cffn10q063009.htm


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
_________________

Form 10-Q
(Mark One)
 
þ          QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2009

                                                                                                 or

 
¨        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
 
              OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number:  000-25391
_________________

Capitol Federal Financial
(Exact name of registrant as specified in its charter)

                                                                                                                 United States                                                                   48-1212142
                                                                                                                               (State or other jurisdiction of incorporation                         (I.R.S. Employer
                                                                                                                                or organization)                                                          Identification No.)
 
                                                                                                                                700 Kansas Avenue, Topeka, Kansas                                              66603
                                                                                                                                (Address of principal executive offices)                                      (Zip Code)

Registrant’s telephone number, including area code:
(785) 235-1341


         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 requirements for the past 90 days.   Yes þ    No ¨       
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes ¨  No ¨   

         Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer, large accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer    þ         Accelerated filer    ¨        Non-accelerated filer   ¨      Smaller Reporting Company   ¨
                                                                                              (do not check if a smaller
                                                                                                   reporting company)
        
 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No  þ      
                                                                                                                                   
          As of July 27, 2009, there were 74,098,655 shares of Capitol Federal Financial Common Stock outstanding.




 
1

 


 
Page
Number
 
Item 1.  Financial Statements (Unaudited):
 
             Consolidated Balance Sheets at June 30, 2009 and September 30, 2008
3
             Consolidated Statements of Income for the three and nine months ended
 
                  June 30, 2009 and June 30, 2008
4
             Consolidated Statement of Stockholders’ Equity for the nine months ended
 
                  June 30, 2009
5
             Consolidated Statements of Cash Flows for the nine months ended
 
                  June 30, 2009 and June 30, 2008
6
8
Item 2.  Management’s Discussion and Analysis of Financial Condition and
 
                  Results of Operations
18
56
63
   
PART II -- OTHER INFORMATION
 
Item 1.    Legal Proceedings
63
Item 1A. Risk Factors
63
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds
63
63
63
Item 5.    Other Information
64
Item 6.    Exhibits
64
   
65
   
INDEX TO EXHIBITS
66
   


 
2

 

PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
CAPITOL FEDERAL FINANCIAL AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except per share data and amounts)
   
June 30,
   
September 30,
 
   
2009
   
2008
 
ASSETS:
 
(Unaudited)
       
Cash and cash equivalents
  $ 74,101     $ 87,138  
Investment securities:
               
  Available-for-sale (“AFS”) at estimated fair value (amortized cost of $260,886 and $51,700)
    259,309       49,586  
  Held-to-maturity (“HTM”) at cost (estimated fair value of $63,757 and $92,211)
    62,857       92,773  
Mortgage-backed securities (“MBS”):
               
  AFS, at estimated fair value (amortized cost of $1,433,171 and $1,491,536)
    1,472,547       1,484,055  
  HTM, at cost (estimated fair value of $643,110 and $743,764)
    628,451       750,284  
Loans receivable, net
    5,541,731       5,320,780  
Capital stock of Federal Home Loan Bank (“FHLB”), at cost
    132,071       124,406  
Accrued interest receivable
    32,828       33,704  
Premises and equipment, net
    35,008       29,874  
Real estate owned (“REO”), net
    5,077       5,146  
Other assets
    75,312       77,503  
        TOTAL ASSETS
  $ 8,319,292     $ 8,055,249  
                 
LIABILITIES:
               
Deposits
  $ 4,175,251     $ 3,923,883  
Advances from FHLB
    2,410,949       2,447,129  
Other borrowings, net
    713,609       713,581  
Advance payments by borrowers for taxes and insurance
    30,412       53,213  
Income taxes payable
    4,500       6,554  
Deferred income tax liabilities, net
    24,477       3,223  
Accounts payable and accrued expenses
    37,460       36,450  
        Total liabilities
    7,396,658       7,184,033  
                 
STOCKHOLDERS' EQUITY:
               
Preferred stock ($0.01 par value) 50,000,000 shares authorized; none issued
    --       --  
Common stock ($0.01 par value) 450,000,000 shares authorized, 91,512,287
               
      shares issued; 74,098,155 and 74,079,868 shares outstanding
               
      as of June 30, 2009 and September 30, 2008, respectively
    915       915  
Additional paid-in capital
    451,543       445,391  
Unearned compensation, Employee Stock Ownership Plan (“ESOP”)
    (8,569 )     (10,082 )
Unearned compensation, Recognition and Retention Plan (“RRP”)
    (403 )     (553 )
Retained earnings
    775,214       759,375  
Accumulated other comprehensive gain (loss)
    23,512       (5,968 )
Less shares held in treasury (17,414,132 and 17,432,419 shares as of
               
       June 30, 2009 and September 30, 2008, respectively, at cost)
    (319,578 )     (317,862 )
         Total stockholders' equity
    922,634       871,216  
                 
        TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 8,319,292     $ 8,055,249  
See accompanying notes to consolidated interim financial statements.
<Index>

 
3

 

CAPITOL FEDERAL FINANCIAL AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars and share counts in thousands except per share data)

   
For the Three Months Ended
   
For the Nine Months Ended
 
   
June 30,
   
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
INTEREST AND DIVIDEND INCOME:
                       
Loans receivable
  $ 76,745     $ 74,651     $ 230,907     $ 226,190  
MBS
    24,211       24,869       75,701       62,242  
Investment securities
    1,279       1,298       3,560       8,489  
Capital stock of FHLB
    793       1,502       2,351       5,446  
Cash and cash equivalents
    50       465       167       3,262  
     Total interest and dividend income
    103,078       102,785       312,686       305,629  
                                 
INTEREST EXPENSE:
                               
FHLB advances
    25,307       30,248       81,505       96,205  
Deposits
    24,705       31,174       76,201       104,352  
Other borrowings
    7,144       4,682       21,978       10,762  
     Total interest expense
    57,156       66,104       179,684       211,319  
                                 
NET INTEREST AND DIVIDEND INCOME
    45,922       36,681       133,002       94,310  
PROVISION FOR LOAN LOSSES
    3,112       1,602       5,768       1,721  
                                 
     NET INTEREST AND DIVIDEND INCOME
                               
       AFTER PROVISION FOR LOAN LOSSES
    42,810       35,079       127,234       92,589  
                                 
OTHER INCOME:
                               
Retail fees and charges
    4,671       4,566       13,271       13,150  
Gains on sale of loans held-for-sale (“LHFS”), net
    1,629       244       2,169       501  
Insurance commissions
    528       486       1,892       1,661  
Loan fees
    564       572       1,730       1,751  
Income from bank-owned life insurance (“BOLI”)
    262       577       887       1,810  
Other, net
    578       900       1,900       3,565  
     Total other income
    8,232       7,345       21,849       22,438  
                                 
OTHER EXPENSES:
                               
Salaries and employee benefits
    10,715       11,021       32,447       31,729  
Occupancy of premises
    3,936       3,750       11,428       10,384  
Federal insurance premium
    5,307       116       5,700       350  
Advertising
    1,704       1,216       5,393       3,433  
Deposit and loan transaction fees
    1,276       1,364       3,998       3,935  
Regulatory and other services
    857       1,267       2,986       4,345  
Office supplies and related expense
    582       493       2,030       1,614  
Other, net
    2,034       609       6,650       4,404  
     Total other expenses
    26,411       19,836       70,632       60,194  
INCOME BEFORE INCOME TAX EXPENSE
    24,631       22,588       78,451       54,833  
INCOME TAX EXPENSE
    9,155       8,233       28,991       19,638  
NET INCOME
  $ 15,476     $ 14,355     $ 49,460     $ 35,195  
                                 
Basic earnings per common share
  $ 0.21     $ 0.20     $ 0.68     $ 0.48  
Diluted earnings per common share
  $ 0.21     $ 0.20     $ 0.68     $ 0.48  
Dividends declared per public share
  $ 0.50     $ 0.50     $ 1.61     $ 1.50  
                                 
Basic weighted average common shares
    73,173       72,933       73,116       72,922  
Diluted weighted average common shares
    73,232       73,021       73,190       72,985  
 
See accompanying notes to consolidated interim financial statements.

 
4

 

CAPITOL FEDERAL FINANCIAL AND SUBSIDIARY
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)
(Dollars in thousands)


                                 
Accumulated
             
         
Additional
   
Unearned
   
Unearned
         
Other
             
   
Common
   
Paid-In
   
Compensation
   
Compensation
   
Retained
   
Comprehensive
   
Treasury
       
   
Stock
   
Capital
   
ESOP
   
RRP
   
Earnings
   
Gain (Loss)
   
Stock
   
Total
 
                                                 
Balance at October 1, 2008
  $ 915     $ 445,391     $ (10,082 )   $ (553 )   $ 759,375     $ (5,968 )   $ (317,862 )   $ 871,216  
Comprehensive income:
                                                               
   Net income
                                    49,460                       49,460  
   Changes in unrealized gains (losses) on
                                                               
   securities AFS, net of deferred income
                                                               
   taxes of $17,914
                                            29,480               29,480  
Total comprehensive income
                                                            78,940  
                                                                 
ESOP activity, net
            4,653       1,513                                       6,166  
RRP activity, net
            128               (100 )                     24       52  
Stock based compensation - stock options and RRP
            225               250                               475  
Acquisition of treasury stock
                                                    (2,426 )     (2,426 )
Stock options exercised
            1,146                                       686       1,832  
Dividends on common stock to public
                                                               
  stockholders ($1.61 per public share)
                                    (33,621 )                     (33,621 )
Balance at June 30, 2009
  $ 915     $ 451,543     $ (8,569 )   $ (403 )   $ 775,214     $ 23,512     $ (319,578 )   $ 922,634  


See accompanying notes to consolidated interim financial statements.


<Index>


 
5

 

CAPITOL FEDERAL FINANCIAL AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
   
For the Nine Months Ended
 
   
June 30,
 
   
2009
   
2008
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net income
  $ 49,460     $ 35,195  
Adjustments to reconcile net income to net cash provided by
               
  operating activities:
               
    FHLB stock dividends
    (2,351 )     (5,446 )
    Provision for loan losses
    5,768       1,721  
    Originations of LHFS
    (858 )     (32,555 )
    Proceeds from sales of LHFS
    97,838       31,220  
    Amortization and accretion of premiums and discounts on
               
      MBS and investment securities
    1,377       496  
    Depreciation and amortization of premises and equipment
    3,751       3,934  
    Amortization of deferred amounts related to FHLB advances, net
    2,208       1,294  
    Common stock committed to be released for allocation - ESOP
    6,166       5,350  
    Stock based compensation - stock options and RRP
    475       575  
    Other, net
    (1,432 )     (442 )
  Changes in:
               
      Accrued interest receivable
    876       3,561  
      Other assets
    2,052       (2,185 )
      Income taxes payable/receivable
    1,840       15,583  
      Accounts payable and accrued expenses
    1,010       (4,362 )
             Net cash provided by operating activities
    168,180       53,939  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Proceeds from maturities or calls of investment securities AFS
    45,032       99,791  
Purchases of investment securities AFS
    (255,046 )     (49,248 )
Proceeds from maturities or calls of investment securities HTM
    39,600       514,108  
Purchases of investment securities HTM
    (10,116 )     (185,138 )
Principal collected on MBS AFS
    227,574       171,534  
Purchases of MBS AFS
    (169,452 )     (1,044,847 )
Principal collected on MBS HTM
    125,176       215,767  
Purchases of MBS HTM
    (3,217 )     (5,483 )
Proceeds from the redemption of capital stock of FHLB
    3,688       28,861  
Purchases of capital stock of FHLB
    (9,002 )     (12,926 )
Loan originations, net of principal collected
    (196,002 )     (85,692 )
Loan purchases, net of principal collected
    (133,849 )     45,015  
Net deferred fee activity
    1,330       463  
Purchases of premises and equipment
    (8,944 )     (5,113 )
Proceeds from sales of REO
    6,047       4,084  
             Net cash used in investing activities
    (337,181 )     (308,824 )

(Continued)

 
6

 



   
For the Nine Months Ended
 
   
June 30,
 
   
2009
   
2008
 
CASH FLOWS FROM FINANCING ACTIVITIES:
           
Dividends paid
  $ (33,621 )   $ (31,091 )
Deposits, net of withdrawals
    251,368       38,761  
Proceeds from advances/line of credit from FHLB
    1,561,102       725,000  
Repayments on advances/line of credit from FHLB
    (1,561,102 )     (925,000 )
Deferred FHLB prepayment penalty
    (38,388 )     --  
Proceeds from repurchase agreements
    --       400,000  
Change in advance payments by borrowers for taxes and insurance
    (22,801 )     (22,208 )
Acquisitions of treasury stock
    (2,426 )     (7,307 )
Stock options exercised and excess tax benefits from stock options
    1,832       376  
             Net cash provided by financing activities
    155,964       178,531  
                 
NET DECREASE IN CASH AND CASH EQUIVALENTS
    (13,037 )     (76,354 )
CASH AND CASH EQUIVALENTS:
               
Beginning of period
    87,138       162,791  
End of period
  $ 74,101     $ 86,437  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
               
      Income tax payments, net of refund
  $ 27,116     $ 4,003  
      Interest payments, net of interest credited to deposits
  $ 103,229     $ 106,659  
                 
SUPPLEMENTAL DISCLOSURE OF NON-CASH
               
      INVESTING AND FINANCING ACTIVITIES:
               
      Loans transferred to REO
  $ 7,320     $ 4,188  
                 
      Fair value change related to fair value hedge:
               
            Interest rate swaps hedging FHLB advances
  $ --     $ (13,817 )
                 
      Transfer of loans receivable to LHFS, net
  $ 94,672     $ --  

(Concluded)
See accompanying notes to consolidated interim financial statements.
<Index>
7



Notes to Consolidated Interim Financial Statements (Unaudited)

1.   Basis of Financial Statement Presentation

The accompanying consolidated financial statements of Capitol Federal Financial (“CFFN”) and subsidiary (the “Company”) have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.  These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2008 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”).  Interim results are not necessarily indicative of results for a full year.

In preparing the financial statements, management is required 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 revenues and expenses during the reporting periods.  Significant estimates include the allowance for loan losses (“ALLL”), other-than-temporary declines in the fair value of securities and other financial instruments. Actual results could differ from those estimates.  See “Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies.”

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Capitol Federal Savings Bank (the “Bank”). The Bank has a wholly owned subsidiary, Capitol Funds, Inc.  Capitol Funds, Inc. has a wholly owned subsidiary, Capitol Federal Mortgage Reinsurance Company.  All intercompany accounts and transactions have been eliminated.

2.   Earnings Per Share (“EPS”)

The Company accounts for the 3,024,574 shares acquired by its ESOP in accordance with Statement of Position (“SOP”) 93-6 and the shares awarded pursuant to its RRP in a manner similar to the ESOP shares.  Shares acquired by the ESOP and shares awarded pursuant to the RRP are not considered in the basic average shares outstanding until the shares are committed for allocation or vested to an employee’s individual account.  The following is a reconciliation of the numerators and denominators of the basic and diluted EPS calculations.

   
For the Three Months Ended
   
For the Nine Months Ended
 
   
June 30,
   
June 30,
 
   
2009(1) (2)
   
2008(3)
   
2009(1)(2)
   
2008(4)(5)
 
   
(Dollars in thousands, except per share amounts)
 
Net income
  $ 15,476     $ 14,355     $ 49,460     $ 35,195  
                                 
Average common shares outstanding
    73,071,448       72,832,039       73,065,433       72,870,800  
Average committed ESOP shares outstanding
    101,374       101,374       50,779       50,778  
Total basic average common shares outstanding
    73,172,822       72,933,413       73,116,212       72,921,578  
                                 
                                 
Effect of dilutive RRP shares
    3,842       5,240       5,626       4,295  
Effect of dilutive stock options
    55,832       82,132       67,663       58,784  
                                 
Total diluted average common shares outstanding
    73,232,496       73,020,785       73,189,501       72,984,657  
                                 
Net earnings per share:
                               
     Basic
  $ 0.21     $ 0.20     $ 0.68     $ 0.48  
     Diluted
  $ 0.21     $ 0.20     $ 0.68     $ 0.48  

8

(1) Options to purchase 72,050 shares of common stock at prices between $38.77 per share and $43.46 per share were outstanding as of June 30, 2009, but were not included in the computation of diluted EPS because they were anti-dilutive for the three and nine months ended June 30, 2009.

(2) At June 30, 2009, there were 2,000 unvested RRP shares at $39.95 per share that were excluded from the computation of diluted EPS because they were anti-dilutive for the three and nine months ended June 30, 2009.

(3) Options to purchase 31,500 shares of common stock at $38.77 per share were outstanding as of June 30, 2008, but were not included in the computation of diluted EPS because they were anti-dilutive for the three months ended June 30, 2008.

(4) Options to purchase 128,055 shares of common stock at prices between $32.23 per share and $38.77 per share were outstanding as of June 30, 2008, but were not included in the computation of diluted EPS because they were anti-dilutive for the nine months ended June 30, 2008.

(5) At June 30, 2008, there were 6,000 unvested RRP shares at $32.30 per share that were excluded from the computation of diluted EPS because they were anti-dilutive for the nine months ended June 30, 2008.

3.   Recent Accounting Pronouncements

In January 2009, the Financial Accounting Standards Board (“FASB”) issued Staff Position (“FSP”) Emerging Issues Task Force (“EITF”) 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20.”  FSP EITF 99-20-1 eliminates the requirement that a security holder’s best estimate of cash flows be based upon those that “a market participant” would use.  Instead, an other-than-temporary impairment (“OTTI”) should be recognized as a realized loss through earnings when it is probable there has been an adverse change in the security holder’s estimated cash flows from previous projections.  This treatment is consistent with the impairment model in Statement of Financial Accounting Standards (“SFAS”) No. 115 “Accounting for Certain Investments in Debt and Equity Securities.”  FSP EITF 99-20-1 was effective for the Company for the period ended December 31, 2008.  The Company’s adoption of the FSP did not have a material impact on its financial condition or results of operations.

In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.”  The FSP provides additional guidance on valuation techniques for estimating the fair value of assets or liabilities in accordance with SFAS No. 157 “Fair Value Measurements” when there has been a significant decrease in volume and level of market activity.  The FSP provides guidance on identifying circumstances that indicate a transaction is not orderly.  As part of the judgment involved with estimating fair value, the entity will need to determine which valuation technique or techniques are the most appropriate, and, within those techniques, which results are “most representative” of fair value under market conditions.  FSP FAS 157-4 emphasizes that the notion of exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions remains unchanged.  FSP FAS 157-4 was effective for the Company for the period ended June 30, 2009.  The Company’s adoption of the FSP did not have a material impact on its financial condition or results of operations.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.”  The FSP amends existing OTTI guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of OTTI on debt and equity securities in the financial statements.  An OTTI is present for a security which has a fair value less than amortized cost if an entity has the intent to sell the impaired security, it is more likely than not that the entity will be required to sell the impaired security before recovery, or if the entity does not expect to recover the entire amortized cost basis of the impaired security.  If the entity has the intent to sell the security or it is more likely than not that it will be required to sell the security, the entire impairment (amortized cost basis over fair value) should be recognized in earnings as a credit loss.  If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security, the credit component of the impairment should be recognized in earnings, and the non-credit component should be recognized in other comprehensive income.  The FSP does not amend existing recognition and measurement guidance related to OTTI of equity securities.  The FSP expands and increases the frequency of existing disclosures about OTTI for debt and equity securities and requires new disclosures to help users of financial statements understand the significant inputs used in determining credit losses, as well as a rollforward of that amount each period.  The FSP was effective for the Company for the period ended June 30, 2009.  The Company’s adoption of the FSP did not have a material impact on its financial condition or results of operations.

 
9

 

 

In April 2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board (“APB”) Opinion No. 28-1, “Interim Disclosures about Fair Value of Financial Instruments.”  The FSP amends the disclosure requirements of SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”, to require fair value disclosures of financial instruments in interim financial statements as well as in annual financial statements.  The FSP also amends APB No. 28,” Interim Financial Reporting”, to require such disclosures in all interim financial statements.  The FSP requires an entity to disclose in the body or in the accompanying footnotes of its interim financial statements and its annual financial statements the fair value of all financial instruments, whether recognized or not recognized in the consolidated balance sheet, as required by FAS No. 107.  The FSP also requires entities to disclose the methods and significant assumptions used to estimate the fair value of financial instruments, and to disclose significant changes in methods or assumptions used to estimate fair values.  The FSP was effective for the Company for the period ended June 30, 2009.  Since the provisions of the FSP are disclosure related, the Company’s adoption of the FSP did not have an impact on its financial condition or results of operations.
 
