest Expense:
Deposits .......................................... 41,766 30,356 26,634
Borrowed funds .................................... 32,359 27,981 29,342
Junior subordinated deferrable interest debentures 3,657 3,047 2,698
------------------------------------------------
77,782 61,384 58,674
------------------------------------------------
Net Interest and Dividend Income Before
Provision for Loan Losses ......................... 37,494 43,338 37,602
Provision for Loan Losses ........................... -- -- --
------------------------------------------------
Net Interest and Dividend Income After
Provision for Loan Losses ......................... 37,494 43,338 37,602
------------------------------------------------
Non-Interest Income:
Fees and service charges .......................... 5,670 3,096 4,175
Income on BOLI .................................... 966 690 512
Net gain on sales of loans ........................ 143 394 759
Net gain (loss) from real estate operations ....... (6) 156 58
Other ............................................. 740 660 925
------------------------------------------------
7,513 4,996 6,429
------------------------------------------------
Non-Interest Expenses:
Compensation and employee benefits ................ 12,202 12,263 14,593
Equipment ......................................... 2,573 2,140 2,057
Net occupancy expense ............................. 2,426 2,319 1,894
Extinguishment of debt ............................ 1,351 -- --
Advertising ....................................... 637 719 390
Federal deposit insurance premium ................. 175 172 168
Amortization of intangible assets ................. -- 1,361 1,816
Other ............................................. 4,834 5,197 4,512
------------------------------------------------
24,198 24,171 25,430
------------------------------------------------
Income Before Income Taxes .......................... 20,809 24,163 18,601
Income Tax Expense .................................. 7,411 8,669 6,543
------------------------------------------------
Net Income .......................................... $ 13,398 $ 15,494 $ 12,058
================================================
Weighted average number of common shares outstanding:
Basic ............................................. 13,053,853 13,612,502 13,548,796
================================================
Diluted ........................................... 13,451,005 14,010,684 14,449,170
================================================
Net income per common share:
Basic ............................................. $ 1.03 $ 1.14 $ 0.89
================================================
Diluted ........................................... $ 1.00 $ 1.11 $ 0.83
================================================
See notes to consolidated financial statements.
51
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Consolidated Statements of Comprehensive Income
For the years ended June 30,
------------------------------------
2006 2005 2004
------------------------------------
(In thousands)
Net income ................................................. $ 13,398 $ 15,494 $ 12,058
Other comprehensive income (loss), net of tax:
Unrealized holding gains (losses) arising during period
on investment securities available for sale, net of tax (164) 67 (149)
------------------------------------
Comprehensive income ....................................... $ 13,234 $ 15,561 $ 11,909
====================================
See notes to consolidated financial statements.
52
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Consolidated Statements of
Changes in Stockholders' Equity
For the Years Ended June 30, 2006, 2005 and 2004
Employee
Serial Additional Stock
Preferred Common Paid-In Ownership Retained
Stock Stock Capital Plan Earnings
-------------------------------------------------------------------------
(Dollars in thousands, except per share amounts)
Balance at June 30, 2003 ............ $ -- $ 60 $ 63,025 $ (644) $ 127,461
Allocation of Employee Stock
Ownership Plan ("ESOP") stock ... 644
ESOP adjustment ..................... 2,659
Purchase of 792,200 shares
of treasury stock ...............
Issuance of 692,202 shares
of treasury stock for options
exercised and Dividend
Reinvestment Plan ("DRP") ....... (3,309) (40)
Cash dividends of $ 0.20 per
common share .................... (2,650)
Unrealized holding losses
on investment securities
available for sale, net of income
taxes of $(77) ..................
Reclassification of treasury shares . (51) (25,509) (55,333)
Net income for the year ended
June 30, 2004 ................... 12,058
-------------------------------------------------------------------------
Balance at June 30, 2004 ............ -- 9 36,866 -- 81,496
Repurchase of 731,800
outstanding shares .............. (6) (1,823) (9,451)
Issuance of 435,778 shares of
stock for options exercised
and DRP ......................... 2 1,087 247
Tax benefit from stock option plan .. 2,962
Cash dividends of $0.22 per
common share .................... (2,924)
Unrealized holding gains on
investment securities available
for sale, net of income taxes
of $46 ..........................
Two-for-one split in the
form of a 100% stock dividend ... 128 (128)
Net income for the year ended
June 30, 2005 ................... 15,494
-------------------------------------------------------------------------
Balance at June 30, 2005 ............ -- 133 39,092 -- 84,734
Repurchase of 626,300
outstanding shares .............. (6) (1,560) (10,067)
Issuance of 210,309 shares
of stock for options
exercised and DRP ............... 2 524 546
Tax benefit from stock option plan .. 269
Cash dividends of $0.28 per
common share .................... (3,575)
Unrealized holding losses on
investment securities available
for sale, net of income taxes of
$(114) ..........................
Net income for the year ended
June 30, 2006 ................... 13,398
-------------------------------------------------------------------------
Balance at June 30, 2006 ............ $ -- $ 129 $ 38,325 $ -- $ 85,036
=========================================================================
Accumulated
Other
Comprehensive Treasury
Income (Loss) Stock Total
-------------------------------------------------
(Dollars in thousands, except per share amounts)
Balance at June 30, 2003 ............ $ 177 $ (73,244) $ 116,835
Allocation of Employee Stock
Ownership Plan ("ESOP") stock ... 644
ESOP adjustment ..................... 2,659
Purchase of 792,200 shares
of treasury stock ............... (12,908) (12,908)
Issuance of 692,202 shares
of treasury stock for options
exercised and Dividend
Reinvestment Plan ("DRP") ....... 5,259 1,910
Cash dividends of $ 0.20 per
common share .................... (2,650)
Unrealized holding losses
on investment securities
available for sale, net of income
taxes of $(77) .................. (149) (149)
Reclassification of treasury shares . 80,893 --
Net income for the year ended
June 30, 2004 ................... 12,058
-------------------------------------------------
Balance at June 30, 2004 ............ 28 -- 118,399
Repurchase of 731,800
outstanding shares .............. (11,280)
Issuance of 435,778 shares of
stock for options exercised
and DRP ......................... 1,336
Tax benefit from stock option plan .. 2,962
Cash dividends of $0.22 per
common share .................... (2,924)
Unrealized holding gains on
investment securities available
for sale, net of income taxes
of $46 .......................... 67 67
Two-for-one split in the
form of a 100% stock dividend ... --
Net income for the year ended
June 30, 2005 ................... 15,494
-------------------------------------------------
Balance at June 30, 2005 ............ 95 -- 124,054
Repurchase of 626,300
outstanding shares .............. (11,633)
Issuance of 210,309 shares
of stock for options
exercised and DRP ............... 1,072
Tax benefit from stock option plan .. 269
Cash dividends of $0.28 per
common share .................... (3,575)
Unrealized holding losses on
investment securities available
for sale, net of income taxes of
$(114) .......................... (164) (164)
Net income for the year ended
June 30, 2006 ................... 13,398
-------------------------------------------------
Balance at June 30, 2006 ............ $ (69) $ -- $ 123,421
=================================================
See notes to consolidated financial statements.
53
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Consolidated Statements of Cash Flows
For the years ended June 30,
-----------------------------------
2006 2005 2004
(Note U)
-----------------------------------
(In thousands)
Cash Flows from Operating Activities:
Net income ...................................................................... $ 13,398 $ 15,494 $ 12,058
Adjustments to reconcile net income to net cash provided by operating
activities:
Net gain on sales of loans ...................................................... (143) (394) (759)
Proceeds from sales of loans originated for sale ................................ 6,224 11,154 48,667
Originations of loans held for sale ............................................. (5,420) (12,051) (42,266)
Net (gain) loss on sales of real estate owned ................................... 4 (158) (57)
Amortization of investment and mortgage-backed securities premium, net .......... 295 249 503
Depreciation and amortization ................................................... 2,169 1,920 1,733
Amortization of cost of stock plans ............................................. -- -- 3,304
Amortization of intangible assets ............................................... -- 1,361 1,816
Amortization of premiums on loans and loan fees ................................. 1,912 1,824 2,878
Amortization of junior subordinated debentures issuance costs ................... 44 45 38
Income on BOLI .................................................................. (966) (690) (512)
Increase in deferred income tax liability ....................................... 731 1,219 163
(Increase) decrease in accrued interest receivable, net of accrued
interest payable .............................................................. (1,117) 329 (1,627)
(Increase) decrease in other assets ............................................. (449) 527 (590)
Increase (decrease) in accounts payable and other liabilities ................... (4,570) 644 (8,611)
Increase (decrease) in mortgage escrow funds .................................... 1,479 659 (752)
Other, net ...................................................................... -- -- 6
-----------------------------------
Net cash provided by operating activities ....................................... 13,591 22,132 15,992
-----------------------------------
Cash Flows From Investing Activities:
Proceeds from maturities of investment securities held to maturity .............. -- 44,652 96,275
Purchases of investment securities held to maturity ............................. (34,977) (30,000) (177,140)
Purchases of investment securities available for sale ........................... (203) (177) (205)
Proceeds from principal repayments of mortgage-backed securities held to maturity 15,058 21,739 47,976
Purchases of mortgage-backed securities ......................................... -- -- (54,823)
Net outflow from loan originations net of principal repayments of loans ......... (231,918) (203,896) (56,769)
Proceeds from loans sold ........................................................ 23,531 24,883 42,729
Purchases of loans .............................................................. (13,407) -- (53,034)
Purchases of premises and equipment ............................................. (1,681) (1,133) (2,326)
Net inflow from real estate owned activity ...................................... 473 630 84
Purchases of BOLI ............................................................... (7,000) (10,000) (12,000)
(Purchases) redemptions of Federal Home Loan Bank of New York stock ............. (5,323) 1,382 1,450
-----------------------------------
Net cash used in investing activities ........................................... (255,447) (151,920) (167,783)
-----------------------------------
Cash Flows From Financing Activities:
Net increase in deposits ........................................................ 74,876 151,449 93,550
Proceeds from advances from the Federal Home Loan Bank of New York
and other borrowings .......................................................... 185,000 29,475 24,986
Repayment of advances from the Federal Home Loan Bank of
New York and other borrowings ................................................. (150,000) (60,000) (48,350)
Increase in other short term borrowings ......................................... 147,241 19,131 27,066
Cash dividends paid ............................................................. (3,575) (2,924) (2,650)
Repurchases of outstanding shares, net of reissuances ........................... (10,561) (9,944) (10,998)
Tax benefit related to stock options ............................................ 269 2,962 --
-----------------------------------
Net cash provided by financing activities ....................................... 243,250 130,149 83,604
-----------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents ............................... 1,394 361 (68,187)
Cash and Cash Equivalents, Beginning of Year ....................................... 15,220 14,859 83,046
-----------------------------------
Cash and Cash Equivalents, End of Year ............................................. $ 16,614 $ 15,220 $ 14,859
===================================
Supplemental Disclosures of Cash Flow Information:
Cash paid during the year for:
Interest ........................................................................ $ 77,333 $ 61,510 $ 59,335
===================================
Income taxes .................................................................... $ 8,536 $ 3,649 $ 7,105
===================================
Supplemental Schedule of Non-Cash Activities:
Transfer of loans receivable to loans held for sale, at lower of cost or market . $ 19,583 $ 28,417 $ 33,876
===================================
Transfer of loans receivable to real estate owned, net .......................... $ 477 $ 472 $ --
===================================
See notes to consolidated financial statements.
54
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
Years Ended June 30, 2006, 2005 and 2004
A. Summary of Significant Accounting Policies
PennFed Financial Services, Inc. ("PennFed") was organized in March 1994 for the
purpose of becoming the savings and loan holding company for Penn Federal
Savings Bank (the "Bank") in connection with the Bank's conversion from a
federally chartered mutual savings bank to a federally chartered stock savings
bank (the "Conversion").
Principles of Consolidation -- The consolidated financial statements of PennFed
and subsidiaries (with its subsidiaries, the "Company") include the accounts of
PennFed and its subsidiaries (including the Bank). PennFed owns all of the
outstanding stock of the Bank issued on July 14, 1994. All intercompany accounts
and transactions with consolidated subsidiaries have been eliminated in
consolidation.
Use of Estimates -- The preparation of financial statements in conformity with
U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The most significant area in the accompanying financial statements where
estimates have an impact is in the allowance for loan losses.
Cash and Cash Equivalents -- For purposes of reporting cash flows, cash and cash
equivalents include cash and amounts due from depository institutions.
Investment Securities and Mortgage-Backed Securities -- In accordance with
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS 115"), debt securities
classified as held to maturity are carried at amortized cost only if the
reporting entity has a positive intent and ability to hold those securities to
maturity.
The Company classifies investment securities and mortgage-backed securities as
either held to maturity or available for sale. Investment securities and
mortgage-backed securities held to maturity are stated at cost, adjusted for
amortization of premiums and accretion of discounts, since the Company has both
the ability and intent to hold the securities to maturity. Investments available
for sale are carried at market value with unrealized gains and losses excluded
from earnings and reported as accumulated other comprehensive income (loss) in
stockholders' equity. Realized and unrealized gains and losses are accounted for
on a specific identification method. Held to maturity and available for sale
securities are periodically reviewed for impairment. The review considers the
length of time the market value has been below cost, the expectation for the
security's performance, the credit worthiness of the issuer and the Company's
ability and intent to hold the security. A decline that is considered to be
other than temporary is recorded as a loss within other non-interest expenses in
the Consolidated Statements of Income.
In accordance with Statement of Financial Accounting Standards No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities" ("SFAS 140"), with certain loan sales, the Company may record an
interest-only strip ("IO"). These IO's represent the contractual right to
receive some or all of the interest due on the mortgage loans sold.
Loans Held for Sale -- Mortgage loans originated and intended for sale in the
secondary market are carried at the lower of cost or estimated market value in
the aggregate. Aggregate net unrealized losses are recorded as a valuation
allowance and recognized as charges to income.
Loans Receivable -- Loans are stated at unpaid principal balances, net of the
allowance for loan losses, unamortized premiums and deferred loan costs.
Interest income on loans is accrued and credited to income as earned. Loan
origination fees and premiums on purchased loans are deferred and amortized to
interest income over the life of the loan as an adjustment to the loan's yield.
Interest income is not accrued on loans where management has determined that the
borrowers may be unable to meet contractual principal or interest obligations or
where interest and/or principal is 90 days or more past due. When a loan is
placed on nonaccrual status, accrual of interest ceases and, in general,
uncollected past due interest (including
55
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
interest applicable to prior years, if any) is reversed and charged against
current income. Therefore, interest income is not recognized unless the
financial condition and payment record of the borrower warrant the recognition
of interest income. Interest on loans that have been restructured is generally
accrued according to the renegotiated terms.
In accordance with Statement of Financial Accounting Standards No. 114,
"Accounting by Creditors for Impairment of a Loan" ("SFAS 114") and Statement of
Financial Accounting Standards No. 118, "Accounting by Creditors for Impairment
of a Loan - Income Recognition and Disclosures" ("SFAS 118"), the Company
accounts for impaired loans, except those loans that are accounted for at market
value or at the lower of cost or market value, at the present value of the
estimated future cash flows of the loan discounted at the loan's effective
interest rate or at the loan's observable market price or the fair value of the
collateral if the loan is collateral dependent. A loan is impaired when it is
probable that all principal and interest amounts will not be collected according
to the loan contract. Delinquent, smaller balance, homogeneous loans that are
evaluated for impairment collectively on a portfolio basis are not considered
impaired under SFAS 114. The Company generally evaluates the collectibility of
consumer and one- to four-family mortgage loans on a total portfolio basis.
Allowance for Loan Losses -- The allowance for loan losses is established
through charges to income. Loan losses are charged against the allowance for
loan losses when management believes that the recovery of principal is unlikely.
If, as a result of loans charged off or increases in the size or risk
characteristics of the loan portfolio, the allowance is below the level
considered by management to be adequate to absorb probable loan losses on
existing loans, the provision for loan losses is increased to the level
considered necessary to provide an adequate allowance. The allowance is an
amount that management believes will be adequate to absorb probable losses on
existing loans that may become uncollectible, based on evaluations of the
collectibility of the loans. The evaluations take into consideration such
factors as changes in the nature and volume of the loan portfolio, overall
portfolio quality, review of specific problem loans and current economic
conditions that may affect the borrowers' ability to pay. Economic conditions
may result in the necessity to change the allowance in order to react to
deteriorating financial conditions of the Company's borrowers. As a result,
additional provisions on existing loans may be required in the future if
borrowers' financial conditions deteriorate or if real estate values decline.
Loan Origination Fees/Costs and Discounts and Premiums -- Nonrefundable loan
origination fees and certain direct loan origination costs are deferred. Net
deferred amounts on loans held for investment are amortized into income over the
life of the related loans by use of the level-yield method. Net deferred amounts
on loans originated for sale are deferred and recognized as part of the gain or
loss on sale of loans.
Discounts and premiums on investment and mortgage-backed securities and loans
purchased are recognized in interest income over the estimated life of the asset
purchased using the level-yield method.
Premises and Equipment -- Premises and equipment are stated at cost, less
accumulated depreciation and amortization. Provisions for depreciation of
premises and equipment are computed on the straight-line method over three to
ten years for furniture and equipment and twenty-five to forty years for
buildings. Amortization of leasehold improvements is provided using the
straight-line method over the terms of the respective lease or estimated useful
life of the improvement, whichever is shorter.
Real Estate Owned -- Real estate properties acquired by foreclosure are recorded
at the lower of cost or estimated fair value less anticipated costs to dispose
with any write down charged against the allowance for loan losses. Subsequent
valuations are periodically performed by management and the carrying value is
adjusted by a charge to expense to reflect any subsequent declines in the
estimated fair value or increases in the estimated costs to dispose.
Unanticipated declines in real estate values may result in increased foreclosed
real estate expense in the future. Routine holding costs are charged to expense
as incurred and improvements to real estate owned that increase the fair value
of the real estate are capitalized. Gains on sale of real estate owned are
generally recognized upon disposition of the property. Losses are charged to
operations as incurred.
Core Deposit Premium -- The premium resulting from the valuation of core
deposits arising from the acquisition discussed in Note B was amortized to
expense over the estimated average remaining life of the existing customer
deposit base acquired (10 years). As of June 30, 2005, the entire amount has
been amortized.
56
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Bank Owned Life Insurance - The Bank has purchased Bank Owned Life Insurance
("BOLI") policies in consideration of future employee benefit costs associated
with the Supplemental Executive Retirement Plan and the Directors' Retirement
Plan as well as current benefit costs for medical insurance coverage. The BOLI
is recorded at its cash surrender value and increases in the cash surrender
value of the insurance are recorded as a component of non-interest income.
Income Taxes -- In accordance with Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes" ("SFAS 109"), the Company uses the asset
and liability method for financial accounting and reporting for income taxes.
Deferred income taxes are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred taxes of a change in tax rates
is recognized in income tax expense in the period that includes the enactment
date.
Earnings Per Common Share -- Basic earnings per common share is computed by
dividing income available to common stockholders by the weighted average number
of common shares outstanding during the period, less the weighted average
unallocated ESOP shares of common stock. The computation of diluted earnings per
share is similar to the computation of basic earnings per share except that the
denominator is increased to include the number of additional common shares that
would have been outstanding if contracts to issue common stock, such as stock
options, were exercised or resulted in the issuance of common stock. The number
of additional shares is computed using the treasury stock method.
Stock Dividend - All share information has been adjusted to reflect a
two-for-one stock split in the form of a 100% stock dividend paid on October 29,
2004. For further information, refer to Note N - Stockholders' Equity and
Regulatory Capital.
Reclassifications - Certain reclassifications have been made to prior years'
financial statements to conform with current year's presentation.
Recently Adopted Accounting Standards - Effective July 1, 2005, the Company
adopted Statement of Financial Accounting Standards No. 153, "Exchanges of
Nonmonetary Assets" ("SFAS 153"), which amends APB Opinion No. 29, "Accounting
for Nonmonetary Transactions." SFAS 153 eliminates the exception from fair value
measurement for nonmonetary exchanges of similar productive assets in APB
Opinion No. 29 and replaces it with an exception for exchanges that do not have
commercial substance. SFAS 153 specifies that a nonmonetary exchange has
commercial substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The adoption of SFAS 153 did
not have an impact on the Company's consolidated financial condition, results of
operations or cash flows.
Effective July 1, 2005, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"), which
requires entities to measure the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair value of the
award (with limited exceptions). The cost is recognized as an expense over the
period during which the employee is required to provide service in exchange for
the award, which is usually the vesting period. As a result of SFAS 123R, the
Company will recognize the grant-date fair value of options as compensation
expense over the applicable vesting period. This accounting treatment differs
significantly from the previous accounting for fixed stock options under APB
Opinion No. 25, which generally required expense recognition only when the
exercise price of the option was less than the market price of the underlying
stock on the grant date. As required by SFAS 123R, the Company will estimate the
fair value of stock options on each grant date, using an appropriate valuation
approach such as the Black-Scholes option pricing model. The adoption of SFAS
123R did not have an impact on the Company's consolidated financial condition,
results of operations or cash flows.
B. Branch Acquisitions
In 1995, the Bank acquired the deposit liabilities and certain of the assets and
other liabilities of three branch offices of another financial institution. The
Bank recorded a total deposit premium intangible asset of $18,141,000 in
connection with the acquisition. For the years ended June 30, 2005 and 2004,
amortization of the deposit premium intangible of $1,361,000 and $1,814,000 was
recorded, respectively. The deposit premium intangible was fully amortized by
June 30, 2005.
57
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
C. Investment Securities
Gross Gross Estimated
Amortized Unrealized Unrealized Fair Market
Cost Gains Losses Value
------------------------------------------------------
(In thousands)
June 30, 2006
Available for Sale:
Equity securities ................ $ 5,053 $ -- $ (117) $ 4,936
======================================================
Held to Maturity:
U.S. government agency obligations $ 406,470 $ -- $ (19,849) $ 386,621
Corporate bonds .................. 1,018 126 -- 1,144
Trust preferred securities ....... 32,872 282 (256) 32,898
------------------------------------------------------
Total held to maturity ....... $ 440,360 $ 408 $ (20,105) $ 420,663
======================================================
June 30, 2005
Available for Sale:
Equity securities ................ $ 4,849 $ 162 $ -- $ 5,011
======================================================
Held to Maturity:
U.S. government agency obligations $ 371,487 $ 255 $ (472) $ 371,270
Corporate bonds .................. 1,022 214 -- 1,236
Trust preferred securities ....... 32,989 1,233 (2) 34,220
------------------------------------------------------
Total held to maturity ....... $ 405,498 $ 1,702 $ (474) $ 406,726
======================================================
The amortized cost and estimated fair market value of investment securities held
to maturity at June 30, 2006, by contractual maturity, are shown below. The
expected maturity may differ from the contractual maturity because issuers may
have the right to call obligations. Available for sale securities have been
excluded from the table as they are equity securities.
June 30, 2006
---------------------------
Estimated
Amortized Fair Market
Cost Value
---------------------------
(In thousands)
Held to Maturity:
Maturing after one year but within five years $ 11,014 $ 10,641
Maturing after five years but within ten years 76,850 74,180
Maturing after ten years ..................... 352,496 335,842
---------------------------
Total held to maturity ................... $ 440,360 $ 420,663
===========================
At June 30, 2006 and 2005, investment securities with a carrying value of
$243,690,000 and $189,814,000, respectively, were pledged to secure Federal Home
Loan Bank of New York advances and other borrowings.
There were no sales of investment securities for the years ended June 30, 2006,
2005 and 2004.
58
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
The following tables provide gross unrealized losses and market value for
investment securities, aggregated by category and the length of time the
individual investments have been in a continuous unrealized loss position.