In April 2009, the SEC issued Staff Accounting Bulletin (“SAB”) 111 which amends Topic 5.M “Other-Than-Temporary Impairment of Certain Investments in Debt and Equity Securities” to exclude investments in debt securities from the scope of the other-than-temporary impairment guidance.  SAB 111 was issued in response to the FASB’s issuance of FSB FAS 115-2 and FAS 124-2.  The SEC staff has not changed its views in SAB Topic 5.M on investments in equity securities.  SAB 111 was effective for the Company for the period ended June 30, 2009.  The Company’s adoption of SAB 111 did not have a material impact on its financial condition or results of operation.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” which is intended to assist management in assessing and disclosing subsequent events by establishing general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued.  Financial statements are considered to be available to be issued when they are complete in a form and format that complies with GAAP and all necessary approvals for issuance, such as from management, the board of directors, and/or significant shareholders, have been obtained.  The date through which an entity has evaluated subsequent events and the basis for that date should also be disclosed.   Management must perform its assessment of subsequent events for both interim and annual financial reporting periods.  SFAS No. 165 was effective for the Company for the period ended June 30, 2009.  The Company’s adoption of SFAS No. 165 did not have a material impact on its financial condition or results of operations.
 
In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets an Amendment of FASB Statement No. 140.”  The objective of SFAS No. 166 is to improve the relevance, representational faithfulness, and comparability of the information provided in the financial statements related to the transfer of financial assets; the effects of a transfer on the company’s financial position, financial performance and cash flows; and a transferor’s continuing involvement in transferred financial assets.  SFAS No. 166 is effective for financial asset transfers occurring after the beginning of an entity’s first fiscal year that begins after November 15, 2009, which for the Company is October 1, 2010.  Early adoption is prohibited.  The Company has not yet completed its assessment of the impact of SFAS No. 166.
 
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” to improve financial reporting by entities involved with variable interest entities.  SFAS No. 167 carries forward the scope of FASB Interpretation No. 46(R), with the addition of entities previously considered qualifying special-purpose entities, as the concept of these entities was eliminated in SFAS No. 166.  SFAS No. 167 is effective as of the beginning of the first fiscal year that begins after November 15, 2009, which for the Company is October 1, 2010.  Early adoption is prohibited.  The Company has not yet completed its assessment of the impact of SFAS No. 167.
 
In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” which replaces SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” as the source of authoritative accounting principles recognized by FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP.  SFAS No. 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009, which for the Company is September 30, 2009.  Since the underlying GAAP guidance for nongovernmental entities will not change as a result of the issuance of SFAS No. 168, the Company’s adoption of the SFAS is not expected to have an impact on its financial condition or results of operations.  References to codification guidance will be updated in the Annual Report on Form 10-K for the fiscal year ending September 30, 2009.

 
10

 



4.   Fair Value of Financial Instruments

Fair Value Measurements
Effective October 1, 2008, the Company adopted SFAS No. 157 “Fair Value Measurements” which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The statement applies whenever other standards require or permit assets or liabilities to be measured at fair value.  The statement does not require new fair value measurements, but rather provides a definition and framework for measuring fair value which will result in greater consistency and comparability among financial statements prepared under GAAP. The Company’s adoption of SFAS No. 157 did not have a material impact on its financial condition or results of operations.

The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. The Company did not have any liabilities that were measured at fair value at June 30, 2009.  The Company’s AFS securities are recorded at fair value on a recurring basis.  Additionally, from time to time, the Company may be required to record at fair value other assets or liabilities on a non-recurring basis, such as REO, LHFS, and impaired loans. These non-recurring fair value adjustments involve the application of lower-of-cost-or-fair value accounting or write-downs of individual assets.

In accordance with SFAS No. 157, the Company groups its assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

 
Level 1 — Valuation is based upon quoted prices for identical instruments traded in active markets.
     
 
Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
     
 
Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models, and similar techniques. The results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability.
 
The Company bases its fair values on the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.  SFAS No. 157 requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The following is a description of valuation methodologies used for assets measured at fair value on a recurring basis.

AFS Securities
The Company’s AFS securities portfolio is carried at estimated fair value on a recurring basis, with any unrealized gains and losses, net of taxes, reported as accumulated other comprehensive income/loss in stockholders' equity.  In the table below, in accordance with FSP FAS 157-4, the Company has disclosed its major security types based on the nature and risks of the securities.  Substantially all of the securities within the AFS portfolio are issued by U.S. Government sponsored enterprises or agencies.  The fair values for all the AFS securities are obtained from independent nationally recognized pricing services. Various modeling techniques are used to determine pricing for the Company’s securities, including option pricing and discounted cash flow models. The inputs to these models may include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers and reference data.  There are some AFS securities in the AFS portfolio that have significant unobservable input requiring the independent pricing services to use some judgment in pricing the related securities.  These AFS securities are classified as Level 3.  All other AFS securities are classified as Level 2.

 
11

 



The following table provides the level of valuation assumption used to determine the carrying value of the Company’s assets measured at fair value on a recurring basis at June 30, 2009:

         
Quoted Prices
   
Significant
   
Significant
 
         
in Active Markets
   
Other
   
Unobservable
 
   
Carrying
   
for Identical Assets
   
Observable Inputs
   
Inputs
 
   
Value
   
(Level 1)
   
(Level 2)
   
(Level 3)(1)
 
   
(Dollars in thousands)
 
AFS securities:
                       
 U.S. government-sponsored agencies
  $ 254,745     $ --     $ 254,745     $ --  
 Municipal bonds
    2,738       --       2,738       --  
 Trust preferred securities
    1,826       --       --       1,826  
 MBS
    1,472,547       --       1,472,547       --  
  
  $ 1,731,856     $ --     $ 1,730,030     $ 1,826  

(1) The Company’s Level 3 AFS securities were immaterial as of June 30, 2009 and had no material activity during the nine months ended June 30, 2009.

The following is a description of valuation methodologies used for significant assets measured at fair value on a non-recurring basis.

Loans Receivable
Loans which meet certain criteria are evaluated individually for impairment. A loan is considered impaired when, based upon current information and events, it is probable the Bank will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the loan agreement.  Substantially all of the Bank’s impaired loans at June 30, 2009 are secured by real estate.  These impaired loans are individually assessed to determine that the carrying value of the loan is not in excess of the fair value of the collateral, less estimated selling costs. Fair value is estimated through current appraisals, real estate brokers or listing prices.  Fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3.  Impaired loans at June 30, 2009 were $29.4 million. Based on this evaluation, the Company maintains an allowance for loan losses of $4.4 million at June 30, 2009 for such impaired loans.

REO, net
REO represents real estate acquired as a result of foreclosure or by deed in lieu of foreclosure and is carried at the lower of cost or fair value less estimated selling costs.  Fair value is estimated through current appraisals, real estate brokers or listing prices.  As these properties are actively marketed, estimated fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3.  REO at June 30, 2009 was $5.1 million. During the three and nine months ended June 30, 2009, charge-offs to the allowance for loan losses related to loans that were transferred to REO were $328 thousand and $1.0 million, respectively. Write downs related to REO that were charged to other expense were $245 thousand and $885 thousand for the three and nine months ended June 30, 2009.

 
12

 



The following table provides the level of valuation assumption used to determine the carrying value of the Company’s assets measured at fair value on a non-recurring basis at June 30, 2009:

         
Quoted Prices
   
Significant
   
Significant
 
         
in Active Markets
   
Other
   
Unobservable
 
   
Carrying
   
for Identical Assets
   
Observable Inputs
   
Inputs
 
   
Value
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
   
(Dollars in thousands)
 
Impaired loans
  $ 29,399     $ --     $ --     $ 29,399  
REO, net
    5,077       --       --       5,077  
    $ 34,476     $ --     $ --     $ 34,476  



Fair Value Disclosures
Effective June 30, 2009, the Company adopted FSP FAS 107-1 and ABP Opinion No. 28-1, “Interim Disclosures about Fair Value of Financial Instruments.”  The FSP requires interim and annual disclosures of the fair value of financial instruments, the methods and significant assumptions used to determine the estimated fair values and significant changes in the methods or assumptions used to calculate the estimated fair values.  The Company determined estimated fair value amounts using available market information and a selection from a variety of valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amount the Company could realize in a current market exchange. The use of different market assumptions and estimation methodologies may have a material effect on the estimated fair value amounts.  The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2009 and September 30, 2008. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date.

The estimated fair values of the Company’s financial instruments as of June 30, 2009 and September 30, 2008 are as follows:

   
At
   
At
 
   
June 30, 2009
   
September 30, 2008
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
   
(Dollars in thousands)
 
Assets:
                       
Cash and cash equivalents
  $ 74,101     $ 74,101     $ 87,138     $ 87,138  
Investment securities:
                               
  AFS
    259,309       259,309       49,586       49,586  
  HTM
    62,857       63,757       92,773       92,211  
MBS:
                               
  AFS
    1,472,547       1,472,547       1,484,055       1,484,055  
  HTM
    628,451       643,110       750,284       743,764  
Loans receivable
    5,541,731       5,693,858       5,320,780       5,301,179  
Capital stock of FHLB
    132,071       132,071       124,406       124,406  
Liabilities:
                               
 Deposits
    4,175,251       4,238,765       3,923,883       3,934,188  
Advances from FHLB
    2,410,949       2,543,948       2,447,129       2,485,545  
 Other borrowings
    713,609       737,770       713,581       716,951  


The following methods and assumptions were used to estimate the fair value of the financial instruments:

Cash and Cash Equivalents - The carrying amounts of cash and cash equivalents are considered to approximate their fair value due to the nature of the financial asset.

 
13

 



Investment Securities and MBS - Estimated fair values of securities are based on one of three methods:  1) quoted market prices where available, 2) quoted market prices for similar instruments if quoted market prices are not available, 3) unobservable data that represents the Bank’s assumptions about items that market participants would consider in determining fair value where no market data is available.  AFS securities are carried at estimated fair value.  HTM securities are carried at amortized cost.

Loans Receivable - Fair values are estimated for portfolios with similar financial characteristics.  Loans are segregated by type, such as one- to four-family residential mortgages, multi-family residential mortgages, nonresidential and installment loans.  Each loan category is further segmented into fixed and adjustable interest rate categories.  Market pricing sources are used to approximate the estimated fair value of fixed and adjustable-rate one- to four-family residential mortgages.  For all other loan categories, future cash flows are discounted using the LIBOR curve at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturity.

Capital Stock of FHLB – The carrying value of FHLB stock equals cost.  The fair value is based on redemption at par value.

Deposits - The estimated fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date. The estimated fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered by the Bank for certificates of similar remaining maturities.

Advances from FHLB - The estimated fair value of advances from FHLB are determined by discounting the future cash flows of each advance using the LIBOR curve.

Other Borrowings – Other borrowings consists of repurchase agreements and Junior Subordinated Deferrable Interest Debentures (“the debentures”). The estimated fair value of the repurchase agreements is determined by discounting the future cash flows of each agreement using the LIBOR curve.  The debentures have a variable rate structure.  The Company was able to prepay the debentures at a premium until April 2009, at which point the borrowings became redeemable at par.  The carrying value of the debentures approximates their estimated fair value.


 
14

 



5.   Securities

The following tables reflect the amortized cost, estimated fair value, and gross unrealized gains and losses of AFS and HTM securities at June 30, 2009 and September 30, 2008.  The majority of the security portfolio is composed of securities issued by U.S. government-sponsored enterprises.
 
   
June 30, 2009
 
         
Gross
   
Gross
   
Estimated
 
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
   
(Dollars in thousands)
 
AFS:
                       
   U.S. government-sponsored agencies
  $ 254,424     $ 549     $ 228     $ 254,745  
   Municipal bonds
    2,673       99       34       2,738  
   Trust preferred securities
    3,789       --       1,963       1,826  
   MBS
    1,433,171       40,819       1,443       1,472,547  
      1,694,057       41,467       3,668       1,731,856  
HTM:
                               
   Municipal bonds
    62,857       1,171       271       63,757  
   MBS
    628,451       15,100       441       643,110  
      691,308       16,271       712       706,867  
                                 
    $ 2,385,365     $ 57,738     $ 4,380     $ 2,438,723  
                                 
   
September 30, 2008
 
           
Gross
   
Gross
   
Estimated
 
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
Value
 
   
(Dollars in thousands)
 
AFS:
                               
   U.S. government-sponsored agencies
  $ 45,155     $ --     $ 967     $ 44,188  
   Municipal bonds
    2,686       61       4       2,743  
   Trust preferred securities
    3,859       --       1,204       2,655  
   MBS
    1,491,536       3,940       11,421       1,484,055  
      1,543,236       4,001       13,596       1,533,641  
HTM:
                               
   U.S. government-sponsored agencies
    37,397       19       647       36,769  
   Municipal bonds
    55,376       408       342       55,442  
   MBS
    750,284       2,105       8,625       743,764  
      843,057       2,532       9,614       835,975  
                                 
    $ 2,386,293     $ 6,533     $ 23,210     $ 2,369,616  

 

 
15

 


The following tables summarize the estimated fair value and gross unrealized losses of those securities on which an unrealized loss at June 30, 2009 and September 30, 2008 was reported and the continuous unrealized loss position for the twelve months prior to June 30, 2009 and September 30, 2008 or for a shorter period of time, as applicable. At June 30, 2009 and September 30, 2008, there were 84 and 92 securities, respectively, in a continuous unrealized loss position for more than 12 months.

   
June 30, 2009
 
   
Less Than
   
Equal to or Greater
 
   
12 Months
   
Than 12 Months
 
   
Count
   
Estimated
Fair Value
   
Unrealized
   
Count
   
Estimated
Fair Value
   
Unrealized
 
   
Losses
   
Losses
 
AFS:
 
(Dollars in thousands)
 
   U.S. government-sponsored agencies
    5     $ 102,600     $ 228       --     $ --     $ --  
   Municipal bonds
    5       1,293       34       --       --       --  
   Trust preferred securities
    1       1,826       1,963       --       --       --  
   MBS
    12       77,288       1,106       73       37,919       337  
      23     $ 183,007     $ 3,331       73     $ 37,919     $ 337  
                                                 
HTM:
                                               
   Municipal bonds
    22     $ 11,649     $ 234       1     $ 463     $ 37  
   MBS
    6       16,374       83       10       44,352       358  
      28     $ 28,023     $ 317       11     $ 44,815     $ 395  
                                                 
                                                 
   
September 30, 2008
 
   
Less Than
   
Equal to or Greater
 
   
12 Months
   
Than 12 Months
 
   
Count
   
Estimated
Fair Value
   
Unrealized
   
Count
   
Estimated
Fair Value
   
Unrealized
 
   
Losses
   
Losses
 
AFS:
 
(Dollars in thousands)
 
   U.S. government-sponsored agencies
    2     $ 44,189     $ 967       --     $ --     $ --  
   Municipal bonds
    2       491       4       --       --       --  
   Trust preferred securities
    1       2,655       1,204       --       --       --  
   MBS
    150       956,968       10,191       62       51,515       1,230  
      155     $ 1,004,303     $ 12,366       62     $ 51,515     $ 1,230  
                                                 
HTM:
                                               
   U.S. government-sponsored agencies
    1     $ 24,353     $ 647       --     $ --     $ --  
   Municipal bonds
    47       24,522       342       --       --       --  
   MBS
    42       417,400       5,004       30       166,807       3,621  
      90     $ 466,275     $ 5,993       30     $ 166,807     $ 3,621  

On a quarterly basis, management conducts a formal review of securities for the presence of OTTI.  Management assesses whether an OTTI is present when the fair value of a security is less than its amortized cost basis at the balance sheet date.  For such securities, OTTI is considered to have occurred if the Company intends to sell the security, if it is more likely than not the Company will be required to sell the security before recovery of its amortized cost basis or if the present values of expected cash flows is not sufficient to recover the entire amortized cost.

 
16

 



The unrealized losses are primarily a result of increases in market yields from the time of purchase.  In general, as market yields rise, the fair value of securities will decrease; as market yields fall, the fair value of securities will increase. Management generally views changes in fair value caused by changes in interest rates as temporary; therefore, these securities have not been classified as other-than-temporarily impaired.  Additionally, the impairment is also considered temporary because scheduled coupon payments have been made, it is anticipated that the entire principal balance will be collected as scheduled, and management neither intends to sell the securities and it is not more likely than not that the Company will be required to sell the securities before the recovery of the remaining amortized cost amount.

The amortized cost and estimated fair value of securities by remaining contractual maturity without consideration for call features or pre-refunding dates as of June 30, 2009 are shown below.  Actual maturities of MBS may differ from contractual maturities because borrowers have the right to call or prepay obligations, sometimes without penalties.  Maturities of MBS depend on the repayment characteristics and experience of the underlying financial instruments.
 
   
June 30, 2009
 
   
Available-For-Sale
   
Held-To-Maturity
 
         
Estimated
         
Estimated
 
   
Amortized
   
Fair
   
Amortized
   
Fair
 
   
Cost
   
Value
   
Cost
   
Value
 
   
(Dollars in thousands)
 
One year or less
  $ --     $ --     $ 194     $ 194  
One year through five years
    254,801       255,123       12,545       12,810  
Five years through ten years
    70,939       74,015       371,814       381,521  
Ten years and thereafter
    1,368,317       1,402,718       306,755       312,342  
    $ 1,694,057     $ 1,731,856     $ 691,308     $ 706,867  

 

 
Issuers of certain securities have the right to call and prepay obligations with or without prepayment penalties.  As of June 30, 2009, the amortized cost of the securities in our portfolio which are callable or have pre-refunding dates within one year totaled $206.2 million.  All dispositions of securities for the nine months ended June 30, 2009 and twelve months ended September 30, 2008 were the result of principal repayments, maturities, or calls.
As of June 30, 2009, the Bank had pledged AFS and HTM MBS as collateral with an amortized cost of $933.3 million and an estimated fair value of $960.0 million to the public unit depositors, repurchase agreement counterparties, and the Federal Reserve Bank.

6.   FHLB Advances

During the nine months ended June 30, 2009, the Bank prepaid $875.0 million of fixed-rate FHLB advances with a weighted average interest rate of 5.65% and a weighted average remaining term to maturity of 11 months.  The prepaid FHLB advances were replaced with $875.0 million of fixed-rate FHLB advances, with a weighted average contractual interest rate of 3.41% and an average term of 69 months.  The Bank paid a $38.4 million penalty to the FHLB as a result of prepaying the FHLB advances.  The prepayment penalty will be deferred and recognized in interest expense over the life of the new FHLB advances.  As a result, the prepayment penalty will effectively increase the interest rate on the new advances 96 basis points at the time of the transaction.  The benefit of the refinance will be recognized in the form of an immediate decrease in interest expense, and a decrease in interest rate sensitivity, as the maturities of the refinanced advances were extended at a lower rate.  In accordance with EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments”, the prepayment penalty was deferred as an adjustment to the carrying value of the new advances since the new FHLB advances were not “substantially different,” as defined within EITF 96-19, from the prepaid FHLB advances.  The present value of the cash flows under the terms of the new FHLB advances was not more than 10% different from the present value of the cash flows under the terms of the prepaid FHLB advances (including the prepayment penalty) and there were no embedded conversion options in the prepaid FHLB advances or in the new FHLB advances.  The following table presents the face value of FHLB advances and the maturities and rates for all FHLB advances outstanding at June 30, 2009.

 
17

 



         
Weighted
   
Weighted
 
   
FHLB
   
Average
   
Average
 
   
Advances
   
Contractual
   
Effective
 
Maturity by fiscal year
 
Amount
   
Rate
   
Rate(1)
 
                                                             (Dollars in thousands)
 
2009
  $ 20,000       5.09 %     5.09 %
2010
    350,000       4.49       4.49  
2011
    276,000       4.87       4.87  
2012
    350,000       3.35       3.35  
2013
    525,000       3.72       4.06  
2014
    450,000       3.14       3.90  
Thereafter
    475,000       3.67       4.28  
    $ 2,446,000       3.80 %     4.13 %

(1) The effective rate includes the net impact of the amortization of deferred prepayment penalties related to the prepayment of certain FHLB advances and deferred gains related to the termination of interest rate swaps during fiscal year 2008.