June 30, 2006
-----------------------------------------------------------------------------------
Less than 12 months 12 months or more Total
-----------------------------------------------------------------------------------
Market Unrealized Market Unrealized Market Unrealized
Value Losses Value Losses Value Losses
-----------------------------------------------------------------------------------
(In thousands)
Available for Sale:
Equity Securities ........ $ 4,936 $ (117) $ -- $ -- $ 4,936 $ (117)
===================================================================================
Held to Maturity:
U.S. Government agency
obligations .............. $ 291,319 $ (13,248) $ 95,302 $ (6,601) $ 386,621 $ (19,849)
Trust preferred securities 6,458 (239) 1,061 (17) 7,519 (256)
-----------------------------------------------------------------------------------
Total ............... $ 297,777 $ (13,487) $ 96,363 $ (6,618) $ 394,140 $ (20,105)
===================================================================================
June 30, 2005
-----------------------------------------------------------------------------------
Less than 12 months 12 months or more Total
-----------------------------------------------------------------------------------
Market Unrealized Market Unrealized Market Unrealized
Value Losses Value Losses Value Losses
-----------------------------------------------------------------------------------
(In thousands)
Held to Maturity:
U.S. Government agency
obligations .............. $ -- $ -- $ 101,428 $ (472) $ 101,428 $ (472)
Trust preferred securities -- -- 1,080 (2) 1,080 (2)
-----------------------------------------------------------------------------------
Total ............... $ -- $ -- $ 102,508 $ (474) $ 102,508 $ (474)
===================================================================================
At June 30, 2006 and 2005, the majority of the unrealized losses in the
investment portfolio were comprised of securities issued by U.S. Government
sponsored agencies. The Company believes the unrealized losses represent
temporary declines in value and that the market value movements in these
securities are reflective of the movement in market interest rates,
particularly given the negligible inherent credit risk for these securities. The
unrealized losses on equity securities and trust preferred securities also
represent temporary declines in value and are reflective of the movement in
market interest rates, as there has not been any deterioration in the credit
quality of the issuers of these securities. All investment securities are
performing and are expected to continue to perform in accordance with their
respective contractual terms and conditions.
D. Mortgage-Backed Securities
Gross Gross Estimated
Amortized Unrealized Unrealized Fair Market
Cost Gains Losses Value
------------------------------------------------------
(In thousands)
June 30, 2006
Ginnie Mae ................................... $ 55 $ 3 $ -- $ 58
Freddie Mac .................................. 28,384 83 (1,089) 27,378
Fannie Mae ................................... 34,511 72 (1,139) 33,444
Collateralized Mortgage Obligations/REMICs/IOs 13 -- -- 13
------------------------------------------------------
Total mortgage-backed securities ......... $ 62,963 $ 158 $ (2,228) $ 60,893
======================================================
Gross Gross Estimated
Amortized Unrealized Unrealized Fair Market
Cost Gains Losses Value
------------------------------------------------------
(In thousands)
June 30, 2005
Ginnie Mae ................................... $ 151 $ 12 $ -- $ 163
Freddie Mac .................................. 35,232 391 (42) 35,581
Fannie Mae ................................... 42,657 615 (68) 43,204
Collateralized Mortgage Obligations/REMICs/IOs 161 -- -- 161
------------------------------------------------------
Total mortgage-backed securities ......... $ 78,201 $ 1,018 $ (110) $ 79,109
======================================================
59
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
The amortized cost and estimated fair market value of mortgage-backed securities
held to maturity at June 30, 2006, by contractual maturity, are shown below.
June 30, 2006
-------------------------
Estimated
Amortized Fair Market
Cost Value
-------------------------
(In thousands)
Maturing within one year ........................... $ 3 $ 3
Maturing after one year but within five years ...... 2,587 2,624
Maturing after five years but within ten years ..... 797 809
Maturing after ten years ........................... 59,576 57,457
-------------------------
$ 62,963 $ 60,893
=========================
There were no sales of mortgage-backed securities in the years ended June 30,
2006, 2005 and 2004.
The carrying value of mortgage-backed securities pledged were as follows:
June 30,
-------------------
2006 2005
-------------------
(In thousands)
Pledged to secure:
Federal Home Loan Bank of New York advances ......... $28,585 $29,561
Other borrowings .................................... 23,324 15,154
Public funds on deposit ............................. 979 361
-------------------
$52,888 $45,076
===================
The following tables provide gross unrealized losses and market value for
mortgage-backed securities, aggregated by issuer and the length of time the
individual mortgage-backed securities have been in a continuous unrealized loss
position.
June 30, 2006
-----------------------------------------------------------------------------------
Less than 12 months 12 months or more Total
-----------------------------------------------------------------------------------
Market Unrealized Market Unrealized Market Unrealized
Value Losses Value Losses Value Losses
-----------------------------------------------------------------------------------
(In thousands)
Freddie Mac ....... $ 490 $ (5) $ 19,779 $ (1,084) $ 20,269 $ (1,089)
Fannie Mae ........ 21,966 (782) 5,862 (357) 27,828 (1,139)
-----------------------------------------------------------------------------------
Total ......... $ 22,456 $ (787) $ 25,641 $ (1,441) $ 48,097 $ (2,228)
===================================================================================
June 30, 2005
-----------------------------------------------------------------------------------
Less than 12 months 12 months or more Total
-----------------------------------------------------------------------------------
Market Unrealized Market Unrealized Market Unrealized
Value Losses Value Losses Value Losses
-----------------------------------------------------------------------------------
(In thousands)
Freddie Mac ....... $ -- $ -- $ 24,443 $ (42) $ 24,443 $ (42)
Fannie Mae ........ -- -- 7,363 (68) 7,363 (68)
-----------------------------------------------------------------------------------
Total ......... $ -- $ -- $ 31,806 $ (110) $ 31,806 $ (110)
===================================================================================
At June 30, 2006 and 2005, mortgage-backed securities issued by Freddie Mac and
Fannie Mae had unrealized losses as noted in the above table. The Company
believes the unrealized losses represent temporary declines in value and that
the market value movements in these securities are reflective of the movement
in market interest rates, particularly given the negligible inherent credit risk
for these securities. All mortgage-backed securities are performing and are
expected to continue to perform in accordance with their respective contractual
terms and conditions.
60
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
E. Loans Receivable and Loans Held for Sale, Net
June 30,
------------------------------
2006 2005
------------------------------
(In thousands)
First Mortgage Loans:
Conventional ............................... $ 1,301,992 $ 1,147,798
FHA insured/VA guaranteed .................. 455 691
------------------------------
Total one- to four-family .................. 1,302,447 1,148,489
Commercial and multi-family ................ 172,600 169,765
------------------------------
Total first mortgage loans ................... 1,475,047 1,318,254
------------------------------
Consumer:
Second mortgages ........................... 153,024 91,147
Home equity lines of credit ................ 47,500 49,901
Other ...................................... 3,922 3,375
------------------------------
Total consumer loans ......................... 204,446 144,423
------------------------------
Total loans .................................. 1,679,493 1,462,677
------------------------------
Add (Less):
Allowance for loan losses .................. (5,888) (6,050)
Unamortized premium ........................ 433 519
Net deferred loan costs .................... 10,186 8,334
------------------------------
4,731 2,803
------------------------------
$ 1,684,224 $ 1,465,480
==============================
At June 30, 2006, there was a $217,000 one- to four-family mortgage loan
included in loan held for sale and there was a commitment to sell this loan. At
June 30, 2005, there were $4,826,000 of one- to four-family mortgage loans
included in loans held for sale and these loans were sold during fiscal 2006.
Non-accruing loans at June 30, 2006 and 2005 were $1,780,000 and $2,619,000,
respectively, which represents 0.11% and 0.18%, respectively, of total loans
outstanding. The total interest income that would have been recorded for the
years ended June 30, 2006 and 2005, had these loans been current in accordance
with their original terms, or since the date of origination if outstanding for
only part of the year, was approximately $36,000 and $79,000, respectively.
At June 30, 2006 and 2005, there were no impaired loans.
The following is an analysis of the allowance for loan losses:
Year ended June 30,
-----------------------------------
2006 2005 2004
-----------------------------------
(In thousands)
Balance, beginning of year ........... $ 6,050 $ 6,249 $ 6,284
Provisions for loan losses ........... -- -- --
Losses charged to allowance .......... (162) (199) (35)
-----------------------------------
Balance, end of year ................. $ 5,888 $ 6,050 $ 6,249
===================================
The Company's loan portfolio consists primarily of loans secured by residential
and commercial real estate located in its market areas. Therefore, the
collectibility of these loans is dependent to a large degree on the overall
strength of the New Jersey economy, as well as the specific strength of the real
estate sector.
At June 30, 2006 and 2005, the commercial and multi-family real estate loan
portfolio totaled $172,600,000 and $169,765,000, respectively. These loans are
considered by management to be of somewhat greater risk of collectibility due to
their dependency on income production. Nearly all of the Company's commercial
and multi-family real estate loans are collateralized by real estate located in
New Jersey. Commercial and multi-family real estate loans collateralized by
multi-family or mixed use properties were $47,593,000 and $47,281,000 at June
30, 2006 and 2005, respectively. In addition, at June 30, 2006 and 2005, the
commercial and multi-family real estate loan portfolio included $1,265,000 and
$3,185,000, respectively, of lines of credit secured by non-real estate business
assets. Furthermore, there were $5,102,000
61
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
and $5,439,000 of loans outstanding at June 30, 2006 and 2005, respectively,
under the accounts receivable financing program for small and mid-sized
businesses. The remaining loans in this portfolio were collateralized by other
types of non-residential, commercial real estate properties.
Loans serviced for others, consisting of one- to four-family mortgage loans,
totaled approximately $76,082,000 and $69,062,000 at June 30, 2006 and 2005,
respectively. Servicing loans for others generally consists of collecting
mortgage payments, maintaining escrow accounts, disbursing payments to
investors, collection activities and foreclosure processing. Loan servicing
income is recorded on the accrual basis and includes servicing fees from
investors and certain charges assessed to borrowers, such as late payment fees.
In connection with these loans serviced for others, the Company held borrowers'
escrow balances of $816,000 and $715,000 at June 30, 2006 and 2005,
respectively.
F. Premises and Equipment, Net
June 30,
--------------------
2006 2005
--------------------
(In thousands)
Land ................................................... $ 5,577 $ 5,577
Buildings and improvements ............................. 18,599 18,326
Leasehold improvements ................................. 2,335 2,316
Furniture and equipment ................................ 16,395 15,758
--------------------
42,906 41,977
Less: accumulated depreciation and amortization ........ 22,491 21,074
--------------------
$ 20,415 $ 20,903
====================
G. Real Estate Owned
June 30,
--------------------
2006 2005
--------------------
(In thousands)
Acquired by foreclosure or deed in lieu of foreclosure . $ 50 $ 50
Allowance for losses on real estate owned .............. (50) (50)
--------------------
Real estate owned, net ................................. $ -- $ --
====================
Results of real estate operations were as follows:
Year ended June 30,
---------------------------
2006 2005 2004
---------------------------
(In thousands)
Net gain (loss) on sales of real estate owned .... $ (4) $ 158 $ 57
Holding costs, net ............................... (2) (2) 1
Provision for losses on real estate owned ........ -- -- --
---------------------------
Net gain (loss) from real estate operations ...... $ (6) $ 156 $ 58
==========================
Activity in the allowance for losses on real estate owned was as follows:
Year ended June 30,
--------------------------
2006 2005 2004
--------------------------
(In thousands)
Balance, beginning of year ....................... $ 50 $ 50 $ 82
Provisions charged to operations ................. -- -- --
Losses charged to allowance ...................... -- -- (32)
--------------------------
Balance, end of year ............................. $ 50 $ 50 $ 50
==========================
62
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
H. Deposits
June 30, 2006 June 30, 2005
------------------------------------------------------
Weighted Weighted
Average Average
Amount Interest Rate Amount Interest Rate
------------------------------------------------------
(Dollars in thousands)
Non-interest-bearing demand ............... $ 72,557 $ 71,769
Interest-bearing demand ................... 97,155 1.45% 105,011 0.95%
Money market accounts ..................... 142,777 4.52 50,251 2.59
Savings accounts .......................... 300,247 2.68 385,360 2.53
Certificates with remaining maturities of:
Within one year or less ............... 562,484 4.09 438,487 2.88
After one year but within two years ... 139,658 4.13 157,017 3.51
After two years but within three years 52,219 4.44 65,201 3.99
After three years but within four years 34,099 4.21 29,313 4.16
After four years but within five years 12,029 4.65 35,939 4.17
---------- ----------
Total certificates ........................ 800,489 4.13 725,957 3.23
Accrued interest payable .................. 1,363 1,143
---------- ----------
$1,414,588 3.46% $1,339,491 2.65%
========== ==========
The aggregate amount of certificates of deposit with a denomination of $100,000
or more was approximately $251,456,000 and $214,377,000 at June 30, 2006 and
2005, respectively.