7.   Subsequent Events
 
Management has evaluated events and transactions that occurred after the balance sheet date of June 30, 2009 through August 4, 2009, the date the financial statements were available to be issued.  No material events or transactions which would require adjustments to or disclosures in the consolidated financial statements occurred during this period.
 

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

The Company and its wholly-owned subsidiary, the Bank, may from time to time make written or oral “forward-looking statements,” including statements contained in the Company’s filings with the SEC.  These forward-looking statements may be included in this Quarterly Report on Form 10-Q and the exhibits attached to it, in the Company’s reports to stockholders and in other communications by the Company, which are made in good faith by us pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements include statements about our beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors, some of which are beyond our control.  The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause our future results to differ materially from the plans, objectives, goals, expectations, anticipations, estimates and intentions expressed in the forward-looking statements:

·  
our ability to continue to maintain overhead costs at reasonable levels;
·  
our ability to continue to originate a significant volume of one- to four-family mortgage loans in our market area;
·  
our ability to acquire funds from or invest funds in wholesale or secondary markets;
·  
the future earnings and capital levels of the Bank, which could affect the ability of the Company to pay dividends in accordance with its dividend policies;
·  
fluctuations in deposit flows, loan demand, and/or real estate values, which may adversely affect our business;
·  
the credit risks of lending and investing 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 strength of the U.S. economy in general and the strength of the local economies in which we conduct operations;
·  
the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;
·  
the effects of, and changes in, foreign and military policies of the United States Government;

 
18

 



·  
inflation, interest rate, market and monetary fluctuations;
·  
our ability to access cost-effective funding;
·  
the timely development of and acceptance of our new products and services and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors’ products and services;
·  
the willingness of users to substitute competitors’ products and services for our products and services;
·  
our success in gaining regulatory approval of our products and services and branching locations, when required;
·  
the impact of changes in financial services laws and regulations, including laws concerning taxes, banking securities and insurance and the impact of other governmental initiatives affecting the financial services industry;
·  
implementing business initiatives may be more difficult or expensive than anticipated;
·  
technological changes;
·  
acquisitions and dispositions;
·  
changes in consumer spending and saving habits; and
·  
our success at managing the risks involved in our business

This list of important factors is not all inclusive.  We do not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company or the Bank.

As used in this Form 10-Q, unless we specify otherwise, “the Company,” “we,” “us,” and “our” refer to Capitol Federal Financial, a United States corporation. “Capitol Federal Savings,” and “the Bank,” refer to Capitol Federal Savings Bank, a federal savings bank and the wholly-owned subsidiary of Capitol Federal Financial. “MHC” refers to Capitol Federal Savings Bank MHC, a mutual holding company and majority-owner of Capitol Federal Financial.

The following discussion and analysis is intended to assist in understanding the financial condition and results of operations of the Company.  It should be read in conjunction with the consolidated financial statements and notes presented in this report.  The discussion includes comments relating to the Bank, since the Bank is wholly owned by the Company and comprises the majority of its assets and is the principal source of income for the Company.  This discussion and analysis should be read in conjunction with the management discussion and analysis included in the Company’s 2008 Annual Report on Form 10-K filed with the SEC.


Executive Summary

The following summary should be read in conjunction with our Management’s Discussion and Analysis of Financial Condition and Results of Operations in its entirety.

Our principal business consists of attracting deposits from the general public and investing those funds primarily in permanent loans secured by first mortgages on owner-occupied, one- to four-family residences.  We also originate consumer loans, loans secured by first mortgages on non-owner-occupied one- to four-family residences, construction loans secured by one- to four-family residences, commercial real estate loans, and multi-family real estate loans.  While our primary business is the origination of one- to four-family mortgage loans funded through retail deposits, we also purchase whole loans and invest in certain investment securities and MBS using FHLB advances and repurchase agreements as additional funding sources.

The Company is significantly affected by prevailing economic conditions including federal monetary and fiscal policies and federal regulation of financial institutions.  Deposit balances are influenced by a number of factors including interest rates paid on competing personal investment products, the level of personal income, and the personal rate of savings within our market areas.  Lending activities are influenced by the demand for housing and other loans, changing loan underwriting guidelines, as well as interest rate pricing competition from other lending institutions.  The primary sources of funds for lending activities include deposits, loan repayments, investment income, borrowings, and funds provided from operations.

The Company’s results of operations are primarily dependent on net interest income, which is the difference between the interest earned on loans, MBS, investment securities, and cash, and the interest paid on deposits and borrowings.  Net interest income is affected by the shape of the market yield curve, the re-pricing of interest-earning assets and interest-bearing liabilities on our balance sheet, and the prepayment rate on our loans and MBS as it relates to reinvestment opportunities.  On a weekly basis, management reviews deposit flows, loan demand, cash

19

levels, and changes in several market rates to assess all pricing strategies.  We generally price our loan and deposit products based upon an analysis of our competition and changes in market rates.  The Bank generally prices its first mortgage loan products based upon prices available in the secondary market while considering the demand for our products and our ability to service customers in a timely manner.  Generally, deposit pricing is based upon a survey of peers in the Bank’s market areas, and the need to attract funding and retain maturing deposits.  The majority of our loans are fixed-rate products with maturities up to 30 years, while the majority of our deposits have maturity or reprice dates of less than two years.

During the third quarter of fiscal year 2009, the national economy continued to contract due to an increase in unemployment and a general decline in household wealth.  The financial services industry as a whole continued to experience declines in credit quality and asset quality due largely to real estate devaluations and an increase in unemployment caused by the ongoing economic recession.  The Bank has not experienced the same magnitude of adverse operational impacts felt by many financial institutions; however, we are not immune to negative consequences arising from the economic recession and sharp downturn in the housing and real estate markets nationally.  We recorded a $3.1 million provision for loan losses during the current quarter.  The additional provision reflects an increase in our purchased loan loss factors in the formula analysis and purchased loan specific valuation allowances and accounts for charge-offs during the quarter, primarily related to purchased loans..  We have experienced an increase in the overall balance of non-performing loans, but the balance of our non-performing loans continues to remain at low levels relative to the size of our loan portfolio.

The Company recognized net income of $15.5 million for the quarter ended June 30, 2009, compared to net income of $18.1 million for the quarter ended March 31, 2009.  The decrease in net income between the periods was primarily due to the $3.8 million ($2.4 million on an after-tax basis) Federal Deposit Insurance Corporation (“FDIC”) special assessment at June 30, 2009 and a $1.3 million increase in the regular quarterly deposit insurance premiums. Recent bank failures have depleted the Deposit Insurance Fund (the “DIF”) below the required reserve ratio which resulted in the FDIC increasing deposit insurance premiums and charging a five basis point special assessment at June 30, 2009 based upon total assets less Tier 1 capital.  The authority for the FDIC to impose any additional special assessments terminates January 1, 2010.  See additional discussion regarding the FDIC assessments in the section entitled “Liquidity and Capital Resources.”

Since December 2008, mortgage rates have, at various points in time, declined to record lows in response to the Federal Reserve’s purchase of U.S. agency debt and MBS, which has spurred an increased demand for our loan modification program and mortgage refinances.  Additionally, originations during fiscal year 2009 have generally been at rates lower than the overall loan portfolio rate.  As a result of modifications and refinances, approximately 20% of our mortgage loan portfolio has repriced to lower market rates during fiscal year 2009.  Our loan modification program allows existing loan customers, whose loans have not been sold to third parties and who have been current on their contractual loan payments for the previous 12 months, the opportunity to modify their original loan terms to current loan terms being offered.   During fiscal year 2009, we have modified $1.07 billion and refinanced $207.3 million of our originated loans.  The weighted average interest rate reduction for the modified loans is approximately 88 basis points.  In an effort to mitigate the net interest income impact of the loan modifications, refinances and loan originations at rates lower than the overall portfolio, the Bank refinanced $875.0 million of FHLB advances during fiscal year 2009.  As a result of refinancing the FHLB advances, the Bank was able to lower its contractual interest rate on the refinanced advances by 224 basis points, from 5.65% to 3.41%.  See additional discussion regarding the FHLB advance refinance in “Notes to Financial Statements - Note 6 - FHLB Advances.”  Due to the positive gap position of the Bank, our interest-earning assets are repricing faster than our interest-bearing liabilities.  If interest rates were to increase, this would likely result in net interest income expansion in future periods as our interest-earning assets will reprice upward faster than our interest-bearing liabilities.

The Bank continues to maintain access to liquidity in excess of forecasted needs by diversifying its funding sources and maintaining a strong retail oriented deposit portfolio.  We believe the turmoil in the credit and equity markets has made deposit products in strong financial institutions, like the Bank, desirable for many customers.  In response to the economic recession, households have increased their personal savings rate which we believe has contributed to our growth in deposits during fiscal year 2009.  We believe that our strong capital position (the Bank’s tangible equity ratio at June 30, 2009 was 9.8% - see tangible equity to GAAP equity reconciliation in “Liquidity and Capital Resources – Regulatory Capital”), lending policies, and underwriting standards have helped position us to better withstand these adverse economic conditions.  In addition, the investments of the Bank are primarily government-agency backed securities which are highly liquid and have not been credit impaired, and are therefore available as collateral for additional borrowings or for sale if the need or unforeseen conditions warrant.  See additional discussion regarding liquidity in the section entitled “Liquidity and Capital Resources.”

In fiscal year 2009, the Bank has opened three branches in our market areas in Kansas City and Wichita, and has preliminary plans to open three additional branches in those same market areas during fiscal year 2010.

 
20

 




Available Information

Company and financial information, including press releases, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports can be obtained free of charge from our investor relations website, http://ir.capfed.com.  SEC filings are available on our website immediately after they are electronically filed with or furnished to the SEC, and are also available on the SEC’s website at www.sec.gov.


Critical Accounting Policies

Our most critical accounting policies are the methodologies used to determine the allowance for loan losses and other-than-temporary declines in the value of securities.  These policies are important to the presentation of our financial condition and results of operations, involve a high degree of complexity, and require management to make difficult and subjective judgments that may require assumptions or estimates about highly uncertain matters.  The use of different judgments, assumptions, and estimates could cause reported results to differ materially.  These critical accounting policies and their application are reviewed at least annually by our audit committee.  The following is a description of our critical accounting policies and an explanation of the methods and assumptions underlying their application.

Allowance for Loan Losses.  Management maintains an allowance for loan losses to absorb known and inherent losses in the loan portfolio based upon ongoing quarterly assessments of the loan portfolio.  Our methodology for assessing the appropriateness of the allowance for loan losses consists of a formula analysis for general valuation allowances and specific valuation allowances for identified problem loans and portfolio segments.  The allowance for loan losses is maintained through provisions for loan losses which are charged to income.  The provision for loan losses is established after considering the results of management’s quarterly assessment of the allowance for loan losses.
 
All loans that are not impaired, as defined in SFAS No. 114, “Accounting by Creditors for Impairment of a Loan, an Amendment of FASB Statements No. 5 and 15” and SFAS No. 118 “Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosures, an Amendment of FASB Statement No. 114,” are included in a formula analysis, as permitted by SFAS No. 5, “Accounting for Contingencies.”   Each quarter, the loan portfolio is segregated into categories in the formula analysis based upon certain risk characteristics such as loan type (one- to four-family, multi-family, etc.), interest payments (fixed-rate, adjustable-rate), loan source (originated or purchased), and payment status (i.e. current or number of days delinquent).  Loss factors are assigned to each category in the formula analysis based on management’s assessment of the potential risk inherent in each category.  The greater the risks associated with a particular category, the higher the loss factor.  Loss factors increase as individual loans become classified, delinquent, the foreclosure process begins or as economic and market conditions and trends warrant.
 
Management considers quantitative and qualitative factors when determining the appropriateness of the allowance for loan losses.  Such factors include changes in underwriting standards, the trend and composition of delinquent and non-performing loans, results of foreclosed property transactions, historical charge-offs, the current status and trends of local and national economies and housing markets, changes in interest rates, and loan portfolio growth and concentrations. Our allowance for loan loss methodology is applied in a consistent manner; however, the methodology can be modified in response to changing conditions.
 
The loss factors applied in the formula analysis are periodically reviewed by management to assess whether the factors adequately cover probable and estimable losses inherent in the loan portfolio.  The review considers such factors as the trends and composition of delinquent and non-performing loans, the results of foreclosed property transactions, and the status and trends of the local and national economies and housing markets.  Our allowance for loan loss methodology permits modifications to any loss factor used in the computation of the formula analysis in the event that, in management’s judgment, significant factors which affect the collectibility of the portfolio or any category of the loan portfolio, as of the evaluation date, are not reflected in the current loss factors.  Management’s evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with a specific problem loan or portfolio segments. As such, the amounts actually observed with respect to these losses can vary significantly from the estimated amounts. By assessing the estimated losses inherent in our loan portfolio on a quarterly basis, management can adjust specific and inherent loss estimates based upon more current information.


21

 
The Bank has been experiencing an increase in delinquencies, non-performing loans, net loan charge-offs and losses on foreclosed property transactions, primarily on purchased loans, as a result of the decline in housing and real estate markets, as well as the ongoing economic recession.  During the quarter ended March 31, 2009, management noted measurable differences in the performance and loss experience, with respect to the ultimate disposition of the underlying collateral, of our originated and purchased loan portfolios.  As a result, loss factors on 30-89 day delinquent loans were modified based on whether the loan is an originated or purchased loan.  The loss factors for purchased loans were modified higher than the loss factors associated with originated loans to account for the performance difference between the two portfolios.  Management believes this modification to the formula analysis will result in a more accurate estimate of the inherent losses in the 30-89 day delinquent loan portfolio.
 
Additionally, during the quarter ended March 31, 2009, the real estate market factors used to calculate estimated current loan-to-value (“LTV”) ratios in the formula analysis were modified as a result of management’s quarterly analysis.  The real estate market factors used in the formula analysis are based on a nationally recognized source of indices that management believes will more accurately reflect the current market value of the underlying collateral and therefore allocate loans to a more appropriate LTV category in the formula analysis. The factors are updated in the formula analysis each quarter to reflect current market activity.
 
Specific valuation allowances are established in connection with individual loan reviews of specifically identified problem loans and the asset classification process, including the procedures for impairment recognition under SFAS No. 114 and SFAS No. 118.  Evaluations of loans for which full collectability is not reasonably assured include evaluation of the estimated fair value of the underlying collateral based upon current appraisals, real estate broker values or listing prices.  Additionally, trends and composition of non-performing loans, results of foreclosed property transactions and current status and trends in economic and market conditions are also evaluated.  During the quarter ended March 31, 2009, management noted the updated estimated fair values obtained from loan servicers when a loan became 90 days delinquent were not always an accurate representation of the fair value of the collateral once it was sold.  The decline in fair value between the date the loan became 90 days delinquent and the time the property was sold was due to the continued decline in real estate values between those points in time, as it often takes several months for a loan to work through the foreclosure process.  As a result of the analysis, management began applying market value adjustments to non-performing purchased loans as of March 31, 2009 to more accurately estimate the fair values of the underlying collateral based upon recent trends.  The adjustments are determined based on the location of the underlying collateral, recent losses recognized on foreclosed property transactions and trends of non-performing purchased loans entering REO.  Specific valuations on non-performing loans were established if the adjusted estimated fair value was less than the current loan balance.  Management intends to evaluate the appropriateness of the market value adjustments each quarter.  The market value adjustments will continue to be applied to non-performing loans until the real estate markets and economy improve to such a level that the adjustments are no longer necessary.
 
Loans with an outstanding balance of $1.5 million or more are reviewed annually if secured by property in one of the following categories:  multi-family (five or more units) property, unimproved land, other improved commercial property, acquisition and development of land projects, developed building lots, office building, single-use building, or retail building.  Specific valuation allowances are established if the individual loan review determines a quantifiable impairment.
 
Assessing the adequacy of the allowance for loan losses is inherently subjective.  Actual results could differ from our estimates as a result of changes in economic or market conditions.  Changes in estimates could result in a material change in the allowance for loan losses.  In the opinion of management, the allowance for loan losses, when taken as a whole, is adequate to absorb reasonable estimated losses inherent in our loan portfolio.  However, future adjustments may be necessary if portfolio performance or economic or market conditions differ substantially from the conditions that existed at the time of the initial determinations.
 
Securities Impairment.  Management monitors the securities portfolio for OTTI on an ongoing basis and performs a formal review quarterly.  Management’s OTTI evaluation process conforms to the guidance contained in EITF 99-20 “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets”, FSP EITF 99-20-1 “Amendments to the Impairment Guidance of EITF Issue No. 99-20”, SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities”, FSP FAS 115-2 and FSP FAS 124-2 “Recognition and Presentation of Other-Than Temporary Impairments”.  The process involves monitoring market events and other items that could impact issuers.  The evaluation includes, but is not limited to such factors as:  the nature of the investment, the length of time the security has had a fair value less than the cost basis, the cause(s) and severity of the loss, expectation of an anticipated recovery period, recent events specific to the issuer or industry including the issuer’s financial condition and the current ability to make future payments in a timely manner, external credit ratings and recent downgrades in such ratings, the Company’s intent to sell and whether it is more likely than not the Company would be required to sell prior to recovery for debt securities and changes in estimated cash flows of MBS.
 
Management determines whether OTTI losses should be recognized for securities by assessing all known facts and circumstances surrounding the securities.  If the Company intends to sell a security or if it is more likely than not that the Company will be required to sell a security before recovery of its amortized cost basis, OTTI has occurred and the difference between amortized cost and fair value will be recognized as a loss in earnings.
 

 
22

 


If the Company does not intend to sell the security but also does not expect to recover the entire amortized cost basis of the security, an impairment loss would be recognized in earnings in the amount of the expected amortized cost basis that would not be collected (credit loss).  The remaining amount of OTTI would be recognized in other comprehensive income (loss).


Financial Condition

Total assets increased from $8.06 billion at September 30, 2008 to $8.32 billion at June 30, 2009.  The $264.0 million increase in assets was primarily attributed to a $221.0 million increase in loans receivable substantially due to loan purchases.  The growth in assets during fiscal year 2009 was primarily funded by growth in deposits.  Deposits increased from $3.92 billion at September 30, 2008 to $4.18 billion at June 30, 2009.  The $251.4 million increase was primarily in the certificate of deposit and money market portfolios.  Stockholders’ equity increased from $871.2 million at September 30, 2008 to $922.6 million at June 30, 2009.  The $51.4 million increase was due to net income of $49.5 million during fiscal year 2009 and an increase in accumulated other comprehensive gain (loss) of $29.5 million, partially offset by $33.6 million of dividend payments during fiscal year 2009.

The following table presents selected balance sheet data for the Company at the dates indicated.

   
Balance at
 
   
June 30,
   
March 31,
   
December 31,
   
September 30,
   
June 30,
 
   
2009
   
2009
   
2008
   
2008
   
2008
 
   
(Dollars in thousands, except per share amounts)
 
                               
Total assets
  $ 8,319,292     $ 8,269,881     $ 8,157,324     $ 8,055,249     $ 7,892,137  
Cash and cash equivalents
    74,101       52,025       143,134       87,138       86,437  
Investment securities
    322,166       214,410       105,965       142,359       144,346  
MBS
    2,100,998       2,204,369       2,176,302       2,234,339       2,066,685  
Loans receivable, net
    5,541,731       5,377,699       5,456,569       5,320,780       5,326,061  
Capital stock of FHLB
    132,071       131,278       131,230       124,406       129,172  
Deposits
    4,175,251       4,116,514       3,867,304       3,923,883       3,961,543  
Advances from FHLB
    2,410,949       2,411,560       2,596,964       2,447,129       2,547,294  
Other borrowings
    713,609       713,609       713,595       713,581       453,566  
Stockholders' equity
    922,634       916,391       897,435       871,216       863,906  
Accumulated other comprehensive gain (loss)
    23,512       24,622       14,263       (5,968 )     (5,202 )
Equity to total assets at end of period
    11.1 %     11.1 %     11.0 %     10.8 %     10.9 %
Bank tangible equity ratio (1)
    9.8     9.9 %     10.0 %     10.0 %     10.0 %
Book value per share
  $ 12.60     $ 12.52     $ 12.27     $ 11.93     $ 11.84  

(1) See tangible equity to GAAP equity reconciliation in “Liquidity and Capital Resources – Regulatory Capital”.

 
Loans Receivable.  The loans receivable portfolio increased $221.0 million from $5.32 billion at September 30, 2008 to $5.54 billion at June 30, 2009.  The increase was primarily a result of $191.6 million of loan purchases from nationwide lenders.  The loans purchased from nationwide lenders during fiscal year 2009 had an average credit score of 745 at the time of origination and a current weighted average LTV ratio of 50%.  The majority of the loans were seasoned loans and were originated in years outside of the years with peak real estate values and non-traditional underwriting standards.  Approximately 80% were originated in 2004 or earlier and approximately 20% were originated in 2008.  Additionally, states that have experienced historically high foreclosure rates were avoided.  We have not experienced any significant performance problems with this group of purchased loans.  See additional discussion regarding the underwriting standards for purchased loans in “Lending Practices and Underwriting Standards.”  At June 30, 2009 loans purchased from nationwide lenders represented 14% of our loan portfolio and were secured by properties located in each of the continental 48 states and Washington, D.C.  At June 30, 2009, purchases from nationwide lenders in the following states comprised 5% or greater of total loans purchased from nationwide lenders:  Illinois 13%; Florida, New York and Texas 7%; and Arizona 5%. As of June 30, 2009, the average balance of a purchased nationwide mortgage loan was approximately $370 thousand while the average balance of an originated mortgage loan was approximately $140 thousand.


23

 
Included in the loan portfolio at June 30, 2009 were $283.3 million of interest-only loans, which were primarily purchased from nationwide lenders during fiscal year 2005.  These loans do not typically require principal payments during their initial term, and have initial interest-only terms of either five or ten years.  At June 30, 2009, $275.2 million, or 97%, of these loans were still in their interest-only payment term.  As of June 30, 2009, $126.8 million will begin to amortize principal within two years, $17.1 million will begin to amortize principal within two-to-five years, $105.9 million will begin to amortize principal within five-to-seven years, and the remaining $25.4 million will begin amortizing in seven-to-ten years.  Loans of this type generally are considered to be of greater risk to the lender because of the possibility that the borrower may default once principal payments begin.  The loans had an average credit score of 737 and an average LTV ratio of 80% or less at the time of purchase.  The Bank has not purchased any interest-only loans since 2006.  At June 30, 2009, $12.0 million or approximately 40% of non-performing loans were interest-only.  Non-performing interest-only loans represent approximately 4% of the total interest-only portfolio at June 30, 2009.  See discussion regarding the allowance for loan losses in “Critical Accounting Policies – Allowance for Loan Losses.”

 
The following table presents loan origination, refinance and purchase activity for the periods indicated.  Loan originations, purchases and refinances are reported together.  The fixed-rate one- to four-family loans less than or equal to 15 years have an original maturity at origination of less than or equal to 15 years, while fixed-rate one- to four-family loans greater than 15 years have an original maturity at origination of greater than 15 years.  The adjustable-rate one- to four-family loans less than or equal to 36 months have a term to first reset of less than or equal to 36 months at origination and adjustable-rate one- to four-family loans greater than 36 months have a term to first reset of greater than 36 months at origination.

   
For the Three Months Ended
   
For the Three Months Ended
 
   
June 30, 2009
   
June 30, 2008
 
   
Amount
   
Rate
   
% of Total
   
Amount
   
Rate
   
% of Total
 
Fixed-Rate:
 
(Dollars in thousands)
 
   One- to four-family
                                   
      <= 15 years
  $ 108,316       4.67 %     26.69 %   $ 62,965       5.21 %     21.46 %
      > 15 years
    249,645       5.06       61.53       163,671       5.83       55.77  
   Other real estate
    2,547       6.25       0.63       675       6.50       0.23  
   Consumer
    3,044       7.73       0.75       3,996       8.03       1.36  
    Total fixed-rate
    363,552       4.98       89.60       231,307       5.70       78.82  
                                                 
Adjustable-Rate:
                                               
   One- to four-family
                                               
      <= 36 months
    434       4.63       0.11       4,220       5.21       1.44  
      > 36 months
    17,020       4.88       4.19       30,897       5.52       10.53  
   Other real estate
    --       --       --       1,800       6.00       0.61  
   Consumer
    24,742       4.82       6.10       25,234       5.84       8.60  
    Total adjustable-rate
    42,196       4.84       10.40       62,151       5.64       21.18  
                                                 
Total originations, refinances and purchases
  $ 405,748       4.96 %     100.00 %   $ 293,458       5.69 %     100.00 %
                                                 
Purchased loans included above:
                                               
Fixed-Rate:
                                               
    Correspondent
  $ 37,912       5.11 %           $ 18,209       5.51 %        
    Nationwide
    --       --               --       --          
Adjustable-Rate:
                                               
    Correspondent
    9,544       5.04               14,509       5.51          
    Nationwide
    --       --               --       --          
Total purchased loans
  $ 47,456       5.09 %           $ 32,718       5.51 %        


 
24

 



   
For the Nine Months Ended
   
For the Nine Months Ended
 
   
June 30, 2009
   
June 30, 2008
 
   
Amount
   
Rate
   
% of Total
   
Amount
   
Rate
   
% of Total
 
Fixed-Rate:
 
(Dollars in thousands)
 
   One- to four-family
                                   
      <= 15 years
  $ 212,217       4.83 %     18.89 %   $ 120,162       5.36 %     16.46 %
      > 15 years
    582,938       5.21       51.89       415,714       5.85       56.94  
   Other real estate
    14,483       5.99       1.29       975       6.58       0.13  
   Consumer
    8,439       7.68       0.75       15,081       8.13       2.07  
    Total fixed-rate
    818,077       5.15       72.82       551,932       5.81       75.60  
                                                 
Adjustable-Rate:
                                               
   One- to four-family
                                               
      <= 36 months
    138,958       4.92       12.37       22,266       5.33       3.05  
      > 36 months
    96,059       5.20       8.55       88,606       5.64       12.14  
   Other real estate
    --       --       --       1,800       6.00       0.25  
   Consumer
    70,298       4.91       6.26       65,430       7.02       8.96  
    Total adjustable-rate
    305,315       5.01       27.18       178,102       6.11       24.40  
                                                 
Total originations, refinances and purchases
  $ 1,123,392       5.11 %     100.00 %   $ 730,034       5.88 %     100.00 %
                                                 
Purchased loans included above:
                                               
Fixed-Rate:
                                               
    Correspondent
  $ 84,887       5.25 %           $ 40,486       5.77 %        
    Nationwide
    256       4.38               --       --          
Adjustable-Rate:
                                               
    Correspondent
    20,643       5.28               54,456       5.64          
    Nationwide
    191,313       5.00               155       5.38          
Total purchased loans
  $ 297,099       5.09 %           $ 95,097       5.69 %        


Loan modification activity is not included in the tables above because a new loan is not generated at the time of modification.  During the three and nine months ended June 30, 2009, the Bank modified $477.5 million and $1.07 billion loans, respectively, with a weighted average rate change of 92 basis points and 88 basis points, respectively.
 
The Bank generally prices its one- to four-family loan products based upon prices available in the secondary market.  During the nine months ended June 30, 2009, the rate on the Bank’s 30-year fixed-rate one- to four-family loans, with no points paid by the borrower, was approximately 230 basis points above the average 10-year Treasury rate, while the rate on the Bank’s 15-year fixed-rate one- to four-family loans were approximately 190 basis points above the average 10-year Treasury rate.
 

 
25

 

The following table summarizes the activity in the loan portfolio for the periods indicated, excluding changes in loans in process, deferred fees and allowance for loan losses.  Loans that were paid-off as a result of refinances are included in ‘repayments.’  Loan modification activity is not included in the activity in the following table because a new loan is not generated at the time of modification.  See modification activity for the three and nine months ended June 30, 2009 on the previous page.  The modified balance and rate are included in the ending loan portfolio balance and rate.

   
For the Three Months Ended
 
   
June 30, 2009
 
March 31, 2009
 
December 31, 2008
   
September 30, 2008
 
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
 
   
(Dollars in thousands)
 
Beginning balance
  $ 5,422,798       5.50 %   $ 5,506,352       5.63 %   $ 5,379,845       5.66 %   $ 5,389,901       5.63 %
Originations and refinances:
                                                               
  Fixed
    325,640       4.96       276,888       5.06       130,406       5.77       140,565       6.08  
  Adjustable
    32,652       4.78       25,269       4.83       35,437       5.23       45,333       5.69  
Purchases:
                                                               
  Fixed
    37,912       5.11       33,226       5.18       14,005       5.76       7,309       6.12  
  Adjustable
    9,544       5.04       70,349       4.90       132,064       5.09       17,225       5.76  
Repayments
    (322,104 )             (311,733 )             (183,532 )             (216,090 )        
Transfer of modified loans from
  (to) LHFS, net
    81,190               (175,862 )             --               --          
Other (1)
    (502 )             (1,691 )             (1,873 )             (4,398 )        
Ending balance
  $ 5,587,130       5.36 %   $ 5,422,798       5.50 %   $ 5,506,352       5.63 %   $ 5,379,845       5.66 %
                                                                 
   
For the Nine Months Ended
                               
   
June 30, 2009
 
June 30, 2008
                               
   
Amount
   
Rate
   
Amount
   
Rate
                                 
   
(Dollars in thousands)
                               
Beginning balance
  $ 5,379,845       5.66 %   $ 5,346,626       5.68 %                                
Originations and refinances:
                                                               
  Fixed
    732,934       5.14       511,446       5.81                                  
  Adjustable
    93,359       4.97       123,491       6.32                                  
Purchases:
                                                               
  Fixed
    85,143       5.24       40,486       5.77                                  
  Adjustable
    211,956       5.02       54,611       5.64                                  
Repayments
    (817,369 )             (683,088 )                                        
Transfer of modified loans from
  (to) LHFS, net
    (94,672 )             --                                          
Other(1)
    (4,066 )             (3,671 )                                        
Ending balance
  $ 5,587,130       5.36 %   $ 5,389,901       5.66 %                                
(1) “Other” consists of transfers to REO and modification fees advanced.

 


26

 
The following table presents the Company’s loan portfolio at the dates indicated.
 
   
June 30, 2009
   
March 31, 2009
   
September 30, 2008
 
   
Amount
   
Average
Rate
   
% of
Total
   
Amount
   
Average
Rate
   
% of
Total
   
Amount
   
Average
 Rate
   
% of
Total
 
   
(Dollars in thousands)
 
Real Estate Loans
                                                     
     One- to four-family
  $ 5,257,195       5.34 %     94.09 %   $ 5,085,227       5.49 %     93.77 %   $ 5,026,358       5.61 %     93.43 %
     Multi-family and commercial
    84,358       6.01       1.51       67,278       6.30       1.24       56,081       6.44       1.04  
     Construction and development
    41,429       5.19       0.74       63,823       5.28       1.18       85,178       5.66       1.58  
          Total real estate loans
    5,382,982       5.35       96.34       5,216,328       5.50       96.19       5,167,617       5.62       96.05  
                                                                         
Consumer Loans
                                                                       
     Savings loans
    4,832       5.52       0.09       4,524       5.65       0.08       4,634       5.95       0.09  
     Automobile
    2,877       6.96       0.05       3,083       6.96       0.06       3,484       7.00       0.07  
     Home equity
    195,458       5.64       3.50       197,939       5.67       3.65       202,956       6.53       3.77  
     Other
    981       7.97       0.02       924       8.27       0.02       1,154       7.13       0.02  
          Total consumer loans
    204,148       5.67       3.66       206,470       5.70       3.81       212,228       6.52       3.95  
Total loans receivable
    5,587,130       5.36 %     100.00 %     5,422,798       5.50 %     100.00 %     5,379,845       5.66 %     100.00 %
                                                                         
Less:
                                                                       
     Loans in process
    23,740                       27,058                       43,186                  
     Deferred fees and discounts
    11,417                       10,577                       10,088                  
     Allowance for loan losses
    10,242                       7,464                       5,791                  
          Total loans receivable, net
  $ 5,541,731                     $ 5,377,699                     $ 5,320,780                  


 

 
27

 

Lending Practices and Underwriting Standards

The Bank’s primary lending activity is the origination of loans and the purchase of loans from a select group of correspondent lenders.  These loans are generally secured by first mortgages on owner-occupied, one- to four-family residences in the Bank’s primary market areas and select market areas in Missouri.  The Bank also makes consumer loans, construction loans secured by residential or commercial properties, and multi-family real estate loans secured by multi-family dwellings.  Additional lending volume has been generated by purchasing whole one- to four-family mortgage loans from nationwide lenders.  By purchasing loans from nationwide lenders, the Bank is able to attain some geographic diversification in its loan portfolio, and help mitigate the Bank’s interest rate risk exposure as the purchased loans are predominately adjustable-rate or 15-year fixed-rate loans.  As a result of the decline in real estate values and the economic recession, particularly in some of the states where we have purchased loans, we have experienced an increase in non-performing purchased loans.  At the time these loans were purchased, they met our underwriting standards; however, some are located in areas that have recently experienced high unemployment rates and sharp declines in real estate values.  See additional discussion regarding non-performing purchased loans in “Critical Accounting Policies – Allowance for Loan Losses” and “Asset Quality.”  The loans purchased during fiscal year 2009 had an average credit score of 745 and a current weighted average LTV ratio of 50%.  We have not experienced any significant performance problems with this group of purchased loans.  See additional discussion regarding loans purchased during fiscal year 2009 in “Financial Condition – Loans Receivable.”

The Bank’s one- to four-family loans are primarily fully amortizing fixed- or adjustable-rate loans with contractual maturities of up to 30 years, except for interest-only loans which require the payment of interest during the interest-only period, all with payments due monthly.  Our one- to four- family loans are generally not assumable and do not contain prepayment penalties.  A “due on sale” clause, allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the secured property, is generally included in the security instrument.

Current adjustable-rate one- to four-family loans originated by the Bank generally provide for a specified rate limit or cap on the periodic adjustment to the interest rate, as well as a specified maximum lifetime cap and minimum rate, or floor.  As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as our cost of funds. Negative amortization of principal is not allowed.  Borrowers are qualified based on the principal, interest, taxes and insurance payments at the initial rate for three, five and seven year adjustable-rate mortgage (“ARM”) loans.  After the initial three, five or seven year period, the interest rate is repriced annually and the new principal and interest payment is based on the new interest rate, remaining unpaid principal balance and term of the ARM loan.  Our ARM loans are not automatically convertible into fixed-rate loans; however, we do allow borrowers to pay a modification fee to convert an ARM loan to a fixed-rate loan.  ARM loans can pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower’s payment also rises, increasing the potential for default.  This specific risk type is known as repricing risk.

During 2008, the Bank discontinued offering an interest-only ARM product, but holds in its portfolio originated and purchased interest-only ARM loans.  The product was discontinued to reduce future credit risk exposure.  At the time of origination, these loans did not require principal payments for a period of up to ten years.  Borrowers were qualified based on a fully amortizing payment at the initial loan rate.  The Bank was more restrictive on debt-to-income ratios and credit scores on interest-only ARM loans than on other ARM loans to offset the potential risk of payment shock at the time the loan rate adjusts and/or the principal and interest payments begin.   At June 30, 2009, 5% of our loan portfolio consisted of non-amortizing interest-only ARM loans.  The majority of these loans were purchased from nationwide lenders during fiscal year 2005.  These loans had an initial interest-only term of either five or ten years, with approximately equal distribution between the two terms.

One- to four-family loans are underwritten manually or by an automated underwriting system developed by a third party.  The system’s components closely resemble the Bank’s manual underwriting standards which are generally in accordance with Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”) underwriting guidelines.  The automated underwriting system analyzes the applicant’s data, with emphasis on credit history, employment and income history, qualifying ratios reflecting the applicant’s ability to repay, asset reserves, and loan-to-value ratio.   Full documentation to support the applicant’s credit, income, and sufficient funds to cover all applicable fees and reserves at closing are required on all loans. Loans that do not meet the automated underwriting standards are referred to a staff underwriter for manual underwriting.    Properties securing one- to four-family loans are appraised by either staff appraisers or fee appraisers, both of which are independent of the loan origination function and have been approved by the board of directors.

For loans with an LTV ratio in excess of 80% at the time of origination, private mortgage insurance (“PMI”) is required in order to reduce the Bank’s loss exposure to less than 80% of the appraised value or the purchase price of the property.  The Bank will lend up to 97% of the lesser of the appraised value or purchase price for one- to four-family loans provided the Bank is able to obtain PMI.  Management continuously monitors the claim paying ability of our PMI counterparties.  At this time, we believe that our PMI counterparties have the ability to meet potential claim obligations we may file in the foreseeable future.

 
28

 



The underwriting standards of the lenders from whom the Bank purchases loans are generally similar to the Bank’s internal underwriting standards.  “No Doc” or “Stated Income, Stated Assets” loans are not permitted.  Lenders are required to fully document all data sources for each application.  Management believes these requirements reduce the credit risk associated with these loans.  Before committing to purchase a pool of loans from a nationwide lender, the Bank’s Chief Lending Officer or Secondary Marketing Manager reviews specific criteria such as loan amount, credit scores, LTV ratios, geographic location, and debt ratios of each loan in the pool.  If the specific criteria do not meet the Bank’s underwriting standards and compensating factors are not sufficient, then a loan will be removed from the pool.  Once the review of the specific criteria is complete and loans not meeting the Bank’s standards are removed from the pool, changes are sent back to the lender for acceptance and pricing.  Before the pool is funded, an approved Bank underwriter reviews at least 25% of the loan files and the supporting documentation in the pool.  Our standard contractual agreement with the lender includes recourse options for any breach of representation or warranty with respect to the loans purchased.

The underwriting of loans purchased through correspondent lenders is generally performed by our underwriters, using our underwriting standards.  The products offered by the correspondents are at least as restrictive as the Bank’s own internal products and underwriting standards.  Correspondent lenders are located within the metropolitan Kansas City market area and select market areas in Missouri.  The Bank purchases approved loans and the related servicing rights, on a loan-by-loan basis.

In an effort to offset the impact of repayments and to retain our customers, the Bank offers existing loan customers whose loans have not been sold to third parties the opportunity to modify their original loan terms to new loan terms generally consistent with those currently being offered.  This is a convenient tool for customers who may have considered refinancing from an ARM loan to a fixed-rate loan, would like to reduce their term, or take advantage of lower rates associated with current market rates.  The program helps ensure the Bank maintains the relationship with the customer and significantly reduces the amount of effort required for customers to obtain current market pricing and terms without having to refinance their loans.  The Bank charges a fee for this service generally comparable to fees charged on new loans.  The Bank does not solicit customers for this program, but considers it a valuable opportunity to retain customers who, due to our strict initial underwriting, could likely obtain similar financing elsewhere.

The Bank also originates construction-to-permanent loans primarily secured by one- to four-family residential real estate.  Presently, all of the one- to four-family construction loans are secured by property located within the Bank’s market areas.  Construction loans are obtained primarily by homeowners who will occupy the property when construction is complete.  The Bank is also a participant with five other banking institutions on a construction loan secured by a retail shopping center in Kansas with two major retailers.  Construction loans to builders for speculative purposes are not permitted.  The application process includes submission of complete plans, specifications, and costs of the project to be constructed.  These items are used as a basis to determine the appraised value of the subject property.  All construction loans are manually underwritten using the Bank’s internal underwriting standards.  The construction and permanent loans are closed at the same time allowing the borrower to secure the interest rate at the beginning of the construction period and throughout the permanent loan.  Construction draw requests and the supporting documentation are reviewed and approved by management.  The Bank also performs regular documented inspections of the construction project to ensure the funds are being used for the intended purpose and the project is being completed according to the plans and specifications provided.

The Bank offers a variety of secured consumer loans, including home equity loans and lines of credit, home improvement loans, auto loans, and loans secured by savings deposits.  The Bank also originates a very limited amount of unsecured loans.  The Bank does not originate any consumer loans on an indirect basis, such as contracts purchased from retailers of goods or services which have extended credit to their customers.  All consumer loans are originated in the Bank’s market areas.  Home equity loans may be originated in amounts, together with the amount of the existing first mortgage, of up to 95% of the value of the property securing the loan.  In order to minimize risk of loss, home equity loans that are greater than 80% of the value of the property, when combined with the first mortgage, require PMI.  The term-to-maturity of home equity and home improvement loans may be up to 20 years.  Other home equity lines of credit have no stated term-to-maturity and require a payment of 1.5% of the outstanding loan balance per month. Interest-only home equity lines of credit have a maximum term of 12 months, monthly payments of accrued interest, and a balloon payment at maturity.  Repaid principal may be re-advanced at any time, not to exceed the original credit limit of the loan.  Other consumer loan terms vary according to the type of collateral and the length of the contract.  The majority of the consumer loan portfolio is comprised of home equity lines of credit, which have interest rates that can adjust monthly based upon changes in the prime rate, to a maximum of 18%.