I. Federal Home Loan Bank of New York Advances and Other Borrowings
The following table presents Federal Home Loan Bank of New York ("FHLB of New
York") advances by period remaining to the earlier of the callable date or
maturity date:
June 30, 2006 June 30, 2005
------------------------------------------------------
Weighted Weighted
Average Average
Amount Interest Rate Amount Interest Rate
------------------------------------------------------
(Dollars in thousands)
Within one year ........................... $ 30,465 5.32% $ 130,000 5.24%
After one year but within two years ....... 50,000 5.22 40,465 5.51
After two years but within three years .... 75,000 4.50 55,000 5.49
After three years but within four years ... 190,000 5.77 -- --
After four years but within five years .... 110,000 5.86 140,000 6.46
After five years .......................... 10,000 4.48 50,000 5.61
---------- ----------
$ 465,465 5.47% $ 415,465 5.75%
========== ==========
The FHLB of New York advances are all fixed rate borrowings collateralized
either under a Listing Only pledge agreement by one- to four-family mortgage
loans or with investment and mortgage-backed securities. FHLB of New York
advances includes $195.0 million of convertible advances with one-time call
features.
At June 30, 2006, the Company had available from the FHLB of New York an
overnight repricing line of credit and a one-month overnight repricing line of
credit, each in the amount of $100,000,000. Both credit lines renew annually and
currently expire in July 2006. Each line of credit has a variable interest rate.
At June 30, 2006, the Company had $78,250,000 of overnight borrowings from the
FHLB of New York with an interest rate of 5.42%. During fiscal 2006, the Company
incurred a $1.35 million penalty in connection with the prepayment of $35
million of FHLB of New York advances that had an average rate of 5.95% and an
average remaining maturity of 28 months. These advances were replaced with $35
million of FHLB of New York advances with an average rate of 4.20% and an
average maturity of 43 months. At June 30, 2005, the Company had $32,350,000 of
overnight borrowings from the FHLB of New York with
63
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
an interest rate of 3.49%. In addition, the Company had available overnight
variable repricing lines of credit with other correspondent banks totaling
$120,000,000 on an unsecured basis. There were $55,900,000 of borrowings under
these lines at June 30, 2006 with an interest rate of 5.38%. There were
$12,800,000 of borrowings under these lines at June 30, 2005 with an interest
rate of 3.50%. The Company also has a $12,000,000 unsecured revolving line of
credit. This line of credit has a variable interest rate tied to 30-day LIBOR.
At June 30, 2006, the Company had $7,772,000 of borrowings under this line of
credit with an interest rate of 6.63%. Borrowings under this line at June 30,
2005 were $8,341,000 with an interest rate of 4.64%.
From time to time, the Company enters into sales of securities under agreements
to repurchase ("reverse repurchase agreements"). These agreements are accounted
for as financing arrangements and the obligations to repurchase securities sold
are reflected as Other borrowings in the accompanying Consolidated Statements of
Financial Condition. The reverse repurchase agreements are collateralized by
investment and mortgage-backed securities which continue to be carried as assets
by the Company, with a carrying value of $106,635,000 and $57,414,000 and a
market value of $101,595,000 and $57,296,000 at June 30, 2006 and 2005,
respectively. Based on the provisions of these reverse repurchase agreements,
counterparties are not permitted to sell or repledge the collateral pledged by
the Company.
The following table presents reverse repurchase agreements by period remaining
to the maturity date:
June 30, 2006 June 30, 2005
------------------------------------------------------
Weighted Weighted
Average Average
Amount Interest Rate Amount Interest Rate
------------------------------------------------------
(Dollars in thousands)
Within one year ........................... $ 88,271 4.60% $ 15,000 2.88%
After one year but within five years ...... 10,000 3.59 39,461 3.42
---------- ----------
$ 98,271 4.50% $ 54,461 3.27%
========== ==========
The average balance of reverse repurchase agreements for the years ended June
30, 2006 and 2005 was $76,454,000 and $61,898,000, respectively.
J. Junior Subordinated Deferrable Interest Debentures
In 2001, PennFed formed PennFed Capital Trust II ("Trust II"), which on March
28, 2001 sold $12.0 million of 10.18% cumulative trust preferred securities in a
private transaction exempt from registration under the Securities Act of 1933,
as amended (the "Act"). Trust II used the proceeds from the sale of its trust
preferred securities and from the sale of $0.4 million of its common securities
to PennFed to purchase $12.4 million of 10.18% junior subordinated deferrable
interest debentures issued by PennFed, which are the sole assets of Trust II.
These junior subordinated deferrable interest debentures mature in 2031 and are
redeemable at any time after ten years. The obligations of PennFed related to
Trust II constitute a full and unconditional guarantee by PennFed of Trust II
obligations under its trust preferred securities. PennFed used the proceeds from
the junior subordinated deferrable interest debentures for general corporate
purposes, including a $4.2 million capital contribution to the Bank to support
growth.
In 2003, PennFed formed PennFed Capital Trust III ("Trust III"), which on June
2, 2003 sold $30.0 million of variable rate cumulative trust preferred
securities in a private transaction exempt from registration under the Act.
Trust III used the proceeds from the sale of its trust preferred securities and
from the sale of $0.9 million of its common securities to PennFed to purchase
$30.9 million of variable rate junior subordinated deferrable interest
debentures issued by PennFed, which are the sole assets of Trust III. These
junior subordinated deferrable interest debentures mature in 2033 and are
redeemable at any time after five years. The interest rate on the $30.0 million
of trust preferred securities and the $30.9 million junior subordinated
deferrable interest debentures resets quarterly and was 8.58% and 6.66% at June
30, 2006 and 2005, respectively. The obligations of PennFed related to Trust III
constitute a full and unconditional guarantee by PennFed of Trust III
obligations under its trust preferred securities. PennFed used the proceeds from
the junior subordinated deferrable interest debentures together with available
cash to redeem $34.5 million of 8.90% cumulative trust preferred securities
issued by PennFed Capital Trust I in October 1997.
64
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
K. Employee Benefit Plans
401(k) Employee Stock Ownership Plan ("KSOP")
Effective July 1, 2005, the Company merged the Penn Federal Savings Bank 401(k)
Plan with the Employee Stock Ownership Plan ("ESOP"), forming the KSOP. While
the KSOP is one plan, the two separate components of the 401(k) Plan and the
ESOP remain.
Under the 401(k) Plan, all employees of the Company who work at least 1,000
hours per year and are at least 21 years old are eligible to participate. For
the years ended June 30, 2006 and 2005, the Company made safe harbor profit
sharing contributions of $596,000 and $641,000, respectively. For the year ended
June 30, 2004, the Company made a discretionary Company match of employee
contributions of $106,000. At June 30, 2006 and 2005, the 401(k) Plan assets
included common stock of the Company with a market value of $922,000 and
$926,000, respectively.
In connection with the Conversion, the Company established an ESOP for eligible
employees. All full-time employees are eligible to participate in the ESOP after
they attain age 21 and complete one year of service during which they work at
least 1,000 hours. Employees were credited for years of service to the Company
prior to the adoption of the ESOP for participation and vesting purposes. The
Bank's contribution is allocated among participants on the basis of
compensation. Each participant's account is credited with cash or shares of the
Company's common stock based upon compensation earned during the year with
respect to which the contribution is made. After completing seven years of
service, a participant will be 100% vested in his/her ESOP account. ESOP
participants are entitled to receive distributions from the ESOP account only
upon termination of service, which includes retirement and death.
The ESOP borrowed $4,760,000 from PennFed and purchased 1,904,000 shares of
common stock issued in the Conversion. This loan has been repaid from
discretionary contributions by the Bank to the ESOP trust. The Bank made
contributions to the ESOP in amounts at least equal to the principal and
interest requirement of the debt, based on a ten year term and an interest rate
of 7.46%. Annual contributions to the ESOP, which were used to fund principal
and interest payments on the ESOP debt, totaled $692,000. At June 30, 2004, the
loan was paid in full and there were no unallocated shares.
For the year ended June 30, 2004, the Bank recorded compensation expense related
to the ESOP of $4,045,000. The compensation expense related to the ESOP included
$3,453,000 for a valuation adjustment to reflect the increase in the average
fair value of allocated shares for the period from the time of purchase to the
allocation date. The ESOP allocated 257,660 shares for the year ended June 30,
2004 to participants in the plan.
Stock Option Plan
In connection with the Conversion, the Company established the 1994 Stock Option
and Incentive Plan ("Option Plan"). The Option Plan was subsequently amended to
increase the number of shares of common stock available for awards thereunder
from 2,380,000 to 3,342,492. The exercise price for the options granted under
the Option Plan cannot be less than the fair market value of the Company's
common stock on the date of the grant. The options are granted, and the terms of
the options are established, by the Compensation Committee of the Board of
Directors. Transactions during the years ended June 30, 2006, 2005 and 2004
relating to the Option Plan are as follows:
65
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Weighted
Average
Exercise
Options Price
----------------------------
Balance, June 30, 2003 .......................... 2,223,206 $ 5.36
Granted .................................... -- --
Exercised .................................. (686,962) 2.78
Expired .................................... -- --
Forfeited .................................. -- --
----------------------------
Balance, June 30, 2004 .......................... 1,536,244 7.05
Granted .................................... -- --
Exercised .................................. (431,300) 3.10
Expired .................................... -- --
Forfeited .................................. -- --
----------------------------
Balance, June 30, 2005 .......................... 1,104,944 7.83
Granted .................................... -- --
Exercised .................................. (205,798) 5.21
Expired .................................... -- --
Forfeited .................................. -- --
----------------------------
Balance, June 30, 2006 .......................... 899,146 $ 8.43
============================
All options previously granted were accounted for in accordance with Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees." Accordingly, no compensation expense has been recognized for the
stock options. Pro forma net income and earnings per share calculated as if the
Company had accounted for employee stock options and other stock based
compensation under the fair value method would equal the amounts presented
within the Consolidated Statements of Income for each of the years in the three
year period ended June 30, 2006, as all grants had fully vested prior to June
30, 2003.
Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based
Payment" ("SFAS 123R") applies to all awards granted after its effective date
and to awards modified, repurchased, or cancelled after that date. In April
2005, the SEC deferred the adoption of SFAS 123R until the first fiscal year
beginning after June 15, 2005 (i.e., for the Company, the fiscal year beginning
July 1, 2005). The standard permits different transition methods of recognizing
compensation expense. The Company has adopted SFAS 123R and will recognize
compensation expense for (i) any new awards granted after July 1, 2005 and (ii)
the portion of any outstanding awards for which the requisite service has not
been rendered as of July 1, 2005, based on the grant-date fair value of those
awards calculated for purposes of SFAS 123R pro forma disclosures. At July 1,
2005, the Company had no stock options outstanding for which compensation
expense would be recognized under SFAS 123R. No options were granted during the
year ended June 30, 2006.
At June 30, 2006, 899,146 options were exercisable, with exercise prices ranging
from $6.94 to $8.59. At June 30, 2005, 1,104,944 options were exercisable, with
exercise prices ranging from $3.97 to $8.59. At June 30, 2004, 1,536,244 options
were exercisable, with exercise prices ranging from $2.63 to $8.59.