The underwriting standards for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of their 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 in relation to the proposed loan amount.

 
29

 



Consumer loans generally have shorter terms to maturity or reprice more frequently, which reduces our exposure to changes in interest rates, and usually carry higher rates of interest than do one- to four-family mortgage loans.  However, consumer loans may entail greater risk than do one- to four-family mortgage loans, particularly in the case of consumer loans that are secured by rapidly depreciable assets, such as automobiles.  Management believes that offering consumer loan products helps to expand and create stronger ties to our existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities.

The Bank’s multi-family and commercial real estate loans are secured primarily by multi-family dwellings and small commercial buildings generally located in the Bank’s market areas.  These loans are granted based on the income producing potential of the property and the financial strength of the borrower.  LTV ratios on multi-family and commercial real estate loans usually do not exceed 80% of the appraised value of the property securing the loans.  The net operating income, which is the income derived from the operation of the property less all operating expenses, must be sufficient to cover the payments related to the outstanding debt at the time of origination.  The Bank generally requires personal guarantees of the borrowers covering a portion of the debt in addition to the security property as collateral for these loans.  Appraisals on properties securing these loans are performed by independent state certified fee appraisers approved by the board of directors.  Our multi-family and commercial real estate loans are originated with either a fixed or adjustable interest rate.  The interest rate on adjustable-rate loans is based on a variety of indices, generally determined through negotiation with the borrower.  While maximum maturities may extend to 30 years, these loans frequently have shorter maturities and may not be fully amortizing, requiring balloon payments of unamortized principal at maturity.

Our multi-family and commercial real estate loans are generally large dollar loans and involve a greater degree of credit risk than one- to four-family mortgage loans.  Such loans typically involve large balances to single borrowers or groups of related borrowers.  Because payments on multi-family and commercial real estate loans are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy.  If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired.  See “Asset Quality – Non-performing Loans.”

Loans over $500 thousand must be underwritten by two Class V underwriters, which is the highest class of underwriter.  Any loan greater than $750 thousand must be approved by the Asset and Liability Management Committee (“ALCO”) and loans over $1.5 million must be approved by the board of directors.  For loans requiring ALCO and/or board of directors’ approval, lending management is responsible for presenting to the ALCO and/or board of directors information about the creditworthiness of the borrower and the value of the subject property.  Information pertaining to the creditworthiness of the borrower generally consists of a summary of the borrower’s credit history, employment stability, sources of income, assets, net worth, and debt ratios.  The value of the property must be supported by an independent appraisal report prepared in accordance with our appraisal policy.  Loans over $500 thousand are priced above the standard mortgage rate.

 
30

 


 
Asset Quality
 
The Bank’s traditional underwriting guidelines have provided the Bank with loans of high quality and generally low delinquencies and low levels of non-performing assets compared to national levels.  Of particular importance is the complete documentation required for each loan the Bank originates and purchases.  This allows the Bank to make an informed credit decision based upon a thorough assessment of the borrower’s ability to repay the loan compared to underwriting methodologies that do not require full documentation.

The following matrix shows the balance of one-to four-family mortgage loans cross-referenced by LTV ratio and credit score.  The LTV ratios used in the matrix were based on the current loan balance and the most recent bank appraisal available, or the lesser of the purchase price or original appraisal.  In most cases, the most recent appraisal was obtained at the time of origination.  The LTV ratios based upon appraisals obtained at the time of origination may not necessarily indicate the extent to which we may incur a loss on any given loan that may go into foreclosure as the value of the underlying collateral may have declined since the time of origination.  Credit scores were updated in March 2009 for loans originated by the Bank and purchased loans.  Management will continue to update credit scores as deemed necessary based upon economic conditions.  Per the matrix, the greatest concentration of loans fall into the “751 and above” credit score category and have a LTV ratio of less than 70%.  The loans falling into the “less than 660” credit score category and having LTV ratios of more than 80% comprise the lowest concentration.  The average LTV ratio of our one-to four-family mortgage loans at June 30, 2009 was approximately 65%.

   
Credit Score
 
   
Less than 660
   
661 to 700
   
701 to 750
   
751 and above
 
Total
 
         
% of
         
% of
         
% of
         
% of
         
% of
 
LTV ratio
 
Amount
   
total
   
Amount
   
total
   
Amount
   
total
   
Amount
   
total
   
Amount
   
total
 
   
(Dollars in thousands)
 
Less than 70%
  $ 127,680       2.4 %   $ 152,523       2.9 %   $ 443,595       8.4 %   $ 1,922,397       36.6 %   $ 2,646,195       50.3 %
70% to 80%
    111,095       2.1       133,726       2.6       393,592       7.5       1,189,697       22.6       1,828,110       34.8  
More than 80%
    78,878       1.5       79,922       1.5       213,623       4.1       410,467       7.8       782,890       14.9  
Total
  $ 317,653       6.0 %   $ 366,171       7.0 %   $ 1,050,810       20.0 %   $ 3,522,561       67.0 %   $ 5,257,195       100.0 %

 
31

 



The following table presents the Company’s 30 to 89 day delinquent loans, non-performing loans, and REO at the dates indicated.  Purchased loans include loans purchased from nationwide lenders.  Non-performing loans consist of loans 90 or more days delinquent and loans in the process of foreclosure.  Non-performing assets include non-performing loans and REO.
   
June 30,
   
March 31,
   
December 31,
   
September 30,
   
June 30,
 
   
2009
   
2009
   
2008
   
2008
   
2008
 
   
Number
   
Amount
   
Number
   
Amount
   
Number
   
Amount
   
Number
   
Amount
   
Number
   
Amount
 
   
(Dollars in thousands)
 
Loans 30-89 days delinquent
                                                           
  Originated
    193     $ 13,825       157     $ 14,120       199     $ 15,691       179     $ 14,026       160     $ 12,591  
  Purchased
    49       13,225       43       9,698       42       9,359       37       7,083       33       6,621  
      242       27,050       200       23,818       241       25,050       216       21,109       193       19,212  
Non-performing loans
                                                                               
  Originated
    144       11,840       128       10,213       124       9,607       100       6,958       89       6,555  
  Purchased
    59       17,270       45       12,158       32       9,625       25       6,708       26       6,699  
      203       29,110       173       22,371       156       19,232       125       13,666       115       13,254  
REO
                                                                               
  Originated
    36       3,950       48       4,119       38       2,833       36       2,228       31       1,274  
  Purchased
    5       1,127       10       1,705       6       1,644       12       2,918       5       933  
      41       5,077       58       5,824       44       4,477       48       5,146       36       2,207  
                                                                                 
Non-performing assets
                                                                               
   as a percentage of total assets
            0.41 %             0.34 %             0.29 %             0.23 %             0.20 %
Non-performing loans
                                                                               
   as a percentage of total loans
            0.53 %             0.42 %             0.35 %             0.26 %             0.25 %



Loans 30 to 89 days delinquent increased $6.0 million from $21.1 million at September 30, 2008 to $27.1 million at June 30, 2009.   Of the 30-89 day purchased loans at June 30, 2009, approximately 50% are concentrated in Arizona, Nevada, Texas, and Illinois, with the remaining 50% spread across 19 other states. During the past three quarters, on average, approximately 30% of loans that entered the 30 to 89 days delinquent category made their required loan payments and did not go back into the 30-89 day delinquent category or paid off during this time period.  During the same time period, on average, approximately 40% of loans that entered the 30 to 89 days delinquent category made a portion of their required loan payments but the loans either stayed in the 30 to 89 day delinquent category because not all required loan payments were made or went back into the 30-89 day delinquent category at some point during the noted time period as the borrower once again became delinquent on their loan payments.  Approximately 30% of the loans that entered the 30-89 days delinquent category during the past three quarters progressed to the non-performing loan or REO categories.

Non-performing loans increased $15.4 million from $13.7 million at September 30, 2008 to $29.1 million at June 30, 2009.  Of the purchased non-performing loans at June 30, 2009, approximately 45% are concentrated in Arizona and Florida, with the remaining 55% spread across 18 other states.  The increase in non-performing loans reflects the economic recession coupled with the continued deterioration of the housing market, particularly in some of the states in which we have purchased loans.  The deteriorating conditions in the housing market are evidenced by declining house prices, fewer home sales, increasing inventories of houses on the market and an increase in the length of time houses remain on the market.  The increase in non-performing loans increased our ratio of non-performing loans to total loans from 0.26% as of September 30, 2008 to 0.53% at June 30, 2009.

 
32

 


At June 30, 2009, one-to four-family non-performing loans with LTV ratios greater than 80% comprised approximately 20% of total non-performing loans.  Of these loans, approximately 70% have PMI which substantially reduces or eliminates the Bank’s exposure to loss.  The balance of one-to four-family non-performing loans with LTV ratios greater than 80% with no PMI was $1.5 million at June 30, 2009.  At origination, these loans had LTV ratios less than 80%, but as a result of updating the appraisals, the LTV ratios are now in excess of 80%.

Management maintains an allowance for loan losses to absorb known and inherent losses in the loan portfolio based on ongoing quarterly assessments of the loan portfolio.  Our allowance for loan loss methodology considers a number of quantitative and qualitative factors, including the trend and composition of our delinquent and non-performing loans, results of foreclosed property transactions, and the status and trends of the local and national economies and housing markets.  See “Critical Accounting Policies – Allowance for Loan Losses.”  The $3.1 million provision for loan loss recorded in the current quarter reflects an increase in our purchased loan loss factors in the formula analysis and purchased loan specific valuation allowances and accounts for charge-offs during the quarter, primarily related to purchased loans.  The purchase loan loss factors and specific valuation allowances were increased in the current quarter due to deterioration in purchased loan delinquency loan trends and an increase in losses associated with foreclosed property transactions.  Although management believes the allowance for loan losses is established and maintained at adequate levels, additions may be necessary if future economic or other conditions differ substantially from the current operating environment.

The following table presents the Company’s activity for the allowance for loan losses and related ratios at the dates and for the periods indicated.
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
June 30,
   
March 31,
   
June 30,
   
June 30,
 
   
2009
   
2009
   
2008
   
2009
   
2008
 
   
(Dollars in thousands)
 
Beginning balance
  $ 7,464     $ 6,137     $ 4,250     $ 5,791     $ 4,181  
Charge-offs:
                                       
  One- to four-family loans-originated
    35       12       9       57       39  
  One- to four-family loans-purchased
    293       766       124       1,241       124  
  Multi-family loans
    --       --       --       --       --  
  Commercial and other loans
    --       --       --       --       --  
  Consumer loans
    6       2       8       19       28  
    Total charge-offs
    334       780       141       1,317       191  
  Recoveries
    --       --       --       --       --  
  Provision charged to expense
    3,112       2,107       1,602       5,768       1,721  
Ending balance
  $ 10,242     $ 7,464     $ 5,711     $ 10,242     $ 5,711  
                                         
ALLL to non-performing loans
                                       
  at period end
    35.18 %     33.36 %     43.09 %                
ALLL to loans receivable, net
                                       
  at period end
    0.18 %     0.14 %     0.11 %                

Historically, our charge-offs have been low due to our low level of non-performing loans and the amount of underlying equity in the properties collateralizing one-to four family loans.  The increase in non-performing purchased loans and the decline in real estate and housing markets have begun to result in higher charge-offs, specifically related to purchased loans.  However, the overall amount of charge-offs has not been significant because of our strict underwriting standards and the relative economic stability of the geographic areas in which the Bank originates loans.

 
33

 


The following table presents the Company’s allocation of the allowance for loan losses to each respective loan category at June 30, 2009 and September 30, 2008.

   
At
   
At
 
   
June 30, 2009
   
September 30, 2008
 
   
Amount of
   
% of ALLL
   
Total
   
% of Loans
   
Amount of
   
% of ALLL
   
Total
   
% of Loans
 
   
ALLL
   
to Total ALLL
   
Loans
   
to Total Loans
   
ALLL
   
to Total ALLL
   
Loans
   
to Total Loans
 
   
(Dollars in thousands)
 
One- to four-family:
                                               
  Originated
  $ 3,647       35.6 %   $ 4,504,219       80.6 %   $ 3,076       53.2 %   $ 4,302,870       80.0 %
  Purchased
    6,183       60.4       752,976       13.5       2,307       39.8       723,488       13.5  
Multi-family and commercial
    73       0.7       84,358       1.5       53       0.9       56,081       1.0  
Construction and development
    25       0.2       41,429       0.7       41       0.7       85,178       1.6  
Consumer
    314       3.1       204,148       3.7       314       5.4       212,228       3.9  
    $ 10,242       100.0 %   $ 5,587,130       100.0 %   $ 5,791       100.0 %   $ 5,379,845       100.0 %



 
34

 


Mortgage-Backed Securities.  The balance of MBS decreased $133.3 million from $2.23 billion at September 30, 2008 to $2.10 billion at June 30, 2009.  The decrease was due to maturities and repayments not being replaced in their entirety; rather, some of the funds were used to purchase short-term investment securities.  The following tables provide a summary of the activity in our portfolio of MBS for the periods presented.  The yields and weighted average life (“WAL”) for purchases are presented as recorded at the time of purchase.  The yields for the beginning and ending balances are as of the period presented and are generally derived from recent prepayment activity on the securities in the portfolio as of the dates presented.  The decrease in the yield at June 30, 2009 compared to September 30, 2008 was due to repricing and to the purchase of securities with yields lower than the existing portfolio due to a decline in market rates.  The beginning and ending WAL is the estimated remaining maturity after historical prepayment speeds have been applied.  The decrease in the WAL at June 30, 2009 compared to September 30, 2008 was due to purchases with a WAL less than the existing portfolio and an increase in prepayment speeds.

   
For the Three Months Ended
 
   
June 30, 2009
   
March 31, 2009
   
December 31, 2008
   
September 30, 2008
 
   
Amount
   
Yield
   
WAL
   
Amount
   
Yield
   
WAL
   
Amount
   
Yield
   
WAL
   
Amount
   
Yield
   
WAL
 
   
(Dollars in thousands)
 
Beginning balance
  $ 2,204,369       4.72 %     5.55     $ 2,176,302       4.82 %     5.81     $ 2,234,339       4.82 %     5.05     $ 2,066,685       4.76 %     4.32  
Maturities and repayments
    (155,168 )                     (107,388 )                     (90,194 )                     (112,777 )                
Net amortization of premiums/discounts
    (189 )                     46                       27                       23                  
Purchases:
                                                                                               
  Fixed
    3,217       4.34       8.49       --       --       --       --       --       --       60,137       5.03       4.48  
  Adjustable
    50,983       2.83       3.58       118,469       2.68       1.90       --       --       --       219,888       4.99       5.07  
Change in valuation on AFS securities
    (2,214 )                     16,940                       32,130                       383                  
Ending balance
  $ 2,100,998       4.59 %     4.55     $ 2,204,369       4.72 %     5.55     $ 2,176,302       4.82 %     5.81     $ 2,234,339       4.82 %     5.05  
                                                                                                 
   
For the Nine Months Ended
                                                 
   
June 30, 2009
   
June 30, 2008
                                                 
   
Amount
   
Yield
   
WAL
   
Amount
   
Yield
   
WAL
                                                 
   
(Dollars in thousands)
                                                 
Beginning balance
  $ 2,234,339       4.82 %     5.05     $ 1,414,271       4.46 %     4.04                                                  
Maturities and repayments
    (352,750 )                     (387,301 )                                                                
Net amortization of premiums/discounts
    (116 )                     (770 )                                                                
Purchases:
                                                                                               
  Fixed
    3,217       4.34       8.49       725,044       4.93       4.63                                                  
  Adjustable
    169,452       2.73       2.41       325,286       4.68       4.80                                                  
Change in valuation on AFS securities
    46,856                       (9,845 )                                                                
Ending balance
  $ 2,100,998       4.59 %     4.55     $ 2,066,685       4.76 %     4.32                                                  
                                                                                                 



 
35

 



Investment Securities.  Investment securities, which consist primarily of agency bonds (primarily issued by FNMA, FHLMC, or FHLB) and municipal investments, increased $179.8 million from $142.4 million at September 30, 2008 to $322.2 million at June 30, 2009.  The increase was due to purchases of short-term securities.  If market rates were to rise, the short-term nature of these securities may allow management the opportunity to reinvest the maturing funds at a yield higher than current yields.  The following tables provide a summary of the activity of investment securities for the periods presented.  The yields for the beginning and ending balances are as of the periods presented.  The decrease in the yield at June 30, 2009 compared to September 30, 2008 was a result of calls and/or maturities of securities with yields higher than the overall portfolio yield and to purchases of investment securities with yields lower than the existing portfolio.  The beginning and ending WAL represent the estimated remaining maturity of the securities after projected call dates have been considered, based upon market rates at each date presented.  The decrease in the WAL at June 30, 2009 compared to September 30, 2008 was due to issuers of certain securities in the portfolio exercising their option to call the security, to maturing securities, and to purchases of investment securities with WALs shorter than the portfolio.

   
For the Three Months Ended
 
   
June 30, 2009
   
March 31, 2009
   
December 31, 2008
   
September 30, 2008
 
   
Amount
   
Yield
   
WAL
   
Amount
   
Yield
   
WAL
   
Amount
   
Yield
   
WAL
   
Amount
   
Yield
   
WAL
 
   
(Dollars in thousands)
 
Beginning balance
  $ 214,410       2.16 %     2.32     $ 105,965       3.34 %     3.64     $ 142,359       3.94 %     6.06     $ 144,346       3.94 %     4.45  
Maturities and calls
    (25,036 )                     (22,168 )                     (37,428 )                     (119 )                
Net amortization of premiums/discounts
    (685 )                     (329 )                     (247 )                     (244 )                
Purchases:
                                                                                               
  Fixed
    133,047       1.41       1.10       131,229       1.62       1.04       886       4.52       2.75       --                  
Change in valuation of AFS securities
    430                       (287 )                     395                       (1,624 )                
Ending balance
  $ 322,166       1.84 %     2.02     $ 214,410       2.16 %     2.32     $ 105,965       3.34 %     3.64     $ 142,359       3.94 %     6.06  
                                                                                                 
   
For the Nine Months Ended
                                                 
   
June 30, 2009
   
June 30, 2008
                                                 
   
Amount
   
Yield
   
WAL
   
Amount
   
Yield
   
WAL
                                                 
   
(Dollars in thousands)
                                                 
Beginning balance
  $ 142,359       3.94 %     6.06     $ 524,168       4.52 %     1.66                                                  
Maturities and calls
    (84,632 )                     (613,899 )                                                                
Net amortization of premiums/discounts
    (1,261 )                     274                                                                  
Purchases:
                                                                                               
  Fixed
    265,162       1.52       1.09       230,512       3.96       1.07                                                  
  Adjustable
    --       --       --       3,874       6.58       28.98                                                  
Change in valuation of AFS securities
    538                       (583 )                                                                
Ending balance
  $ 322,166       1.84 %     2.02     $ 144,346       3.94 %     4.45                                                  



 
36

 

Liabilities.   Total liabilities increased from $7.18 billion at September 30, 2008 to $7.40 billion at June 30, 2009.  The $212.6 million increase in liabilities was primarily a result of an increase in deposits of $251.4 million.  The increase in deposits was a result of an increase in certificates, money market, and checking accounts.  We believe the turmoil in the credit and equity markets has made deposit products in strong financial institutions, like the Bank, desirable for many customers.  In response to the economic recession, households have increased their personal savings rate which we believe has contributed to our growth in deposits.

During the nine months ended June 30, 2009, the Bank prepaid a total of $875.0 million of fixed-rate FHLB advances with a weighted average contractual rate of 5.65%.  The prepaid FHLB advances were replaced with $875.0 million of fixed-rate FHLB advances with a weighted average contractual interest rate of 3.41%.  The Bank paid a $38.4 million prepayment penalty to the FHLB, which is being deferred as an adjustment to the carrying value of the new advances and will be recognized as expense over the life of the new advances.  As a result, the prepayment penalty will effectively increase the interest rate on the new advances 96 basis points at the time of the transaction.  See additional discussion of the transaction in “Notes to Financial Statements - Note 6 - FHLB Advances.”