The following table summarizes information about stock options outstanding and
exercisable as of June 30, 2006:
Weighted
Number Average
Exercise Outstanding Remaining
Prices at June 30, 2006 Life
- --------------------------------------------------------------------------------
$6.94 77,200 1.06 years
$8.41 103,846 3.08
$8.59 718,100 1.44
-----------
$6.94 to $8.59 899,146 1.60 years
===========
66
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Supplemental Executive Retirement Plan and Directors' Retirement Plan
The Company currently provides for a Supplemental Executive Retirement Plan
("SERP") and a Directors' Retirement Plan ("DP") for certain key executive
employees and directors. Benefits provided are based primarily on years of
service and compensation or fees. Both plans are unfunded and at June 30, 2006
and 2005, the benefit obligations of $1,167,000 and $698,000, respectively, are
included in Accounts payable and other liabilities in the Consolidated
Statements of Financial Condition. At June 30, 2006, the assumptions used in
calculating the benefit obligations included a 4% compensation increase rate and
a discount rate of 6%. The discount rate assumption was compared to certain
corporate bond yields, such as Moody's bond indices, for reasonableness. A
discount rate of 6% was selected for the June 30, 2006 measurement date. At June
30, 2005, the assumptions used in calculating the benefit obligations included a
4% compensation increase rate and a discount rate of 7%. The accounting for
these postretirement benefits is in accordance with Statement of Financial
Accounting Standards No. 87, "Employers' Accounting for Pensions." The Company
has not made any contributions to these plans during the fiscal years ended June
30, 2006 and 2005 and does not expect to make any contributions to these plans
during the next fiscal year.
Net periodic pension cost for the Company's SERP and DP included the following
components:
Year ended June 30,
------------------------------------------------------
2006 2005 2004
------------------------------------------------------
SERP DP SERP DP SERP DP
------------------------------------------------------
(In thousands)
Service cost ..................... $ 145 $ -- $ 245 $ 43 $ 227 $ 40
Interest cost .................... 161 22 27 5 9 2
Amortization of prior service cost 110 28 (6) (2) (6) (2)
Loss recognized .................. 2 1 -- -- -- --
------------------------------------------------------
Net periodic pension expense ..... $ 418 $ 51 $ 266 $ 46 $ 230 $ 40
======================================================
The following are the weighted average assumptions used to determine net
periodic benefit cost:
Year ended June 30,
-------------------------------
2006 2005 2004
-------------------------------
Discount rate .............................. 6.00% 7.00% 3.00%
Rate of compensation increase .............. 4.00 4.00 4.00
The following are the weighted-average assumptions used to determine benefit
obligations:
Year ended June 30,
--------------------
2006 2005
--------------------
Discount rate .......................................... 6.00% 7.00%
Rate of compensation increase .......................... 4.00 4.00
Long-Term Care Insurance Program
In January 2005, the Bank adopted a long-term care insurance program to be
offered on a voluntary basis to all employees, officers and directors of the
Bank. The program provides a nursing home care benefit at $200 per day, to be
adjusted for inflation. Certain officers of the Bank and certain non-employee
directors participate in this program. These participating officers and
directors will be provided with this benefit for their lifetimes at no cost to
them, with the Bank paying the related premiums over a ten-year period. All
other employees who choose to participate must pay the cost of their
participation. With policies becoming effective May 1, 2005, total expense to
the Bank for the year ended June 30, 2005 was $7,000. For the year ended June
30, 2006, total expense was $44,000. The other employees may elect to pay their
premiums over ten years, over twenty years or over their lifetimes and may
choose to receive the benefit for three years, for five years or for their
lifetimes.
67
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
L. Income Taxes
The income tax provision is comprised of the following components:
Year ended June 30,
------------------------------
2006 2005 2004
------------------------------
(In thousands)
Current provision ............................. $ 6,672 $ 7,450 $ 6,380
Deferred expense .............................. 739 1,219 163
------------------------------
Total income tax provision .................... $ 7,411 $ 8,669 $ 6,543
==============================
A reconciliation of the Federal statutory income tax provision to the effective
income tax provision is as follows:
Year ended June 30,
------------------------------
2006 2005 2004
------------------------------
(In thousands)
Income tax provision at Federal statutory rate $ 7,283 $ 8,457 $ 6,510
Amortization of intangible assets ............. -- -- 1
State and local income tax provision .......... 491 417 180
Income on BOLI ................................ (338) (241) (179)
Other, net .................................... (25) 36 31
------------------------------
Total income tax provision .................... $ 7,411 $ 8,669 $ 6,543
==============================
Income taxes payable are included in Accounts payable and other liabilities in
the Consolidated Statements of Financial Condition at June 30, 2006 and 2005.
The financial statements at June 30, 2006 also include a net deferred tax
liability of $526,000 that has been recorded for the temporary differences
between the tax basis and the financial statement carrying amounts of assets and
liabilities. The source of these temporary differences and their deferred tax
effect at June 30, 2006 and 2005 is as follows:
June 30,
--------------------
2006 2005
--------------------
(In thousands)
Deferred tax assets:
Allowance for loan losses ............................................... $ 2,405 $ 2,468
Environmental reserves .................................................. 148 134
Deposit premium intangible .............................................. 1,853 2,347
SERP and DP accrual ..................................................... 477 285
Unrealized loss on investment securities available for sale ............. 48 --
New Jersey Alternative Minimum Assessment credit ........................ 1,081 641
State net operating loss carryforward ................................... 582 1,406
--------------------
Total deferred tax assets ................................................. 6,594 7,281
Valuation allowance for state deferred tax assets ......................... (1,574) (2,063)
--------------------
Deferred tax asset after valuation allowance .............................. 5,020 5,218
--------------------
Deferred tax liabilities:
Net deferred loan costs ................................................. 4,853 4,151
Depreciation ............................................................ 292 550
Purchase accounting ..................................................... 155 155
Servicing asset ......................................................... 246 197
Unrealized gain on investment securities available for sale ............. -- 66
--------------------
Total deferred tax liabilities ............................................ 5,546 5,119
--------------------
Net deferred tax asset (liability) ........................................ $ (526) $ 99
====================
Pursuant to SFAS 109, the Company is not required to provide deferred taxes on
the Bank's tax loan loss reserve as of December 31, 1987. The amount of this
reserve on which no deferred taxes have been provided is approximately
$16,300,000. This reserve could be recognized as taxable income and create a
current and/or deferred tax liability using
68
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
the income tax rates then in effect if one of the following occur: (1) the
Bank's retained earnings represented by this reserve are used for dividends or
distributions in liquidation or for any other purpose other than to absorb
losses from bad debts; (2) the Bank fails to qualify as a bank, as provided by
the Internal Revenue Code; or (3) there is a change in federal tax law.
The Company has state net operating loss carryforwards of $6.5 million which
expire in various years through 2011. The Company has provided a valuation
allowance for the state tax benefit of net operating loss carryforwards, tax
credits and other temporary differences. Management has estimated that it is
more likely than not that it will not be able to utilize these deferred state
income tax benefits.
M. Commitments and Contingencies
Lease Commitments -- At June 30, 2006, minimum rental commitments under all
noncancellable operating leases with initial or remaining terms of more than one
year are as follows:
Minimum Rent
Year ending June 30, (In thousands)
- -------------------- ---------------
2007 ........................................................ $ 746
2008 ........................................................ 669
2009 ........................................................ 500
2010 ........................................................ 389
2011 ........................................................ 376
2012 and later .............................................. 1,939
-------
$ 4,619
=======
Rent expense under long-term operating leases for certain branch offices
amounted to $795,000, $717,000 and $472,000 for the years ended June 30, 2006,
2005 and 2004, respectively. Rental income of $530,000, $532,000 and $534,000
for the years ended June 30, 2006, 2005 and 2004, respectively, is netted
against occupancy expense in the Consolidated Statements of Income. The
Company's leases generally have escalation terms based on certain defined
indexes.
Financial Instruments With Off-Balance Sheet Risk -- The Company is a party to
financial instruments with off-balance sheet risk in the normal course of
business. These financial instruments are not recorded on the balance sheet when
either the exchange of the underlying asset or liability has not yet occurred.
These financial instruments include commitments to extend credit and unused
lines of credit. These instruments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amount recognized in the
Consolidated Statements of Financial Condition.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contractual notional amount of those instruments. The Company
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance sheet instruments.
The following summarizes the notional amount of off-balance sheet financial
instruments:
June 30,
------------------------
2006 2005
------------------------
(In thousands)
Commitments to extend credit ................... $30,346 $35,711
Unused lines of credit ......................... 90,688 88,789
Commitments to sell loans ...................... -- 1,447
Commitments to purchase loans .................. 6,274 --
Commitments to extend credit and unused lines of credit are legally binding
agreements to lend to a customer as long as there is no violation of any
condition established in the contract. Commitments and lines of credit 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 evaluates each customer's credit worthiness on a
case-by-case basis. The amount of collateral obtained by the Company upon
extension of credit is based on management's credit evaluation of the borrower.
Collateral held varies but may include mortgages on commercial and residential
real estate and other tangible properties.
69
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Commitments to purchase loans represent agreements to purchase loans through a
correspondent relationship established by the Company with another institution.
The Company currently purchases newly originated one- to four-family residential
mortgages secured by properties primarily located in New Jersey. Prior to
purchase, the Company applies the same underwriting criteria used in its own
originations.
Other Contingencies -- Penn Federal Savings Bank and ExxonMobil have been
ordered by the New Jersey Department of Environmental Protection to investigate
and remediate soil and ground water pollution that may have been generated at a
branch location that was formerly a gasoline service station. Penn Federal
Savings Bank and ExxonMobil have entered into a cost sharing arrangement under
which ExxonMobil will supervise the investigation and remediation and the cost
will be shared equally. Based on information then available, the Company
recorded a $298,000 (pretax) charge during the fourth quarter of fiscal 2004 to
accrue its share of the estimated cost. At June 30, 2006 and 2005, an
environmental liability of $328,000 was included in Accounts payable and other
liabilities in the Company's Consolidated Statements of Financial Condition.
Management believes the total current liability of $328,000 represents the
probable liability at this time.
The Company is a defendant in certain claims and legal actions arising in the
ordinary course of business. At the present time, management does not anticipate
losses on any of these claims or actions which would have a material adverse
effect on the accompanying consolidated financial statements.
N. Stockholders' Equity and Regulatory Capital
On September 29, 2004, the Company's Board of Directors declared a two-for-one
stock split in the form of a 100% stock dividend, payable on October 29, 2004 to
common stockholders of record as of October 15, 2004. All share and share
related amounts reflect the effect of the stock dividend.
Stock Repurchases
During the year ended June 30, 2006, the Company repurchased 626,300 shares of
its outstanding common stock. The prices paid for the repurchased shares ranged
from $17.10 to $19.75 per share, for a total cost of $11,633,000. During the
year ended June 30, 2005, the Company repurchased 731,800 shares of its
outstanding common stock at prices ranging from $13.30 to $17.25 per share, for
a total cost of $11,280,000. During the year ended June 30, 2004, the Company
repurchased 792,200 shares of its outstanding common stock at prices ranging
from $13.84 to $18.03 per share, for a total cost of $12,908,000. During fiscal
2004, the Company changed its state of incorporation from Delaware to Maryland.
Under the laws of the State of Maryland, shares repurchased are not considered
treasury stock. Rather, the shares acquired constitute authorized but unissued
shares. Accordingly, as of June 30, 2004, the Company has reclassified the cost
of treasury stock by reducing common stock, additional paid-in capital and
retained earnings based on the proceeds received for stock in the initial public
offering.
At June 30, 2006, the Company had a repurchase plan under which it had not yet
completed all approved repurchases. This repurchase plan was publicly announced
January 25, 2006 and authorized the Company to repurchase up to 5%, or 650,000,
of its outstanding shares over the following 18 months. At June 30, 2006, there
were 414,700 shares yet to be purchased under the plan.