The following table presents the amount, average rate and percentage of total deposits for checking, savings, money market and certificates for the periods presented.

   
At
 
At
 
At
 
At
   
June 30, 2009
 
March 31, 2009
 
December 31, 2008
 
September 30, 2008
         
Average
 
% of
       
Average
 
% of
       
Average
 
% of
       
Average
 
% of
   
Amount
   
Rate
 
Total
 
Amount
   
Rate
 
Total
 
Amount
   
Rate
 
Total
 
Amount
   
Rate
 
Total
   
(Dollars in thousands)
Checking
  $ 446,431       0.21 %     10.69 %   $ 448,086       0.21 %     10.89 %   $ 429,170       0.21 %     11.10 %   $ 400,461       0.21 %     10.21 %
Savings
    230,161       0.72       5.51       229,905       0.72       5.58       227,773       0.87       5.89       232,103       1.51       5.91  
Money market
    841,522       0.88       20.16       826,488       1.04       20.08       781,832       1.12       20.21       772,323       1.48       19.68  
Certificates
    2,657,137       3.30       63.64       2,612,035       3.45       63.45       2,428,529       3.64       62.80       2,518,996       3.91       64.20  
Total deposits
  $ 4,175,251       2.34 %     100.00 %   $ 4,116,514       2.46 %     100.00 %   $ 3,867,304       2.59 %     100.00 %   $ 3,923,883       2.91 %     100.00 %

At June 30, 2009, $71.5 million of the $2.66 billion in certificates were brokered deposits, compared to $180.6 million in brokered deposits at September 30, 2008.  The remaining brokered deposits at June 30, 2009 will mature within one year.  Management regularly considers brokered deposits as a source of funding, but does not currently consider the cost of this funding source to be balanced with investment opportunities.  As of June 30, 2009, $80.2 million in certificates were public unit deposits, compared to no public unit deposits at September 30, 2008.  Management will continue to monitor the wholesale deposit market for attractive opportunities.

 
37

 


Stockholders’ Equity.  Stockholders’ equity increased $51.4 million from $871.2 million at September 30, 2008 to $922.6 million at June 30, 2009.  The increase was primarily a result of net income of $49.5 million and an increase in unrealized gains on AFS securities of $29.5 million, partially offset by dividends paid of $33.6 million.

Dividends from the Company are the only source of funds for MHC.  It is expected that MHC will waive future dividends except to the extent they are needed to fund its continuing operations.  The following table shows the number of shares eligible to receive dividends (“public shares”) because of the waiver of dividends by MHC at June 30, 2009.  The unvested shares in the ESOP receive cash equal to the dividends paid on the public shares.  The cash received is used to repay the annual debt obligation on the loan taken out by the ESOP from the Company at the time of the mutual-to-stock conversion of the Bank to purchase shares for the ESOP.  These shares are held in trust for a future employee benefit, and are therefore excluded from the calculation of public shares.

Total voting shares outstanding at September 30, 2008
    74,079,868  
Treasury stock acquisitions
    (56,063 )
RRP grants
    2,500  
Options exercised
    71,850  
Total voting shares outstanding at June 30, 2009
    74,098,155  
Unvested shares in ESOP
    (1,008,194 )
Shares held by MHC
    (52,192,817 )
Total shares eligible to receive dividends at June 30, 2009 (public shares)
    20,897,144  

 
38

 



The following table presents quarterly dividends paid in calendar years 2009, 2008, and 2007.  The dollar amounts represent dividends paid during the quarter.  The actual amount of dividends to be paid during the quarter ending June 30, 2009, as approved by the board of directors on July 20, 2009, will be based upon the number of shares outstanding on the record date of August 7, 2009.  All shares outstanding presented in the table below, except for the quarter ending June 30, 2009, are as of the date of record per the dividend declaration.  For the purposes of the table below, the number of dividend shares for the quarter ending June 30, 2009 is based upon shares outstanding on July 27, 2009.  This does not represent the actual dividend payout, but rather management’s estimate of the number of shares eligible to receive the dividend and the total dividend payout as of July 27, 2009.

   
Calendar Year
 
   
2009
   
2008
   
2007
 
   
(Dollars in thousands, except per share amounts)
 
Quarter ended March 31
                 
Number of dividend shares
    20,874,269       20,660,510       20,520,793  
Dividend per share
  $ 0.50     $ 0.50     $ 0.50  
Total dividends paid
  $ 10,437     $ 10,330     $ 10,261  
Quarter ended June 30
                       
Number of dividend shares
    20,892,544       20,661,660       20,673,933  
Dividend per share
  $ 0.50     $ 0.50     $ 0.50  
Total dividends paid
  $ 10,446     $ 10,331     $ 10,337  
Quarter ended September 30
                       
Number of dividend shares
    20,897,644       20,668,519       20,694,333  
Dividend per share
  $ 0.50     $ 0.50     $ 0.50  
Total dividends paid
  $ 10,449     $ 10,334     $ 10,347  
Quarter ended December 31
                       
Number of dividend shares
            20,881,157       20,860,278  
Dividend per share
          $ 0.50     $ 0.50  
Total dividends paid
          $ 10,441     $ 10,430  
Special year end dividend
                       
Number of dividend shares
            20,881,157       --  
Dividend per share
          $ 0.11     $ --  
Total dividends paid
          $ 2,297     $ --  
                         
Calendar year-to-date dividends per share
  $ 1.50     $ 2.11     $ 2.00  


 
39

 

Analysis of Net Interest Income

Net interest income represents the difference between interest income earned on interest-earning assets, such as mortgage loans, investment securities, and MBS, and interest paid on interest-bearing liabilities, such as deposits, FHLB advances, and other borrowings.  Net interest income depends on the balance of interest-earning assets and interest-bearing liabilities, and the interest rates earned or paid on them.  The following table presents the average balances of our assets, liabilities and stockholders’ equity and the related annualized yields and rates on our interest-earning assets and interest-bearing liabilities for the periods indicated and the yield/rate on our interest-earning assets and interest-bearing liabilities at June 30, 2009.
   
At
   
For the Three Months Ended
 
   
June 30, 2009
   
June 30, 2009
   
March 31, 2009
   
December 31, 2008
   
September 30, 2008
   
June 30, 2008
 
         
Average
         
Average
         
Average
         
Average
         
Average
       
   
Yield/
   
Outstanding
   
Yield/
   
Outstanding
   
Yield/
   
Outstanding
   
Yield/
   
Outstanding
   
Yield/
   
Outstanding
   
Yield/
 
   
Rate
   
Balance
   
Rate(4)
   
Balance
   
Rate(4)
   
Balance
   
Rate(4)
   
Balance
   
Rate(4)
   
Balance
   
Rate(4)
 
Assets:
       
(Dollars in thousands)
 
  Interest-earning assets:
                                                                 
     Loans receivable (1)
    5.42 %   $ 5,532,573       5.55 %   $ 5,485,551       5.65 %   $ 5,419,179       5.66 %   $ 5,328,776       5.69 %   $ 5,316,794       5.62 %
     MBS(2)
    4.59       2,115,159       4.58       2,120,481       4.73       2,201,531       4.80       2,192,268       4.77       2,107,757       4.72  
     Investment securities(2)
    1.84       246,588       2.07       125,932       3.03       136,295       3.89       144,718       3.95       128,784       4.03  
     Capital stock of FHLB
    2.49       131,287       2.42       130,574       2.42       124,958       2.48       124,365       4.72       128,379       4.71  
     Cash and cash equivalents
    0.24       84,360       0.23       103,768       0.26       33,025       0.58       59,351       1.92       90,556       2.03  
  Total interest-earning assets (1) (2)
    4.95       8,109,967       5.08       7,966,306       5.24       7,914,988       5.32       7,849,478       5.36       7,772,270       5.29  
  Other noninterest-earning assets
            219,154               201,462               161,092               151,695               187,701          
Total assets
          $ 8,329,121             $ 8,167,768             $ 8,076,080             $ 8,001,173             $ 7,959,971          
                                                                                         
Liabilities and stockholders' equity:
                                                                                       
  Interest-bearing liabilities:
                                                                                       
    Savings
    0.72     $ 230,869       0.73     $ 227,431       0.74     $ 229,540       1.07     $ 231,986       1.66     $ 230,164       1.42  
    Checking
    0.21       442,227       0.21       423,107       0.20       405,787       0.21       403,327       0.20       412,468       0.20  
    Money market
    0.88       838,281       0.93       800,155       1.08       775,386       1.31       799,408       1.45       814,074       1.53  
    Certificates
    3.30       2,639,347       3.36       2,529,090       3.52       2,473,763       3.75       2,485,619       3.99       2,508,743       4.32  
      Total deposits
    2.34       4,150,724       2.39       3,979,783       2.52       3,884,476       2.73       3,920,340       2.94       3,965,449       3.15  
    FHLB advances (3)
    4.13       2,410,956       4.21       2,451,927       4.40       2,477,961       4.72       2,469,082       4.73       2,547,450       4.75  
    Other borrowings
    3.96       713,609       3.97       713,600       3.99       713,585       4.24       638,463       4.10       452,458       4.09  
     Total borrowings
    4.09       3,124,565       4.16       3,165,527       4.31       3,191,546       4.61       3,107,545       4.60       2,999,908       4.65  
  Total interest-bearing liabilities
    3.09       7,275,289       3.15       7,145,310       3.31       7,076,022       3.58       7,027,885       3.67       6,965,357       3.80  
  Other noninterest-bearing
    liabilities
            127,389               114,699               121,970               103,332               122,747          
  Stockholders' equity
            926,443               907,759               878,088               869,956               871,867          
Total liabilities and
                                                                                       
      stockholders' equity
          $ 8,329,121             $ 8,167,768             $ 8,076,080             $ 8,001,173             $ 7,959,971          

(Continued)

40


                                             
Net interest rate spread
1.86
%
   
1.93
%
   
1.93
%
   
1.74
%
   
1.68
%
   
1.49
%
Net interest-earning assets
   
 $              834,678
     
 $         820,996
     
 $         838,966
     
 $         821,593
     
 $         806,913
     
Net interest margin
       
2.26
%
   
2.30
%
   
2.08
%
   
2.03
%
   
1.89
%
Ratio of interest-earning assets
                                           
      to interest-bearing liabilities
       
1.11
     
1.11
     
1.12
     
1.12
     
1.12
 
                                             
Selected performance ratios:
                                           
  Return on average assets (annualized)
       
0.74
%
   
0.89
%
   
0.79
%
   
0.79
%
   
0.72
%
  Return on average equity (annualized)
       
6.68
%
   
7.99
%
   
7.22
%
   
7.25
%
   
6.59
%
  Average equity to average assets
       
11.12
%
   
11.11
%
   
10.87
%
   
10.87
%
   
10.95
%

(Concluded)
 

(1) Calculated net of deferred loan fees, loan discounts, and loans in process.  Non-accruing loans are included in the loans receivable average balance with a yield of zero percent.
 
(2) MBS and investment securities classified as AFS are stated at amortized cost, adjusted for unamortized purchase premiums or discounts.
 
(3) FHLB advances are stated net of deferred gains and deferred prepayment penalties.
 
(4) Average yields are derived by dividing annualized income by the average balance of the related assets and average rates are derived by dividing annualized expense by the average balance of the related liabilities, for the periods shown.  Average outstanding balances are derived from average daily balances, except as noted.  The yields and rates include amortization of fees, costs, premiums and discounts which are considered adjustments to yields/rates. Yields on tax-exempt securities were not calculated on a tax-equivalent basis.


 

 

 
41

 


The following table presents selected income statement information for the quarters indicated.
 
   
For the Three Months Ended
 
   
June 30,
   
March 31,
   
December 31,
   
September 30,
   
June 30,
 
   
2009
   
2009
   
2008
   
2008
   
2008
 
Selected income statement data:
 
(Dollars in thousands, except per share amounts)
 
Interest and dividend income:
                             
  Loans receivable
  $ 76,745     $ 77,446     $ 76,716     $ 75,830     $ 74,651  
  MBS
    24,211       25,088       26,402       26,153       24,869  
  Investment securities
    1,279       955       1,326       1,428       1,298  
  Other interest and dividend income
    843       846       829       1,766       1,967  
    Total interest and dividend income
    103,078       104,335       105,273       105,177       102,785  
                                         
Interest expense:
                                       
  FHLB advances
    25,307       26,653       29,545       29,543       30,248  
  Deposits
    24,705       24,711       26,785       29,083       31,174  
  Other borrowings
    7,144       7,109       7,725       6,693       4,682  
     Total interest expense
    57,156       58,473       64,055       65,319       66,104  
                                         
Provision for loan losses
    3,112       2,107       549       330       1,602  
                                         
Net interest and dividend income
                                       
     (after provision for loan losses)
    42,810       43,755       40,669       39,528       35,079  
                                         
Other income
    8,232       6,936       6,642       7,589       7,345  
Other expenses
    26,411       21,995       22,187       21,795       19,836  
Income tax expense
    9,155       10,564       9,272       9,563       8,233  
     Net income
  $ 15,476     $ 18,132     $ 15,852     $ 15,759     $ 14,355  
                                         
Efficiency ratio
    48.77       41.66       46.36       45.94       45.05  
                                         
Basic earnings per share
  $ 0.21     $ 0.25     $ 0.22     $ 0.22     $ 0.20  
Diluted earnings per share
  $ 0.21     $ 0.25     $ 0.22     $ 0.22     $ 0.20  
Dividends declared per public share
  $ 0.50     $ 0.50     $ 0.61     $ 0.50     $ 0.50  

 


 
42

 

Comparison of Operating Results for the Three Months Ended June 30, 2009 and 2008
 
Net income for the quarter ended June 30, 2009 was $15.5 million compared to $14.4 million for the same period in the prior fiscal year. The $1.1 million increase in net income was primarily a result of an $8.9 million decrease in interest expense, partially offset by a $6.6 million increase in other expenses and a $1.5 million increase in provision for loan loss.

Interest and Dividend Income
Total interest and dividend income for the current quarter was $103.1 million compared to $102.8 million for the prior year quarter.  The $293 thousand increase was a result of an increase in interest income on loans receivable of $2.1 million, partially offset by a decrease in dividends received on FHLB stock of $709 thousand, a decrease in interest income on MBS of $658 thousand, and a decrease in interest income on cash and cash equivalents of $415 thousand.

Interest income on loans receivable for the current quarter was $76.7 million compared to $74.7 million for the prior year quarter.  The $2.0 million increase was a result of an increase of $215.8 million in the average balance of the loan portfolio between the two periods due primarily to purchases and, to a lesser extent, an increase in deferred fee amortization as a result of modifications and prepayments.  The weighted average yield of the portfolio decreased by seven basis point from 5.62% in the prior year quarter to 5.55% for the current quarter. The decrease in the weighted average yield was a result of modifications, refinances, and originations at rates below the existing portfolio and to the repricing of the home equity loan portfolio to lower market interest rates, partially offset by an increase in deferred fee amortization.

Interest income on MBS for the quarter was $24.2 million compared to $24.9 million for the prior year quarter.  The $658 thousand decrease in interest income was due to a decrease of 14 basis points in the weighted average yield to 4.58% for the current quarter.  The weighted average yield of the MBS portfolio decreased between the two periods due to repricing and purchases of MBS at a lower average yield than the existing portfolio between the two periods.

Interest income on investment securities for the current quarter was relatively unchanged at $1.3 million for the current and prior year quarter, despite an increase of $117.8 million in the average balance of the portfolio.  The weighted average portfolio yield decreased 196 basis points to 2.07% for the current quarter due to calls and maturities of higher yielding securities, and to purchases and reinvestments made at lower yields than the overall portfolio yield.  The funds for the purchases came from MBS principal repayments and maturities, and calls and maturities of investment securities.  The majority of the securities were purchased during the second and third quarters of fiscal year 2009.  The securities purchased had a WAL of approximately one year at the time of purchase.  If market rates were to rise, this may allow management the opportunity to reinvest the maturing funds into higher yielding investments.

Dividends on FHLB stock for the current quarter were $793 thousand compared to $1.5 million for the prior year quarter.  The $709 thousand decrease was due to a 229 basis point decrease in the weighted average yield.  The dividend rate on FHLB stock correlates to the federal funds rate, which decreased between periods.

Interest income on cash and cash equivalents for the current quarter was $50 thousand, compared to $465 thousand in the prior year quarter.  The decrease was primarily due to a 180 basis point decrease in the weighted average yield due to a decrease in short-term interest rates between periods.

Interest Expense
Total interest expense for the quarter ended June 30, 2009 was $57.2 million, compared to $66.1 million for the prior year period.  The $8.9 million decrease was due to a decrease in interest expense on deposits of $6.5 million and interest expense on FHLB advances of $4.9 million, partially offset by a $2.4 million increase in interest expense on other borrowings.

Interest expense on FHLB advances for the current quarter was $25.3 million compared to $30.2 million for the prior year quarter.  The $4.9 million decrease in interest expense was primarily a result of a decrease in the average rate as a result of the refinance of $875.0 million of advances during fiscal year 2009, and to a decrease in the average balance as some maturing FHLB advances were replaced with repurchase agreements.  See additional discussion of the refinance of the FHLB advances in “Notes to Financial Statements - Note 6 - FHLB advances.”

Interest expense on deposits for the current quarter was $24.7 million compared to $31.2 million for the prior year quarter.  The $6.5 million decrease in interest expense was a result of a decrease in the average rate paid on the certificate of deposit, money market, and savings portfolios due to the portfolios repricing to lower market rates, partially offset by a $185.3 million increase in

43

the average balance, primarily in the certificate of deposit portfolio.  We believe the turmoil in the credit and equity markets has made deposit products in strong financial institutions, like the Bank, desirable for many customers.  In response to the economic recession, households have increased their personal savings rate which we believe has contributed to our deposit growth.

Interest expense on other borrowings was $7.1 million compared to $4.7 million in the prior year quarter.  The $2.4 million increase was due to an increase in the average balance of other borrowings due to the Bank entering into $260.0 million of repurchase agreements between the two periods.  The proceeds from the repurchase agreements were used to purchase MBS and to repay maturing FHLB advances.

Provision for Loan Losses
The Bank recorded a provision for loan losses of $3.1 million during the current quarter, compared to $1.6 million in the prior year quarter.  The provision for loan losses recorded in the current quarter reflects an increase in our purchased loan loss factors in the formula analysis and purchased loan specific valuation allowances and accounts for charge-offs during the quarter, primarily related to purchased loans. See additional discussion regarding the provision for loan losses in the sections entitled “Critical Accounting Policies – Allowance for Loan Losses” and “Asset Quality.”

Other Income and Expense
Total other income for the current quarter was $8.2 million compared to $7.3 million in the prior year quarter.  The increase was primarily a result of a $1.4 million increase in gains on sale of LHFS, net primarily due to the sale of modified loans during the current quarter.

Total other expenses for the current quarter increased $6.6 million to $26.4 million, compared to $19.8 million in the prior year quarter.  The increase was due largely to an increase in federal insurance premium of $5.2 million as a result of the FDIC special assessment and increases in the regular quarterly deposit insurance premiums.  See additional discussion regarding the FDIC special assessment and deposit insurance premiums under “Liquidity and Capital Resources.”  Other expenses, net increased $1.4 million primarily due to an impairment and valuation allowance on the mortgage servicing rights (“MSR”) asset of $545 thousand in the current quarter due to an increase in prepayment speeds, compared to a recovery on the MSR asset of $510 thousand in the prior year quarter.  The increase in other expenses, net is also due to an increase in expense associated with REO operations.

Income Tax Expense
Income tax expense for the current quarter was $9.2 million compared to $8.2 million in the prior year quarter.  The increase in income tax expense was primarily due to an increase in earnings compared to the prior year quarter.  The effective tax rate was 37.2% for the current year quarter, compared to 36.4% for the prior year quarter.

 
44

 



The table below presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities, comparing the quarter ended June 30, 2009 to the quarter ended June 30, 2008.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume, which are changes in the average balance multiplied by the previous year’s average rate and (2) changes in rate, which are changes in the average rate multiplied by the average balance from the previous year.  The net changes attributable to the combined impact of both rate and volume have been allocated proportionately to the changes due to volume and the changes due to rate.