Stockholder Protection Rights Plan
On March 21, 1996, the Board of Directors of the Company (the "Board") adopted a
Stockholder Protection Rights Plan ("Rights Plan") and declared a dividend of
one common share purchase right ("Right") for each share of common stock of the
Company outstanding on April 1, 1996 and each share issued after that date and
prior to the expiration or redemption of the Rights. Until it is announced that
a person or group has acquired 15% or more of the outstanding common stock of
the Company ("Acquiring Person") or has commenced a tender offer that could
result in such person or group owning 15% or more of such common stock, the
Rights will initially be redeemable for $0.01 each, will be evidenced solely by
the Company's common stock certificates, will automatically trade with the
Company's common stock and will not be exercisable.
Upon announcement that any person or group has become an Acquiring Person and
unless the Board acts to redeem the Rights, then ten business days after such
announcement (the "Flip-in Date"), each Right (other than Rights beneficially
owned by any Acquiring Person or transferee thereof, which Rights become void)
will entitle the holder to purchase,
70
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
for the $67.50 exercise price, a number of shares of the Company's common stock
having an aggregate market value of $135.00. In addition, if, after the
Acquiring Person gains control of the Board, the Company is involved in a merger
with any person or sells more than 50% of its assets or earning power to any
person (or has entered into an agreement to do either of the foregoing), and, in
the case of a merger, an Acquiring Person will receive different treatment than
other stockholders, each Right will entitle its holder to purchase, for the
$67.50 exercise price, a number of shares of common stock of such other person
having an aggregate market value of $135.00. If any person or group acquires
between 15% and 50% of the Company's common stock, the Board may, at its option,
require the Rights to be exchanged for common stock of the Company. The Rights
generally may be redeemed by the Board for $0.01 per Right prior to the Flip-in
Date.
Regulatory Capital Requirements
The Bank is subject to various regulatory capital requirements administered by
the OTS. Failure to meet minimum capital requirements could result in certain
mandatory and possible discretionary actions by the OTS that, if undertaken,
could have a direct material effect on the Company's financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific quantitative capital guidelines.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of tangible capital of
not less than 1.5% of tangible assets, core capital of not less than 4% of
adjusted tangible assets and risk-based capital of not less than 8% of
risk-weighted assets. As of June 30, 2006 and 2005, the Bank met all capital
adequacy requirements to which it was subject.
As of its last regulatory examination, the Bank was categorized as
"well-capitalized" under the prompt corrective action framework. To be
considered as "well-capitalized," the Bank must maintain a core capital ratio of
not less than 5% and a risk-based capital ratio of not less than 10%. There are
no conditions or events since that notification that management believes have
changed the Bank's category.
The Bank's regulatory capital amounts and ratios are presented in the following
table.
To Be Well
Capitalized Under
For Minimum Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
------------------------------------------------------------------
(Dollars in thousands)
As of June 30, 2006
Tangible capital, and ratio to
adjusted total assets ............ $168,746 7.33% $ 34,535 1.50% N/A N/A
Tier 1 (core) capital, and ratio to
adjusted total assets ............ $168,746 7.33% $ 92,094 4.00% $115,117 5.00%
Tier 1 (core) capital, and ratio to
risk-weighted assets ............. $168,746 13.34% N/A N/A $ 75,871 6.00%
Risk-based capital, and ratio to
risk-weighted assets ............. $174,633 13.81% $101,161 8.00% $126,451 10.00%
As of June 30, 2005
Tangible capital, and ratio to
adjusted total assets ............ $169,765 8.28% $ 30,750 1.50% N/A N/A
Tier 1 (core) capital, and ratio to
adjusted total assets ............ $169,765 8.28% $ 82,001 4.00% $102,501 5.00%
Tier 1 (core) capital, and ratio to
risk-weighted assets ............. $169,765 15.29% N/A N/A $ 66,614 6.00%
Risk-based capital, and ratio to
risk-weighted assets ............. $175,880 15.84% $ 88,819 8.00% $111,024 10.00%
The Bank's management believes that, with respect to regulations, the Bank will
continue to meet its minimum capital requirements in the foreseeable future.
However, events beyond the control of the Bank, such as increased interest rates
71
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
or a downturn in the economy in areas where the Bank has most of its loans,
could adversely affect future earnings and, consequently, the ability of the
Bank to meet its future minimum capital requirements.
The previous table reflects information for the Bank. Savings and loan holding
companies, such as PennFed, are not subject to capital requirements for capital
adequacy purposes or for prompt corrective action requirements. Bank holding
companies, however, are subject to capital requirements established by the Board
of Governors of the Federal Reserve System (the "FRB").
Dividends and Other Capital Distributions
Federal regulations impose certain limitations on the payment of dividends and
other capital distributions by the Bank. Under current regulations, savings
institutions, such as the Bank, are generally permitted to make capital
distributions without OTS approval during any calendar year equal to 100% of
calendar year-to-date net income plus retained net income for the two previous
calendar years. A savings institution, such as the Bank, which is a subsidiary
of a savings and loan holding company, must file a notice of the proposed
dividend or other capital distribution with the OTS at least 30 days prior to
the declaration of such dividend or distribution. At June 30, 2006, the Bank
could have paid dividends totaling approximately $5.9 million.
O. Computation of Earnings Per Share ("EPS")
The computation of EPS is presented in the following table. All share and share
related amounts reflect the effect of a stock dividend described in Note N -
Stockholders' Equity and Regulatory Capital.
For the year ended June 30,
-----------------------------------------------
2006 2005 2004
-----------------------------------------------
(Dollars in thousands, except per share amounts)
Net income ............................................ $ 13,398 $ 15,494 $ 12,058
=============================================
Number of shares outstanding:
Weighted average shares issued and outstanding ........ 13,053,853 13,612,502 13,645,770
Less: Average shares held by the ESOP ................ -- -- 1,904,000
Plus: ESOP shares released or committed to be released -- -- 1,807,026
---------------------------------------------
Average basic shares .................................. 13,053,853 13,612,502 13,548,796
Plus: Average common stock equivalents ............... 397,152 398,182 900,374
---------------------------------------------
Average diluted shares ................................ 13,451,005 14,010,684 14,449,170
=============================================
Earnings per common share:
Basic ............................................. $ 1.03 $ 1.14 $ 0.89
=============================================
Diluted ........................................... $ 1.00 $ 1.11 $ 0.83
=============================================
72
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
P. Disclosure About Fair Value of Financial Instruments
The carrying amounts (or notional amounts) and estimated fair values of the
Company's financial instruments at June 30, 2006 and 2005 were as follows:
June 30, 2006 June 30, 2005
----------------------------------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
----------------------------------------------------------
(In thousands)
Financial assets:
Cash and cash equivalents ........................ $ 16,614 $ 16,614 $ 15,220 $ 15,220
Investment securities ............................ 445,296 425,599 410,509 411,737
Mortgage-backed securities ....................... 62,963 60,893 78,201 79,109
FHLB of New York stock ........................... 27,714 27,714 22,391 22,391
----------------------------------------------------------
Total cash and investments ....................... 552,587 530,820 526,321 528,457
----------------------------------------------------------
Loans held for sale .............................. 217 218 4,826 4,864
Loans receivable, less allowance for loan losses . 1,684,007 1,621,189 1,460,654 1,459,988
----------------------------------------------------------
Total loans ...................................... 1,684,224 1,621,407 1,465,480 1,464,852
Accrued interest receivable, net ................. 11,145 11,145 9,808 9,808
----------------------------------------------------------
Total financial assets ............................... $2,247,956 $2,163,372 $2,001,609 $2,003,117
==========================================================
Financial liabilities:
Deposits ......................................... $1,414,588 $1,408,261 $1,339,491 $1,339,483
FHLB of New York advances ........................ 465,465 464,946 415,465 443,927
Other borrowings ................................. 240,193 239,730 107,952 107,566
Junior subordinated deferrable interest debentures 42,126 45,372 42,082 45,338
Mortgage escrow funds ............................ 11,877 11,877 10,398 10,398
----------------------------------------------------------
Total financial liabilities .......................... $2,174,249 $2,170,186 $1,915,388 $1,946,712
==========================================================
June 30, 2006 June 30, 2005
----------------------------------------------------------
Notional Estimated Notional Estimated
Amount Fair Value Amount Fair Value
----------------------------------------------------------
(In thousands)
Off-balance sheet financial instruments:
Commitments to extend credit ......................... $ 30,346 $ -- $ 35,711 $ --
Unused lines of credit ............................... 90,688 -- 88,789 --
Commitments to sell loans ............................ -- -- 1,447 --
Commitments to purchase loans ........................ 6,274 -- -- --
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate fair
value:
Cash and Cash Equivalents -- For these short-term instruments, the carrying
amount is a reasonable estimate of fair value.
Investment Securities and Mortgage-Backed Securities -- For these securities,
fair values are based on quoted dealer market prices or subscribed pricing
services.
FHLB of New York Stock -- For this security, the carrying amount, which is par,
is a reasonable estimate of fair value. All transactions in the capital stock of
the FHLB of New York are executed at par.
Loans Held for Sale -- Fair value is based on the actual committed sales price.
Loans Receivable -- Fair values are estimated for portfolios of loans with
similar financial characteristics. The total loan portfolio is first divided
into performing, held for sale and non-performing categories. Performing loans
are then segregated into adjustable and fixed rate interest terms. Fixed rate
loans are segmented by type, such as residential real estate mortgage,
commercial real estate and consumer loans. Adjustable rate loans are segmented
by repricing characteristics. Residential loans are further segmented by
maturity.
73
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
For loans, fair value is calculated by discounting scheduled future cash flows
through estimated maturity using a discount rate equivalent to the rate at which
the Company would currently make loans which are similar with regard to
collateral, maturity and type of borrower. The discounted value of the cash
flows is reduced by a credit risk adjustment based on internal loan
classifications. Based on the current composition of the Company's loan
portfolio, as well as both past experience and current economic conditions and
trends, future cash flows are adjusted by prepayment assumptions which shorten
the estimated remaining time to maturity and, therefore, impact the fair market
valuation.
Accrued Interest Receivable -- For this asset, the carrying value is a
reasonable estimate of fair value.
Deposits -- The fair value of deposits with no stated maturity, such as savings,
money market and other demand accounts, is equal to the amount payable on demand
as of June 30, 2006 and 2005. Time deposits are segregated by type and original
term. The fair value of time deposits is based on the discounted value of
contractual cash flows. The discount rate is equivalent to the rate currently
offered by the Company for deposits of similar type and maturity.
FHLB of New York Advances -- The fair value of FHLB of New York advances is
based on the discounted value of contractual cash flows. The discount rate is
equivalent to the rate currently offered by the FHLB of New York on borrowings
of similar type and maturity.
Other Borrowings -- For these short-term borrowings, the fair value is based on
the discounted value of contractual cash flows. The discount rate is equivalent
to the rate currently offered for borrowings of similar type and maturity.
Junior Subordinated Deferrable Interest Debentures -- For these securities, fair
value is based on quoted market prices for similar securities.
Mortgage Escrow Funds -- For these short-term liabilities, the carrying amount
is a reasonable estimate of fair value.
Commitments to Extend Credit and Unused Lines of Credit -- The fair value of
commitments to extend credit is estimated to be zero since the fees collected on
commitments to extend credit approximates the amount of costs incurred. Unused
lines of credit have a zero fair value because the rates associated with these
lines are market rates.
Commitments to Sell Loans -- The fair value of commitments to sell loans is
estimated based on the change in the interest rate environment between the rate
lock date and the Consolidated Statement of Financial Condition date. The
estimated fair value at June 30, 2005 was not significant.
Commitments to Purchase Loans -- The estimated fair value is not significant due
to the short-term nature of these commitments.
Q. Related Party Transactions
In the ordinary course of business, the Company has at times made loans to and
engaged in other financial transactions with its directors, officers and
employees. Such transactions are made on the same terms as those prevailing at
the time for comparable transactions with others and do not involve more than
normal risk of collectibility.
The following sets forth an analysis of loans, all of which are current, to
directors, officers and employees:
June 30,
---------------------------
2006 2005
---------------------------
(In thousands)
Balance, beginning of year ..................... $ 8,004 $ 7,102
New loans granted .............................. 1,251 2,419
Repayments/reductions .......................... (1,072) (1,517)
--------------------------
Balance, end of year ........................... $ 8,183 $ 8,004
==========================
In addition to the above amount of loans, at June 30, 2006 and 2005, there was
$43,000 and $45,000, respectively, of outstanding balances on overdraft checking
lines for directors, officers and employees.
74
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
R. Recently Issued Accounting Standards
In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 154, "Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS 154"). SFAS 154 changes the requirements for the accounting for and
reporting of a voluntary change in accounting principle. SFAS 154 requires
retrospective application to prior periods' financial statements of such
changes, unless it is impracticable to determine either the period-specific
effects or the cumulative effect of the change. When it is impracticable to
determine the period-specific effects of an accounting change on one or more
individual prior periods presented, SFAS 154 requires that the new accounting
principle be applied to the balances of assets and liabilities as of the
beginning of the earliest period for which retrospective application is
practicable and that a corresponding adjustment be made to the opening balance
of retained earnings for that period rather than being reported in an income
statement. When it is impracticable to determine the cumulative effect of
applying a change in accounting principle to all prior periods, SFAS 154
requires that the new accounting principle be applied as if it were adopted
prospectively from the earliest date practicable. SFAS 154 will be effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005.
In March 2006, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 156, "Accounting for Servicing of Financial Assets." SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities," establishes, among other things, the accounting for all
separately recognized servicing assets and servicing liabilities. SFAS No. 156
amends SFAS No. 140 to require that all separately recognized servicing assets
and servicing liabilities be initially measured at fair value, if practicable.
SFAS No. 156 permits, but does not require, the subsequent measurement of
separately recognized servicing assets and servicing liabilities at fair value.
SFAS No. 156 is effective in the first fiscal year beginning after September 15,
2006 with earlier adoption permitted. The Company does not expect the adoption
of SFAS No. 156 to have a material impact on its consolidated financial
condition, results of operations or cash flows.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" ("FIN 48"). FIN 48 establishes a recognition
threshold and measurement for income tax positions recognized in the financial
statements in accordance with Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes." FIN 48 establishes a two-step evaluation
process for tax positions. The first step is recognition, to determine whether
it is more-likely-than-not that a tax position will be sustained upon
examination, including resolution of related appeals or litigation processes,
based on the technical merits of the position. The second step is measurement.
If the tax position meets the more-likely-than-not recognition threshold, it is
measured and recognized in the financial statements as the largest amount of the
tax benefit that is greater than 50% likely of being realized. If a tax position
does not meet the more-likely-than-not recognition threshold, the benefit of
that position is not recognized in the financial statements. Tax positions that
meet the more-likely-than-not recognition threshold at the effective date of FIN
48 may be recognized or, continue to be recognized, upon the adoption of this
Interpretation. The cumulative effect of applying the provisions of FIN 48 shall
be reported as an adjustment to the opening balance of retained earning for that
fiscal year. FIN 48 is effective for fiscal years beginning after December 15,
2006. The Company is evaluating the impact of adoption of FIN 48 and is unable,
at this time, to quantify the impact, if any, to retained earnings at the time
of adoption.
75
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
S. Condensed Financial Information of PennFed Financial Services, Inc. (Parent
Company Only)
The following are the condensed financial statements for PennFed, parent company
only, as of June 30, 2006 and 2005 and for the years ended June 30, 2006, 2005
and 2004 and should be read in conjunction with the Consolidated Financial
Statements and Notes thereto.
Condensed Statements of Financial Condition
June 30,
----------------------
2006 2005
----------------------
(In thousands)
Assets
Cash cash and cash equivalents .......................... $ 27 $ 22
Investment securities held to maturity, at amortized cost 10,871 10,899
Investment in subsidiaries .............................. 170,413 171,530
Prepaid trust preferred securities expenses ............. 1,174 1,218
Accrued interest receivable ............................. 282 282
Other assets ............................................ 1,696 2,720
----------------------
$184,463 $186,671
======================
Liabilities and Stockholders' Equity
Junior subordinated deferrable interest debentures ...... $ 43,300 $ 43,300
Intercompany loan payable ............................... 8,325 8,400
Borrowings under unsecured revolving line of credit ..... 7,772 8,341
Accrued interest payable ................................ 238 202
Other accrued expenses and other liabilities ............ 1,407 2,374
Stockholders' equity .................................... 123,421 124,054
----------------------
$184,463 $186,671
======================
Condensed Statements of Income
Year ended June 30,
--------------------------------------
2006 2005 2004
--------------------------------------
(In thousands)
Income
Interest income on intercompany balances ............................. $ 2 $ -- $ 49
Interest income on investment securities ............................. 947 950 926
Other income ......................................................... 2 1 --
--------------------------------------
951 951 975
Expenses
Interest expense on junior subordinated deferrable interest debentures 3,612 3,002 2,654
Interest on intercompany loan ........................................ 671 498 402
Interest on borrowings under unsecured revolving line of credit ...... 365 289 143
Other expenses ....................................................... 603 791 578
--------------------------------------
5,251 4,580 3,777
---------------------------------------
Loss before undistributed net income of subsidiaries ................. (4,300) (3,629) (2,802)
Equity in undistributed net income of subsidiaries ................... 16,233 17,884 13,907
--------------------------------------
Income before income taxes ........................................... 11,933 14,255 11,105
Income tax benefit ................................................... (1,465) (1,239) (953)
--------------------------------------
Net income ........................................................... $ 13,398 $ 15,494 $ 12,058
======================================
76
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
Condensed Statements of Cash Flows
Year ended June 30,
-------------------------------------
2006 2005 2004
-------------------------------------
(In thousands)
Cash Flows From Operating Activities:
Net income ........................................................... $ 13,398 $ 15,494 $ 12,058
Adjustments to reconcile net income to net cash used in
operating activities:
Equity in undistributed net income of subsidiaries ............ (16,233) (17,884) (13,907)
Amortization of investment securities premium ................. 28 25 23
Increase (decrease) in accrued interest payable, net of accrued
interest receivable ........................................ 36 46 (77)
(Increase) decrease in prepaid trust preferred securities
expense and other assets .................................. 1,068 (1,266) (584)
Increase (decrease) in other accrued expenses and
other liabilities ......................................... (967) 1,404 624
--------------------------------------
Net cash used in operating activities ......................... (2,670) (2,181) (1,863)
--------------------------------------
Cash Flows From Investing Activities:
Proceeds from maturities of investment securities .................. -- -- 1,605
Purchases of investment securities held to maturity ................ -- -- (2,000)
Dividends received from subsidiary bank ............................ 17,455 15,955 12,478
Proceeds from principal repayment of ESOP loan ..................... -- -- 644
--------------------------------------
Net cash provided by investing activities ..................... 17,455 15,955 12,727
--------------------------------------
Cash Flows From Financing Activities:
Increase (decrease) in unsecured revolving line of credit .......... (569) (1,551) 2,598
Increase (decrease) in intercompany loan ........................... (75) -- 300
Cash dividends paid ................................................ (3,575) (2,924) (2,650)
Repurchases of outstanding shares, net of reissuances .............. (10,561) (9,944) (10,998)
--------------------------------------
Net cash used in financing activities ......................... (14,780) (14,419) (10,750)
--------------------------------------
Net increase (decrease) in cash and cash equivalents ................. 5 (645) 114
Cash and cash equivalents, beginning of year ......................... 22 667 553
--------------------------------------
Cash and cash equivalents, end of year ............................... $ 27 $ 22 $ 667
======================================
77
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
T. Quarterly Financial Data (Unaudited)
Quarter ended
----------------------------------------------------------
2005 2006
----------------------------------------------------------
September 30 December 31 March 31 June 30
----------------------------------------------------------
(In thousands, except per share amounts)
Total interest and dividend income ..... $ 27,683 $ 28,350 $ 28,973 $ 30,270
Total interest expense ................. 17,491 18,715 19,762 21,814
----------------------------------------------------------
Net interest and dividend income ....... 10,192 9,635 9,211 8,456
Non-interest income .................... 3,986 1,099 1,215 1,213
Non-interest expenses .................. 7,753 5,388 5,660 5,397
Income tax expense ..................... 2,293 1,892 1,717 1,509
----------------------------------------------------------
Net income .......................... $ 4,132 $ 3,454 $ 3,049 $ 2,763
==========================================================
Net income per common share:
Basic ............................... $ 0.31 $ 0.26 $ 0.24 $ 0.21
==========================================================
Diluted ............................. $ 0.30 $ 0.26 $ 0.23 $ 0.21
==========================================================
Quarter ended
----------------------------------------------------------
2004 2005
----------------------------------------------------------
September 30 December 31 March 31 June 30
----------------------------------------------------------
(In thousands, except per share amounts)
Total interest and dividend income ..... $ 25,805 $ 25,999 $ 26,167 $ 26,751
Total interest expense ................. 14,734 15,060 15,300 16,290
----------------------------------------------------------
Net interest and dividend income ....... 11,071 10,939 10,867 10,461
Non-interest income .................... 1,100 1,355 1,244 1,297
Non-interest expenses .................. 6,119 6,181 6,143 5,728
Income tax expense ..................... 2,264 2,133 2,114 2,158
----------------------------------------------------------
Net income .......................... $ 3,788 $ 3,980 $ 3,854 $ 3,872
==========================================================
Net income per common share:
Basic ............................... $ 0.28 $ 0.29 $ 0.28 $ 0.29
==========================================================
Diluted ............................. $ 0.27 $ 0.28 $ 0.28 $ 0.28
==========================================================
78
PENNFED FINANCIAL SERVICES, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- Continued
U. Restatement of Prior Year Consolidated Statement of Cash Flow
The Consolidated Statement of Cash Flows for the year ended June 30, 2004 was
restated in the Company's fiscal 2005 Form 10-K to correct the classification of
sales of loans initially originated by the Company for retention in its
portfolio (as opposed to loans originated for the purpose of resale). Such cash
flows had been accounted for in the Consolidated Statement of Cash Flows as
operating activities and should have been reported as investing activities in
accordance with Statement of Financial Accounting Standards No. 102, "Statement
of Cash Flows, Exemption of Certain Enterprises and Classification of Cash Flows
from Certain Securities Acquired for Resale."
The following table sets forth the data as previously reported in the Company's
fiscal 2004 Form 10-K and the data as adjusted:
For the year ended June 30, 2004
---------------------------------
As Previously
Reported As Restated
---------------------------------
(In thousands)
Cash Flows from Operating Activities:
Proceeds from sales of loans held for sale .................. $ 88,214 $ 48,667
Originations of loans held for sale ......................... -- (42,266)
Net cash provided by operating activities ................... 97,805 15,992
Cash Flows from Investing Activities:
Net outflow from loan originations net of
principal repayments of loans ........................... (99,034) (56,769)
Proceeds from loans sold .................................... 3,181 42,729
Net cash used in investing activities ....................... (249,596) (167,783)
Supplemental Schedule of Non-Cash Activities:
Transfer of loans receivable to loans held for sale, at cost 76,142 33,876
79
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
No information is required to be disclosed under this item.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures:
An evaluation of the Company's disclosure controls and procedures (as defined in
Rule 13a-15(e) under the Securities Exchange Act of 1934 (the "Act")) was
carried out as of June 30, 2006 under the supervision and with the participation
of the Company's Chief Executive Officer, Chief Financial Officer and several
other members of the Company's senior management. The Company's Chief Executive
Officer and Chief Financial Officer concluded that, as of June 30, 2006, the
Company's disclosure controls and procedures were effective in ensuring that the
information required to be disclosed by the Company in the reports it files or
submits under the Act is (i) accumulated and communicated to the Company's
management (including the Chief Executive Officer and Chief Financial Officer)
as appropriate to allow timely decisions regarding required disclosure and (ii)
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms.
(b) Changes in Internal Controls:
During the quarter ended June 30, 2006, no change occurred in the Company's
internal control over financial reporting that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting.
The Company does not expect that its disclosure controls and procedures and
internal control over financial reporting will prevent all error and all fraud.