   
Quarter Ended June 30,
 
   
2009 vs. 2008
 
   
Increase (Decrease) Due to
 
                   
   
Volume
   
Rate
   
Total
 
   
(Dollars in thousands)
 
Interest-earning assets:
                 
Loans receivable
  $ 2,991     $ (897 )   $ 2,094  
MBS
    87       (745 )     (658 )
Investment securities
    811       (830 )     (19 )
Capital stock of FHLB
    34       (743 )     (709 )
Cash equivalents
    (30 )     (385 )     (415 )
Total interest-earning assets
  $ 3,893     $ (3,600 )   $ 293  
                         
Interest-bearing liabilities:
                       
Savings
  $ 3     $ (403 )   $ (400 )
Checking
    15       11       26  
Money market
    90       (1,256 )     (1,166 )
Certificates
    1,350       (6,279 )     (4,929 )
FHLB advances
    (1,162 )     (3,779 )     (4,941 )
Other borrowings
    2,613       (151 )     2,462  
Total interest-bearing liabilities
  $ 2,909     $ (11,857 )   $ (8,948 )
                         
Net change in net interest and dividend income
  $ 984     $ 8,257     $ 9,241  


 
Comparison of Operating Results for the Nine Months Ended June 30, 2009 and 2008
 
Net income for the nine months ended June 30, 2009 was $49.5 million compared to $35.2 million for the same period in the prior fiscal year. The $14.3 million increase in net income was primarily a result of a $31.6 million decrease in interest expense and a $7.1 million increase in interest and dividend income, partially offset by a $10.4 million increase in other expenses, a $9.4 million increase in income tax expense, and a $4.0 million increase in provision for loan loss.

Interest and Dividend Income
Total interest and dividend income for the nine months ended June 30, 2009 was $312.7 million compared to $305.6 million for the prior year period.  The $7.1 million increase was a result of an increase in interest income on MBS of $13.5 million and an increase in interest income on loans receivable of $4.7 million, partially offset by a decrease in interest income on investment securities of $4.9 million, a decrease in interest income on cash and cash equivalents of $3.1 million, and a decrease in dividends received on FHLB stock of $3.1 million.

Interest income on loans receivable for the nine months ended June 30, 2009 was $230.9 million compared to $226.2 million for the prior year period.  The $4.7 million increase was a result of a $167.7 million increase in the average balance of the loan portfolio between the two periods, partially offset by a decrease of six basis points in the weighted average yield of the portfolio to 5.62% for the current nine month period.  The increase in the average balance was due to loan purchases during fiscal year 2009. The decrease in the weighted average yield was a result of purchases and originations at a lower rate than the portfolio and the home equity loan portfolio repricing to lower market interest rates, partially offset by an increase in deferred fee amortization as a result of prepayments, modifications and refinances.


45


Interest income on MBS for the nine months ended June 30, 2009 was $75.7 million compared to $62.2 million for the prior year period.  The $13.5 million increase in interest income was primarily due to an increase of $359.9 million in the average balance and, to a lesser extent, an increase of 5 basis points in the weighted average yield to 4.70% for the current nine month period.  The increase in the average portfolio balance was a result of purchases.  The funds for the purchases came from maturities and calls of investment securities and from new borrowings.  The weighted average yield of the MBS portfolio increased between the two periods due to purchases of MBS during the last quarter of fiscal year 2008 at an average yield higher than the existing portfolio.

Interest income on investment securities for the nine months ended June 30, 2009 was $3.6 million compared to $8.5 million for the prior year period.  The $4.9 million decrease in interest income was a result of a decrease of $105.6 million in the average balance of the portfolio and a 131 basis point decrease in the weighted average portfolio yield to 2.80% for the current nine month period.  The decrease in the average balance was a result of calls and maturities which were not reinvested in their entirety into the investment securities portfolio, but rather into the higher yielding MBS portfolio.  The decrease in the weighted average yield of the portfolio was attributed to maturities and calls of securities with weighted average yields greater than the portfolio, and also due to reinvestments made at lower yields than the overall portfolio yield.

Dividends on FHLB stock for the nine months ended June 30, 2009 were $2.4 million compared to $5.4 million for the prior year period.  The $3.0 million decrease was due primarily to a 312 basis point decrease in the weighted average yield.  The dividend rate on FHLB stock correlates to the federal funds rate, which decreased during the period.

Interest income on cash and cash equivalents for the nine months ended June 30, 2009 was $167 thousand, compared to $3.3 million in the prior year period.  The decrease was due to a 303 basis point decrease in the weighted average yield due to a decrease in short-term interest rates between the two periods, and a decrease in the average balance of $46.3 million.  The decrease in the average balance was a result of cash being utilized to purchase MBS.

Interest Expense
Total interest expense for the nine months ended June 30, 2009 was $179.7 million, compared to $211.3 million for the prior year period.  The $31.6 million decrease was primarily due to a decrease in interest expense on deposits of $28.2 million.

Interest expense on FHLB advances for the current nine month period was $81.5 million compared to $96.2 million for the prior year period.  This $14.7 million decrease was a result of the termination and maturity of the interest rate swap agreements during fiscal year 2008, maturing advances which were replaced with repurchase agreements, and a decrease in the rate due to the refinance of $875.0 million of advances during the second and third quarters of fiscal year 2009.  The decrease was also due to a decrease in the average balance as a result of maturing advances that were replaced with repurchase agreements.  See additional discussion of the refinance of the FHLB advances in “Notes to Financial Statements - Note 6 - FHLB advances.”

Interest expense on deposits for the nine months ended June 30, 2009 was $76.2 million compared to $104.4 million for the prior year period.  This $28.2 million decrease was primarily a result of a decrease in the average rate paid on the certificate of deposit, money market and savings portfolios due to the portfolios repricing to lower market rates.

Interest expense on other borrowings was $22.0 million compared to $10.8 million in the prior year period.  The $11.2 million increase was due to an increase in the average balance of other borrowings due to the Bank entering into $260.0 million of repurchase agreements between the two periods.  The proceeds from the repurchase agreement funds were used to purchase MBS and to repay maturing FHLB advances.

 
46

 



Provision for Loan Losses
The Bank recorded a provision for loan losses of $5.8 million during the current nine month period, compared to a provision of $1.7 million in the prior year period.  Of the $5.8 million, $3.1 million was recorded in the current quarter as a result of an increase in our purchased loan loss factors in the formula analysis, an increase in our purchased loan specific valuation allowances and charge-offs during the quarter, primarily related to purchased loans.  During the second quarter of fiscal year 2009, a $2.1 million provision for loan loss was recorded which reflected changes in our allowance for loan loss methodology and charge-offs during the quarter. See additional discussion regarding the provision for loan losses in the sections entitled “Critical Accounting Policies – Allowance for Loan Losses” and “Asset Quality.”

Other Income and Expense
Total other income for the current nine month period was $21.8 million compared to $22.4 million in the prior year period.  The $589 thousand decrease in other income was a result of a $1.7 million decrease in other income, net and a decrease in income from BOLI of $923 thousand due to a decrease in the net crediting rate as a result of a decrease in market interest rates, partially offset by an increase in gains on sale of LHFS, net of $1.7 million.  The decrease in other income, net was due primarily to the redemption of shares received in the Visa, Inc. initial public offering of $992 thousand in the prior year period and to interest received on a tax refund of $235 thousand also in the prior year period, with no corresponding item in the current period.

Total other expenses for the current nine month period was $70.6 million compared to $60.2 million in the prior year period.  The $10.4 million increase was due to an increase in federal insurance premium of $5.4 million, an increase in other expense, net of $2.2 million, and an increase in advertising expense of $2.0 million.  The increase in federal insurance premium was a result of the FDIC special assessment and increases in the regular quarterly deposit insurance premiums.  See additional discussion regarding the FDIC special assessment and deposit insurance premiums under “Liquidity and Capital Resources.”  The increase in other expense, net was due primarily to an impairment and valuation allowances on the MSR asset due to an increase in prepayment speeds and to an increase in net expense related to REO operations.  These increases were partially offset by the reversal of a portion of the Visa, Inc. litigation liability accrued in the prior year period.  The increase in advertising expense was due to expense associated with the Bank’s new debit card rewards program and to advertising campaigns undertaken to reassure customers of the Bank’s safety and soundness in response to current economic conditions.

Income Tax Expense
Income tax expense for the current nine month period was $29.0 million compared to $19.6 million in the prior year period.  The increase in income tax expense was primarily due to an increase in earnings compared to the prior year period.  The effective tax rate was 37.0% for the current year period, compared to 35.8% for the prior year period.  The 120 basis point difference in effective tax rates between the two periods was primarily a result of a decrease in nontaxable income from BOLI, an increase in nondeductible expenses associated with the ESOP and an increase in pre-tax income which reduced the effective tax rate benefit of nontaxable income.

 
47

 




The following table presents the average balances of our assets, liabilities and stockholders’ equity and the related annualized yields and costs on our interest-earning assets and interest-bearing liabilities for the periods indicated.

   
For the Nine Months Ended
 
   
June 30, 2009
   
June 30, 2008
 
   
Average
         
Average
       
   
Outstanding
   
Yield/
   
Outstanding
   
Yield/
 
   
Balance
   
Rate(4)
   
Balance
   
Rate(4)
 
Assets:
 
(Dollars in thousands)
 
  Interest-earning assets:
                       
     Loans receivable (1)
  $ 5,478,858       5.62 %   $ 5,311,111       5.68 %
     MBS(2)
    2,146,021       4.70       1,786,085       4.65  
     Investment securities(2)
    169,643       2.80       275,234       4.11  
     Capital stock of FHLB
    128,919       2.44       130,845       5.56  
     Cash and cash equivalents
    84,116       0.26       130,375       3.29  
  Total interest-earning assets (1) (2)
    8,007,557       5.21       7,633,650       5.34  
  Other noninterest-earning assets
    183,097               197,944          
Total assets
  $ 8,190,654             $ 7,831,594          
                                 
Liabilities and stockholders' equity:
                               
  Interest-bearing liabilities:
                               
    Savings
  $ 229,288       0.84     $ 230,426       1.81  
    Checking
    423,643       0.21       396,785       0.21  
    Money market
    804,517       1.10       806,359       2.29  
    Certificates
    2,547,198       3.54       2,514,228       4.60  
      Total deposits
    4,004,646       2.54       3,947,798       3.52  
    FHLB advances (3)
    2,447,044       4.44       2,581,022       4.94  
    Other borrowings
    713,598       4.06       307,922       4.60  
     Total borrowings
    3,160,642       4.35       2,888,944       4.90  
  Total interest-bearing liabilities
    7,165,288       3.34       6,836,742       4.10  
  Other noninterest-bearing liabilities
    121,378               124,741          
  Stockholders' equity
    903,988               870,111          
Total liabilities and stockholders' equity
  $ 8,190,654             $ 7,831,594          
                                 
Net interest rate spread
            1.87 %             1.24 %
Net interest-earning assets
  $ 842,269             $ 796,908          
Net interest margin
            2.21 %             1.65 %
Ratio of interest-earning assets
                               
      to interest-bearing liabilities
            1.12               1.12  
                                 
Selected Performance Ratios:
                               
  Return on average assets (annualized)
            0.81 %             0.60 %
  Return on average equity (annualized)
            7.30 %             5.39 %
  Average equity to average assets
            11.04 %             11.11 %

(1) Calculated net of deferred loan fees, loan discounts, and loans in process.  Non-accruing loans are included in the loans receivable average balance with a yield of zero percent.
 
(2) MBS and investment securities classified as AFS are stated at amortized cost, adjusted for unamortized purchase premiums or discounts.
 
(3) FHLB advances are stated net of deferred gains and deferred prepayment penalties.


 
48

(4) Average yields are derived by dividing annualized income by the average balance of the related assets and average rates are derived by dividing annualized expense by the average balance of the related liabilities, for the periods shown.  Average outstanding balances are derived from average daily balances, except as noted.  The yields and rates include amortization of fees, costs, premiums and discounts which are considered adjustments to yields/rates. Yields on tax-exempt securities were not calculated on a tax-equivalent basis.
 

The table below presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities, comparing the nine months ended June 30, 2009 to the nine months ended June 30, 2008.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume, which are changes in the average balance multiplied by the previous year’s average rate and (2) changes in rate, which are changes in the average rate multiplied by the average balance from the previous year.  The net changes attributable to the combined impact of both rate and volume have been allocated proportionately to the changes due to volume and the changes due to rate.

   
For the Nine Months Ended
 
   
June 30, 2009 vs. June 30, 2008
 
   
Increase (Decrease) Due to
 
                   
   
Volume
   
Rate
   
Total
 
   
(Dollars in thousands)
 
Interest-earning assets:
                 
Loans receivable
  $ 6,991     $ (2,274 )   $ 4,717  
MBS
    12,777       682       13,459  
Investment securities
    (2,689 )     (2,240 )     (4,929 )
Capital stock of FHLB
    (79 )     (3,016 )     (3,095 )
Cash and cash equivalents
    (861 )     (2,234 )     (3,095 )
Total interest-earning assets
  $ 16,139     $ (9,082 )   $ 7,057  
                         
Interest-bearing liabilities:
                       
Savings
  $ (16 )   $ (1,678 )   $ (1,694 )
Checking
    42       --       42  
Money market
    (32 )     (7,228 )     (7,260 )
Certificates
    1,117       (20,356 )     (19,239 )
FHLB advances
    (4,541 )     (10,159 )     (14,700 )
Other borrowings
    12,176       (960 )     11,216  
Total interest-bearing liabilities
  $ 8,746     $ (40,381 )   $ (31,635 )
                         
Net change in net interest and dividend income
  $ 7,393     $ 31,299     $ 38,692  
                         

Comparison of Operating Results for the Three Months Ended June 30, 2009 and March 31, 2009

For the quarter ended June 30, 2009, the Company recognized net income of $15.5 million, compared to net income of $18.1 million for the quarter ended March 31, 2009.  The decrease in net income between periods was primarily due to the FDIC special assessment at June 30, 2009 and an increase in the regular quarterly deposit insurance premiums.  However, due to an additional day of interest expense in the current quarter, the net interest margin also decreased between the two periods from 2.30% to 2.26%.

Interest and Dividend Income
Total interest and dividend income for the current quarter was $103.1 million compared to $104.3 million for the quarter ended March 31, 2009.  The decrease of $1.2 million was primarily a result of decreases in interest income on MBS of $877 thousand and loans receivable of $701 thousand, partially offset by an increase in interest income on investment securities of $324 thousand.

 
49

 



Interest income on loans receivable for the current quarter was $76.7 million compared to $77.4 million for the quarter ended March 31, 2009.  The $701 thousand decrease in interest income was primarily a result of a decrease of 10 basis points in the weighted average yield to 5.55% for the current quarter, partially offset by a $47.0 million increase in the average balance of the portfolio.  The decrease in the weighted average yield was due to modifications, refinances and originations at rates lower than the overall loan portfolio rate, partially offset by an increase in deferred fee amortization as a result of prepayments, modifications and refinances.

Interest income on MBS for the current quarter was $24.2 million compared to $25.1 million for the quarter ended March 31, 2009.  The $877 thousand decrease was primarily a result of a decrease in the weighted average yield of 15 basis points to 4.58% for the current quarter and a $5.3 million decrease in the average balance of the portfolio due to principal repayments which were not replaced.  The weighted average yield decreased between the two periods due to an increase of prepayments on MBS with yields higher than the existing portfolio and, to a lesser extent, purchases of MBS at a lower average yield than the existing portfolio between the two periods and securities repricing to lower market rates.

Interest income on investment securities for the current quarter was $1.3 million compared to $955 thousand for the quarter ended March 31, 2009.  The increase was primarily a result of a $120.7 million increase in the average balance, partially offset by a decrease in the average yield of 96 basis points to 2.07% for the current quarter.  The average balance increased due to the purchase of $127.9 million of short-term securities during the current quarter.  The average yield decreased due to purchases at yields lower than the overall portfolio yield.

Interest Expense
Interest expense decreased $1.3 million to $57.2 million for the current quarter from $58.5 million for the quarter ended March 31, 2009.  The decrease was due to a decrease in interest expense on FHLB advances as a result of the refinance of $300.0 million of FHLB advances during the current quarter.  See additional discussion of the refinance of the FHLB advances in “Notes to Financial Statements - Note 6 - FHLB advances.”

Provision for Loan Losses
The Bank recorded a provision for loan losses of $3.1 million during the current quarter, compared to a provision of $2.1 million in the quarter ended March 31, 2009.  The $3.1 million provision for loan loss recorded in the current quarter reflects an increase in our purchased loan loss factors in the formula analysis and purchased loan specific valuation allowances and accounts for charge-offs during the quarter, primarily related to purchased loans.  See additional discussion regarding the provision for loan losses in the sections entitled “Critical Accounting Policies – Allowance for Loan Losses” and “Asset Quality.”

Other Income and Expense
Total other income was $8.2 million for the current quarter compared to $6.9 million for the quarter ended March 31, 2009.  The $1.3 million increase was due primarily to an increase of $1.1 million in gains on sale of LHFS, net due to the sale of certain modified loans.

Total other expenses for the current quarter were $26.4 million for the current quarter, compared to $22.0 million in the prior quarter.  The $4.4 million increase was due primarily to an increase in federal insurance premium of $5.1 million.  The increase in federal insurance premium was a result of the FDIC special assessment and an increase in the regular quarterly deposit insurance premiums.  See additional discussion regarding the FDIC special assessment and deposit insurance premiums under “Liquidity and Capital Resources.”

Income Tax Expense
Income tax expense for the current quarter was $9.2 million compared to $10.6 million for the quarter ended March 31, 2009.  The $1.4 million decrease was due to a decrease in earnings between periods.  The effective tax rate for the quarter ended June 30, 2009 was 37.2%, compared to 36.8% for the quarter ended March 31, 2009.

 
50

 



The table below presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities, comparing the quarter ended June 30, 2009 to the quarter ended March 31, 2009.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume, which are changes in the average balance multiplied by the previous year’s average rate and (2) changes in rate, which are changes in the average rate multiplied by the average balance from the previous year.  The net changes attributable to the combined impact of both rate and volume have been allocated proportionately to the changes due to volume and the changes due to rate.

   
Quarter Ended
 
   
June 30, 2009 vs. March 31, 2009
 
   
Increase (Decrease) Due to
 
                   
   
Volume
   
Rate
   
Total
 
   
(Dollars in thousands)
 
Interest-earning assets:
                 
Loans receivable
  $ 670     $ (1,371 )   $ (701 )
MBS
    (63 )     (814 )     (877 )
Investment securities
    698       (374 )     324  
Capital stock of FHLB
    10       6       16  
Cash and cash equivalents
    (12 )     (7 )     (19 )
Total interest-earning assets
  $ 1,303     $ (2,560 )   $ (1,257 )
                         
Interest-bearing liabilities:
                       
Savings
  $ 6     $ (6 )   $ --  
Checking
    --       --       --  
Money market
    152       (156 )     (4 )
Certificates
    990       (992 )     (2 )
FHLB advances
    (84 )     (1,262 )     (1,346 )
Other borrowings
    78       (43 )     35  
Total interest-bearing liabilities
  $ 1,142     $ (2,459 )   $ (1,317 )
                         
Net change in net interest and dividend income
  $ 161     $ (101 )   $ 60  


Liquidity and Capital Resources

Liquidity management is both a daily and long-term function of our business management.  The Bank’s most available liquid assets are represented by cash and cash equivalents, AFS MBS and investment securities and short-term investment securities.  The Bank’s primary sources of funds are deposits, FHLB advances, other borrowings, repayments on and maturities of outstanding loans and MBS, other short-term investments, and funds provided from operations.  While scheduled payments from the amortization of loans and MBS and payments on short-term investments are relatively predictable sources of funds, deposit flows and prepayments on loans and MBS are greatly influenced by general interest rates, economic conditions and competition and are less predictable sources of funds.  The most significant liquidity challenge we currently face is the variability in cash flows as a result of mortgage modification and refinance activity.  To the extent possible, the Bank manages the cash flows of its loan and deposit portfolios by the rates it offers customers.  Sources of funds are used primarily to meet ongoing operations, to pay maturing certificates of deposit and savings withdrawals, and to fund loan commitments.  At June 30, 2009, $1.64 billion of the $2.66 billion in certificates of deposit were scheduled to mature within one year.  Included in the $1.64 billion are $71.5 million of brokered deposits and $80.2 million in public unit deposits.  Based on our deposit retention experience and our pricing strategy, we anticipate the majority of the maturing retail deposits will renew, although no assurance can be given in this regard.  Management will continue to monitor the wholesale deposit market for attractive opportunities.