A control procedure, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control procedure
are met. Because of the inherent limitations in all control procedures, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls may be circumvented by the individual acts of some
persons, by collusion of two or more people, or by override of the control. The
design of any control procedure also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions; over time, controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
procedure, misstatements due to error or fraud may occur and not be detected.
(c) Management's Annual Report on Internal Control Over Financial Reporting:
The annual report of management on the effectiveness of the Company's internal
control over financial reporting and the attestation report thereon issued by
the Company's independent registered public accounting firm are set forth under
"Report of Management on Internal Control Over Financial Reporting" and "Report
of Independent Registered Public Accounting Firm on Internal Control Over
Financial Reporting" under Item 8. Financial Statements and Supplementary Data.
Item 9B. Other Information
No information is required to be disclosed under this item.
80
PART III
Item 10. Directors and Executive Officers of the Registrant
Information Concerning Directors and Executive Officers
Information required by this item concerning Directors of the Registrant is
incorporated herein by reference from the Registrant's definitive Proxy
Statement for the Annual Meeting of Stockholders scheduled to be held on October
26, 2006, except for information contained under the headings "Audit Committee
Reports," "Compensation Committee Report on Executive Compensation" and "Stock
Performance Presentation," a copy of which will be filed not later than 120 days
after the close of the fiscal year. For information required by this item
concerning Executive Officers of the Registrant who are not also Directors, see
"Executive Officers" in Part I of this Annual Report on Form 10-K.
Section 16(a) Beneficial Ownership Reporting Compliance
Information required by this item concerning compliance with the reporting
requirements of Section 16(a) of the Securities Exchange Act of 1934 by
Directors, Officers and ten percent beneficial owners of the Registrant is
incorporated herein by reference from the Registrant's definitive Proxy
Statement for the Annual Meeting of Stockholders scheduled to be held on October
26, 2006, a copy of which will be filed not later than 120 days after the close
of the fiscal year.
Code of Ethics
The Registrant has adopted a code of ethics that applies to its principal
executive officer, principal financial officer, principal accounting officer,
and persons performing similar functions, and to all of its other employees and
directors. A copy of the Registrant's code of ethics is available on its
Internet website, at www.pennfsb.com, under "Investor Relations" on the
"Corporate Governance" page of the website.
Item 11. Executive Compensation
Information required by this item concerning executive compensation is
incorporated herein by reference from the Registrant's definitive Proxy
Statement for the Annual Meeting of Stockholders scheduled to be held on October
26, 2006, except for information contained under the headings "Compensation
Committee Report on Executive Compensation" and "Stock Performance
Presentation," a copy of which will be filed not later than 120 days after the
close of the fiscal year.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
Information required by this item concerning security ownership of certain
beneficial owners and management is incorporated herein by reference from the
Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders
scheduled to be held on October 26, 2006, except for information contained under
the headings "Compensation Committee Report on Executive Compensation" and
"Stock Performance Presentation," a copy of which will be filed not later than
120 days after the close of the fiscal year.
81
The following table sets forth information as of June 30, 2006 with respect to
compensation plans under which shares of Company common stock were issued.
Equity Compensation Plan Information
Number of Shares
Remaining Available
for Future Issuance
Under Equity
Number of Shares to Compensation Plans
be Issued Upon Weighted Average (Excluding Shares
Exercise of Exercise Price of Reflected in the
Plan Category Outstanding Options Outstanding Options First Column)
- --------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved
by stockholders(1) ....................... 899,146 $8.43 --
Equity compensation plans not approved
by stockholders .......................... N/A N/A N/A
Total ....................................... 899,146 $8.43 --
- -----------------------
(1) The only equity compensation plan approved by stockholders under which
there are outstanding awards is the Company's 1994 Stock Option and
Incentive Plan.
Item 13. Certain Relationships and Related Transactions
Information required by this item concerning certain relationships and related
transactions is incorporated herein by reference from the Registrant's
definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to
be held on October 26, 2006, except for information contained under the headings
"Compensation Committee Report on Executive Compensation" and "Stock Performance
Presentation," a copy of which will be filed not later than 120 days after the
close of the fiscal year.
Item 14. Principal Accountants Fees and Services
Information required by this item concerning principal accountants fees and
services is incorporated herein by reference from the Registrant's definitive
Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on
October 26, 2006, a copy of which will be filed not later than 120 days after
the close of the fiscal year.
82
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) (1) Financial Statements:
The following information appearing in Part II, Item 8 of this Form 10-K
is incorporated herein by reference.
Reports of Independent Registered Public Accounting Firms
Consolidated Statements of Financial Condition at June 30, 2006 and
2005
Consolidated Statements of Income for the Years Ended June 30, 2006,
2005 and 2004
Consolidated Statements of Comprehensive Income for the Years Ended
June 30, 2006, 2005 and 2004
Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended June 30, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the Years Ended June 30,
2006, 2005 and 2004
Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedules:
All financial statement schedules have been omitted as the information is
not required under the related instructions or is not applicable.
83
(a) (3) Exhibits:
Exhibit Index
Regulation Reference to
S-K Prior Filing
Exhibit or Exhibit
Number Document Number
- ------------------------------------------------------------------------------------------------------------------------------------
2 Plan of acquisition, reorganization, arrangement, liquidation or succession None
3 (i) Articles of Incorporation (a)
3 (ii) Bylaws (a)
4 Instruments defining the rights of security holders, including indentures (b)
4 (i) Stockholder Protection Rights Agreement (c)
10 Material contracts:
(i) 1994 Amended and Restated Stock Option and Incentive Plan (d)
(ii) Employment Agreement with Joseph L. LaMonica (e)
(iii) Employment Agreement with Patrick D. McTernan (e)
(iv) Employment Agreement with Jeffrey J. Carfora (e)
(v) Employment Agreement with Claire M. Chadwick (e)
(vi) Employment Agreement with Maria F. Magurno (e)
(vii) Supplemental Executive Retirement Plan (f)
(a) First Amendment to the Supplemental Executive Retirement Plan (g)
(b) Second Amendment to the Supplemental Executive Retirement Plan (h)
(viii) Amended and Restated Supplemental Executive Death Benefit Plan (h)
(ix) Outside Directors' Retirement Plan (f)
(x) Form of Consulting Agreement (f)
(xi) Description of Named Executive Officer Salary and Bonus Arrangements (i)
(xii) Description of Director Fees (i)
(xiii) Description of Long-Term Care Insurance Program (i)
11 Statement re: computation of per share earnings (j)
12 Statements re: computation ratios 12
14 Code of Ethics (k)
16 Letter re: change in certifying accountant None
18 Letter re: change in accounting principles None
19 Report furnished to security holders None
21 Subsidiaries of the registrant 21
22 Published report regarding matters submitted to vote of security holders None
23 Consents of independent registered public accounting firm and counsel
(a) Consent of KPMG LLP 23.1
(b) Consent of Deloitte & Touche LLP 23.2
24 Power of Attorney None
31.1 Certification Required by Securities Exchange Act of 1934 Rule 13a-14(a) (Chief Executive Officer) 31.1
31.2 Certification Required by Securities Exchange Act of 1934 Rule 13a-14(a) (Chief Financial Officer) 31.2
32 Certifications Required by Section 1350 of Title 18 of the United States Code 32
99 Additional Exhibits Not applicable
- -----------------------------
(a)Included as an appendix to the Company's definitive proxy statement under
the Securities Exchange Act of 1934, filed with the Securities and
Exchange Commission on September 22, 2003 (File No. 0-24040). Such
previously filed document is hereby incorporated by reference in
accordance with Item 601 of Regulation S-K.
(b)The Company hereby agrees to furnish the Securities and Exchange
Commission, upon request, the instruments defining the rights of the
holders of each issue of the Company's long-term debt.
(c)Filed as an exhibit to the Company's Registration Statement on Form 8-A
under the Securities Exchange Act of 1934, filed with the Securities and
Exchange Commission on March 28, 1996 as amended on Form 8-A/A (the "Form
8-A/A") filed with the Securities and Exchange Commission on February 11,
1998, as further amended on Form 8-A/A-2 (the "Form 8-A/A-2") filed with
the Securities and Exchange Commission on October 14, 1998 and as further
amended on Form 8-A/A-3 (the "Form 8-A/A-3") filed with the Securities and
Exchange Commission on March 1, 2004. The First Amendment to the
Stockholders Protection Rights Agreement is filed as an exhibit to the
Form 8-A/A, the Second Amendment to the Stockholders Protection Rights
Agreement is filed as an exhibit to the Form 8-A/A-2, the Third Amendment
to the Stockholder Protection Rights Agreement is filed as an exhibit to
the Current Report on Form
84
8-K filed by the Company with the Securities and Exchange Commission on
October 29, 2003 and the Fourth Amendment to the Stockholder Protection
Rights Agreement is filed as an exhibit to the Form 8-A/A-3. These
documents are hereby incorporated by reference in accordance with Item 601
of Regulation S-K.
(d)Filed as an exhibit to the Company's Form 10-K under the Securities
Exchange Act of 1934, filed with the Securities and Exchange Commission on
September 24, 2001 (File No. 0-24040). Such previously filed document is
hereby incorporated by reference in accordance with Item 601 of Regulation
S-K.
(e)Filed as an exhibit to the Company's Current Report on Form 8-K under the
Securities Exchange Act of 1934, filed with the Securities and Exchange
Commission on September 15, 2004 (File No. 0-24040). Such previously filed
document is hereby incorporated by reference in accordance with Item 601
of Regulation S-K.
(f)Filed as an exhibit to the Company's Form 10-K under the Securities
Exchange Act of 1934, filed with the Securities and Exchange Commission on
September 22, 2003 (File No. 0-24040). Such previously filed document is
hereby incorporated by reference in accordance with Item 601 of Regulation
S-K.
(g)Filed as an exhibit to the Company's Form 10-Q under the Securities
Exchange Act of 1934, filed with the Securities and Exchange Commission on
February 17, 2004 (File No. 0-24040). Such previously filed document is
hereby incorporated by reference in accordance with Item 601 of Regulation
S-K.
(h)Filed as exhibits to the Company's Current Report on Form 8-K under the
Securities Exchange Act of 1934, filed with the Securities and Exchange
Commission on February 14, 2005 (File No. 0-24040). Such previously filed
document is hereby incorporated by reference in accordance with Item 601
of Regulation S-K.
(i)Filed as an exhibit to the Company's Form 10-K under the Securities
Exchange Act of 1934, filed with the Securities and Exchange Commission on
September 13, 2005 (File No. 0-24040). Such previously filed document is
hereby incorporated by reference in accordance with Item 601 of Regulation
S-K.
(j)Refer to Note O - Computation of Earnings Per Share ("EPS") in the Notes
to Consolidated Financial Statements included in the June 30, 2006 Form
10-K.
(k)Available on the Company's website at www.pennfsb.com.
85
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
PENNFED FINANCIAL SERVICES, INC.
Date: September 13, 2006 By: /s/ Joseph L. LaMonica
---------------------------------
Joseph L. LaMonica
President and Chief
Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
By: /s/ Joseph L. LaMonica By: /s/ William C. Anderson
------------------------------------------ ---------------------------------
Joseph L. LaMonica William C. Anderson
President, Chief Executive Officer Chairman of the Board
and Director
(Principal Executive Officer)
Date: September 13, 2006 Date: September 13, 2006
By: /s/ Patrick D. McTernan By: /s/ Amadeu L. Carvalho
------------------------------------------ ---------------------------------
Patrick D. McTernan Amadeu L. Carvalho
Senior Executive Vice President, General Director
Counsel, Secretary and Director
Date: September 13, 2006 Date: September 13, 2006
By: /s/ Marvin D. Schoonover By: /s/ Mario Teixeira, Jr.
------------------------------------------ --------------------------------
Marvin D. Schoonover Mario Teixeira, Jr.
Director Director
Date: September 13, 2006 Date: September 13, 2006
By: /s/ Claire M. Chadwick
------------------------------------------
Claire M. Chadwick
Senior Executive Vice President,
Chief Financial Officer and Controller
(Principal Financial and Accounting Officer)
Date: September 13, 2006
86