51


The Bank has paid competitive rates for its deposits while not “paying-up” in rates to grow its deposit base beyond the Bank’s need for funding.  The Bank’s borrowings have been used primarily to invest in U.S. government agency securities in order to improve the earnings of the Bank and to help with the management of its interest rate risk while maintaining its capital ratios in excess of regulatory standards for well-capitalized financial institutions.  In addition, the Bank’s focus on managing risk has provided it liquidity capacity by remaining below borrowing limits at FHLB and through the uncollateralized balance of its government agency MBS and investment securities available as collateral for borrowings.
 
The Bank has used FHLB advances to provide funds for lending and investment activities.  FHLB lending guidelines set borrowing limits as part of their underwriting standards, which, for the Bank, is 40% of total assets.  At June 30, 2009, the Bank’s ratio of the face amount of advances to total assets, as reported to the Office of Thrift Supervision (“OTS”), was 29%.  Our advances are secured by a blanket pledge of our loan portfolio, as collateral, supported by quarterly reporting to FHLB Topeka.  Advances in excess of 40% of total assets, but not exceeding 55% of total assets, may be approved by the president of FHLB Topeka based upon a review of documentation supporting the use of the advances.  Currently, the blanket pledge is sufficient collateral for our outstanding FHLB advances.  It is possible that increases in our borrowings or decreases in our loan portfolio could require the Bank to pledge securities as collateral on the FHLB advances.  The Bank’s policy allows borrowing from FHLB of up to 55% of total assets.
 
The Bank has used repurchase agreements primarily to fund purchases of MBS and to repay maturing FHLB advances.  The repurchase agreements are treated as secured borrowings and are reported as a liability of the Company on a consolidated basis.  The Bank has pledged securities with a fair value of $773.9 million as collateral.  At the maturity date of these borrowings, the pledged securities will be delivered back to the Bank.  The Bank may enter into additional repurchase agreements as management deems appropriate.  At June 30, 2009, repurchase agreements were 8% of total assets.  The Bank’s policy allows for repurchase agreements to total up to 15% of Bank assets.

In 2004, the Company issued $53.6 million in debentures in connection with a trust preferred securities offering.  The Company received $52.0 million, net, from the issuance of the debentures and an investment of $1.6 million in Capitol Federal Financial Trust I (the “Trust”).  The Company did not down-stream the proceeds to be used by the Bank for Tier 1 capital because the Bank exceeded all regulatory requirements to be a well-capitalized institution.  Instead, the Company deposited the proceeds into certificate accounts at the Bank to be used to further the Company’s general corporate and capital management strategies, which could include the payment of dividends.
 
At June 30, 2009, cash and cash equivalents totaled $74.1 million, a decrease of $13.0 million from September 30, 2008.  The cash was used to fund loan originations and purchase securities.  The Bank maintains access to additional liquidity through its management of the level of borrowings from the FHLB and counterparties of repurchase agreements through the availability of high quality collateral for borrowings.  At June 30, 2009, $1.03 billion of securities were eligible but unused for collateral.  Securities eligible for collateral consist of unpledged securities with current fair value of $10.0 million or greater.  The Bank also has access to the brokered deposit market but does not currently consider the cost of this funding source to be balanced with investment opportunities.
 
The Bank is a member of the DIF, which is administered by the FDIC.  Deposits are insured up to the applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government.  As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions.  Recent bank failures have decreased the DIF to levels below its required reserve ratio.  When the reserve ratio is below $1.15 for every $100 insured, the FDIC is required to replenish the fund by increasing deposit insurance premiums.  In order to replenish the DIF, the FDIC has increased deposit insurance premiums at a rate designed to restore the DIF to required levels within seven years, and has imposed a special assessment of five basis points to be collected on September 30, 2009, based upon total Bank assets less Tier 1 capital balances at June 30, 2009.  As of June 30, 2009, management has estimated the Bank’s deposit insurance premium will be approximately 16 basis points (annualized) in future periods.  An institution (or its successor) insured by the FDIC on December 31, 1996 which had previously paid assessments was eligible for certain credit against deposit insurance assessments.  This credit had offset the majority of the Bank’s FDIC premium expense in past fiscal years but was fully utilized during the third quarter of fiscal year 2009.  For the current quarter, the Bank has recorded $1.5 million in expense related to the regular FDIC quarterly premiums, compared to $227 thousand for the quarter ended March 31, 2009, and $3.8 million in expense related to the special assessment.  The FDIC has the authority to impose additional special assessments of up to 5 basis points on all insured depository institutions based on each institution’s total assets less Tier 1 capital whenever the FDIC estimates the DIF reserve ratio will fall to a level the FDIC believes would adversely impact public confidence or to a level that will be close to or below zero.  Any additional special assessment would be capped at 10 basis points of an institution’s assessment base for the corresponding quarter’s risk based assessment.  The authority for the FDIC to impose any additional special assessments terminates January 1, 2010.

 
52

 



The Bank also participates in the FDIC’s Transaction Account Guarantee Program (“TAGP”).  The TAGP extended the FDIC’s insurance to full coverage of noninterest-bearing transaction accounts for participating institutions through the end of 2009 at an annualized rate of 10 basis points on deposit balances in excess of the $250 thousand insurance limit currently in place.  The Bank does not expect this program to have a material impact on the FDIC premium.

At June 30, 2009, CFFN, at the holding company level, had $121.8 million in cash and certificates of deposit at the Bank to be used to further the Company’s general corporate and capital management strategies, which could include the payment of dividends.  It is management’s and the board of directors’ intention to continue to pay regular quarterly dividends of $0.50 per share for the foreseeable future.  Dividend payments depend upon a number of factors including the Company's financial condition and results of operations, the Bank’s regulatory capital requirements, regulatory limitations on the Bank's ability to make capital distributions to the Company, the amount of cash at the holding company and the continued waiver of dividends by MHC.  See additional discussion and calculation of public shares in “Item 2, Management’s Discussion and Analysis – Stockholders’ Equity.”
 
The long-term ability of the Company to pay dividends to its stockholders is based primarily upon the ability of the Bank to make capital distributions to the Company.  Under OTS safe harbor regulations, the Bank may distribute to the Company capital not exceeding net income for the current calendar year and the prior two calendar years.  At June 30, 2009, the Bank was in compliance with the OTS safe harbor regulations.  The Bank has received a waiver from the OTS to distribute capital from the Bank to the Company, not to exceed 100% of the Bank's net quarterly earnings, through June 30, 2010 so the Bank will not be required to notify the OTS prior to paying dividends through that date.
 

Off Balance Sheet Arrangements, Commitments and Contractual Obligations
 
The Company, in the normal course of business, makes commitments to buy or sell assets or to incur or fund liabilities.  Commitments may include, but are not limited to:
 
·  
the origination, purchase, or sale of loans,
·  
the purchase or sale of investment securities and MBS,
·  
extensions of credit on home equity loans and construction loans,
·  
terms and conditions of operating leases, and
·  
funding withdrawals of deposit accounts.

 
53

 



The Company’s contractual obligations related to operating leases and debentures have not changed significantly from September 30, 2008.  The following table summarizes our other contractual obligations as of June 30, 2009.

   
Maturity Range
 
         
Less than
     
1 - 3            
      3 - 5                 
More than
 
   
Total
   
1 year
   
years
   
years
   
5 years
 
       
                                   
Certificates of Deposit
  $ 2,657,137     $ 1,635,029     $ 924,348     $ 96,690     $ 1,070  
    Weighted average rate
    3.30 %     3.10 %     3.64 %     3.43 %     3.80 %
                                         
FHLB Advances
    2,446,000       120,000       776,000       1,075,000       475,000  
    Weighted average rate
    3.80 %     4.13 %     4.21 %     3.53 %     3.67 %
                                         
Repurchase Agreements
    660,000       --       395,000       145,000       120,000  
    Weighted average rate
    3.97 %     -- %     3.94 %     3.81 %     4.24 %
                                         
Commitments to originate and
                                       
   purchase mortgage loans
    211,236       211,236       --       --       --  
    Weighted average rate
    5.04 %     5.04 %     -- %     -- %     -- %
                                         
Commitments to fund unused home
                                       
   equity lines of credit
    270,374       270,374       --       --       --  
    Weighted average rate
    4.44 %     4.44 %     -- %     -- %     -- %
                                         
Unadvanced portion of
                                       
   construction loans
    23,740       23,740       --       --       --  

A percentage of commitments to originate mortgage loans are expected to expire unfunded, so the amounts reflected in the table above are not necessarily indicative of future liquidity requirements.  Additionally, the Bank is not obligated to honor commitments to fund unused home equity lines of credit if a customer is delinquent or otherwise in violation of the loan agreement.  

The maturity schedule for our certificate of deposit portfolio at June 30, 2009 is located under “Item 3. Quantitative and Qualitative Disclosure About Market Risk.”  We anticipate we will continue to have sufficient funds, through repayments and maturities of loans and securities, deposits and borrowings, to meet our current commitments.


54

 
The following table presents the maturity of FHLB advances at par and repurchase agreements as of June 30, 2009.  The balance of FHLB advances excludes the deferred gain on the terminated interest rate swaps and the deferred prepayment penalty.  Management will continue to monitor the Bank’s investment opportunities and balance those opportunities with the cost of FHLB advances or other funding sources.

               
Weighted
   
Weighted
 
   
FHLB
   
Repurchase
   
Average
   
Average
 
Maturity by
 
Advances
   
Agreements
   
Contractual
   
Effective
 
Fiscal year
 
Amount
   
Amount
   
Rate
   
Rate(1)
 
   
(Dollars in thousands)
             
2009
  $ 20,000     $ --       5.09 %     5.09 %
2010
    350,000       45,000       4.33       4.33  
2011
    276,000       200,000       4.42       4.42  
2012
    350,000       150,000       3.67       3.67  
2013
    525,000       145,000       3.74       4.00  
2014
    450,000       100,000       3.33       3.96  
2015
    200,000       20,000       3.50       4.16  
2016
    275,000       --       3.86       4.39  
  
  $ 2,446,000     $ 660,000       3.84 %     4.10 %

(1) The effective rate includes the net impact of the amortization of deferred prepayment penalties related to the prepayment of certain FHLB advances and deferred gains related to the termination of interest rate swaps during fiscal year 2008.

The following table presents the maturity of FHLB advances and other borrowings for the next four quarters as of June 30, 2009.  There are no maturities of repurchase agreements during the next four quarters.

         
Weighted
 
         
Average
 
Maturity by
       
Contractual
 
Quarter End
 
Amount
   
Rate
 
  (Dollars in thousands)      
September 30, 2009
  $ 20,000       5.09 %
December 31, 2009
    --       --  
March 31, 2010
    --       --  
June 30, 2010
    100,000       3.94  
    $ 120,000       4.13 %

Contingencies
 
In the normal course of business, the Company and its subsidiary are named defendants in various lawsuits and counter claims.  In the opinion of management, after consultation with legal counsel, none of the currently pending suits are expected to have a materially adverse effect on the Company’s consolidated financial statements for the current interim or future periods.

55


 
Capital
 
Consistent with our goal to operate a sound and profitable financial organization, we actively seek to maintain a “well-capitalized” status in accordance with regulatory standards.  Total equity under GAAP for the Bank was $839.9 million at June 30, 2009, or 10% of total Bank assets on that date.  As of June 30, 2009, the Bank exceeded all capital requirements of the OTS.  The following table presents the Bank’s regulatory capital ratios at June 30, 2009 based upon regulatory guidelines.

         
Regulatory
 
         
Requirement
 
   
Bank
   
For “Well-
 
 
 
Ratios
   
Capitalized” Status
 
Tangible equity
    9.8 %     N/A  
Core capital
    9.8 %     5.0 %
Tier I risk-based capital
    22.9 %     6.0 %
Total risk-based capital
    23.0 %     10.0 %

A reconciliation of the Bank’s equity under GAAP to regulatory capital amounts as of June 30, 2009 is as follows (dollars in thousands):

Total equity as reported under GAAP
  $ 839,929  
  Unrealized gains on AFS securities         
    (23,511 )
  Other
    (348 )
Total tangible and core capital
    816,070  
  Allowance for loan losses
    5,848  
Total risk based capital
  $ 821,918  
 

 
Item 3.   Quantitative and Qualitative Disclosure About Market Risk

For a complete discussion of the Company’s asset and liability management policies, as well as the potential impact of interest rate changes upon the market value of the Company’s portfolios, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management and Market Risk” in the Company’s Annual Report to Stockholders for the year ended September 30, 2008, attached as Exhibit 13 to the Company’s Annual Report on Form 10-K for the year ended September 30, 2008.

The general objective of our interest rate risk management is to determine and manage an appropriate level of interest rate risk while maximizing net interest income, in a manner consistent with our policy to reduce, to the extent possible, the exposure of our net interest income to changes in market interest rates.  ALCO regularly reviews the interest rate risk exposure of the Bank by forecasting the impact of hypothetical, alternative interest rate environments on net interest income and market value of portfolio equity (“MVPE”) at various dates.  The MVPE is defined as the net of the present value of the cash flows of an institution’s existing assets, liabilities and off-balance sheet instruments.  The present values are determined in alternative interest rate environments providing potential changes in net interest income and MVPE under those alternative interest rate environments. The Bank’s analysis of its MVPE at June 30, 2009 indicates a decrease in its risk exposure compared to September 30, 2008 primarily due to lower interest rates at June 30, 2009 compared to September 30, 2008.  The Bank’s analysis of the sensitivity of its net interest income to parallel changes in interest rates at June 30, 2009 indicates a decrease in sensitivity since September 30, 2008.

For each period end presented in the following table, the estimated percentage change in the Bank’s net interest income based on the indicated instantaneous, parallel and permanent change in interest rates is presented.  The percentage change in each interest rate environment represents the difference between estimated net interest income in the zero basis point interest rate environment (“base case”, assumes the forward market and product interest rates implied by the yield curve are realized) and estimated net interest income in each alternative interest rate environment (assumes market and product interest rates have a parallel shift in rates across all maturities by the indicated change in rates).  At June 30, 2009, the three-month Treasury bill yield was less than one
56


percent, so the -100 and -200 basis point scenarios are not presented.  Estimations of net interest income used in preparing the table below are based upon the assumptions the total composition of interest-earning assets and interest-bearing liabilities does not change materially and any repricing of assets or liabilities occurs at anticipated product and market rates for the alternative rate environments as of the dates presented.  The estimation of net interest income does not include any projected gain or loss related to the sale of loans or securities, or income derived from non-interest income sources, but does include the use of different prepayment assumptions in the alternative interest rate environments.  Although certain assets and liabilities may have similar maturities or periods to repricing, they may react differently to changes in market interest rates.  Assumptions may not reflect how actual yields and costs respond to market changes. 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 of assets and liabilities may lag behind changes in market interest rates.  Certain assets, such as ARM loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset.  In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed. It is important to consider that the estimated changes in net interest income are for a cumulative four-quarter period.  These do not reflect the earnings expectations of management.

Percentage Change in Net Interest Income
 
   
At
Change (in Basis Points)
 
June 30,
 
March 31,
 
September 30,
 
in Interest Rates(1)
 
2009
 
 2009
 
 2008
 
               
   000 bp
 
--
 
--
 
--
 
 +100 bp  
 
1.57%
 
3.52%
 
-2.20%
 
 +200 bp  
 
2.19%
 
3.58%
 
-5.08%
 
 +300 bp  
 
2.78%
 
3.26%
 
-8.62%
 

(1)
Assumes an instantaneous, permanent and parallel change in interest rates at all maturities.

The percentage change in the estimated net interest income for March 31, 2009 and June 30, 2009 was positive for all interest rate shock scenarios presented.  The percentage increase in net interest income as of June 30, 2009 was smaller compared to March 31, 2009.  At March 31, 2009, the percentage change in net interest income was quite large in the +100 basis point scenario, with a marginal improvement in the +200 basis point scenario before decreasing somewhat between the +200 and +300 basis point scenarios.  At June 30, 2009, the percentage change in net interest income increase more consistently as rates were shocked higher.  Two factors changed between March 31, 2009 and June 30, 2009 which caused the change in the projected net interest income.  The first change was the increase in interest rates between the two periods.  This resulted in a significant decline in expected cash flows from mortgage-related assets, as borrowers have less incentive to make additional principal payments or refinance their mortgage.  The decline in cash flows resulted in a smaller benefit to the Bank in the rising interest rate scenarios at June 30, 2009, particularly in the +100 basis point scenario, as a result of fewer cash flows reinvesting at higher rates.  At March 31, 2009, expected cash flows from mortgage-related assets remained relatively high in the +100 basis point scenario as a result of the low level of interest rates at that time.  As of June 30, 2009, interest rates for the base case had moved up considerably from March 31, 2009, resulting in a decrease in expected cash flows and therefore a corresponding decrease in net interest income on mortgage-related assets in the base case as compared to March 31, 2009.

The second change was, in May 2009, the Bank refinanced $300.0 million of FHLB advances that were expected to mature in July 2009 into new advances with longer maturities.  The negative impact to net interest income at June 30, 2009 due to the significant decline in cash flows of our mortgage-related assets was primarily offset by the impact of the FHLB refinances.  See additional discussion of the refinance of the FHLB advances in “Notes to Financial Statements - Note 6 - FHLB advances.”  The refinance decreased the amount of interest-bearing liabilities at June 30, 2009 that are expected to reprice in the upcoming year, as compared to March 31, 2009.  As a result, when interest rates are shocked upwards from the base case, interest expense is much lower at June 30, 2009 than March 31, 2009 which results in an increase in net interest income.

 
57

 



The following table sets forth the estimated percentage change in MVPE at each period end presented based on the indicated instantaneous, parallel and permanent change in interest rates.  The MVPE is defined as the net of the present value of the cash flows of an institution’s existing assets, liabilities and off-balance sheet instruments.  The percentage change in each interest rate environment represents the difference between MVPE in the base case and MVPE in each alternative interest rate environment.  At June 30, 2009, the three-month Treasury bill was less than one percent, so the -100 and -200 basis point scenarios are not presented.  The estimations of MVPE used in preparing the table below are based upon the assumptions the total composition of interest-earning assets and interest-bearing liabilities does not change, any repricing of assets or liabilities occurs at current product or market rates for the alternative rate environments as of the dates presented, and different prepayment rates are used in each alternative interest rate environment.  The estimated MVPE results from the valuation of cash flows from financial assets and liabilities over the anticipated lives of each for each interest rate environment.  The table presents the effects of the change in interest rates on our assets and liabilities as they mature, repay or reprice, as shown by the change in the MVPE in changing interest rate environments.
 
Percentage Change in MVPE
     
   
At
Change (in Basis Points)
 
June 30,
 
March 31,
 
September 30,
 
in Interest Rates(1)
 
 2009
 
 2009
 
 2008
 
               
000 bp
 
--
 
--
 
--
 
 +100 bp  
 
-5.95%
 
0.70%
 
-6.99%
 
 +200 bp  
 
-16.17%
 
-6.51%
 
-19.37%
 
 +300 bp  
 
-29.18%
 
-18.34%
 
-34.88%
 

 (1)
Assumes an instantaneous, permanent and parallel change in interest rates at all maturities.

Changes in the estimated market values of our financial assets and liabilities drive changes in the estimates of MVPE.  The market value of shorter term-to-maturity financial instruments are less sensitive to changes in interest rates than the market value of longer term-to-maturity financial instruments.  Because of this, our certificates of deposit (which have relatively short average lives) tend to display less sensitivity to changes in interest rates than do our mortgage-related assets (which have relatively long average lives).  However, the expected average life on our mortgage-related assets varies under different interest rate environments because borrowers have the ability to prepay their mortgage loans.  Prepayment assumptions change on mortgage-related assets under various interest rate environments because many borrowers look to obtain financing at the lowest cost available.  Generally, there is no penalty to prepay a mortgage loan we have originated or purchased.  If interest rates decrease, the borrower has an economic incentive to lower their mortgage payment (through a lower interest rate) with only the fees associated on the new mortgage or loan modification as a cost to lower this rate.  In a decreasing interest rate environment, prepayments increase and the average life of a mortgage shortens compared to higher interest rate environments.  When interest rates increase, the economic incentive for borrowers to refinance or modify their mortgage payment is reduced, resulting in lower prepayment assumptions and longer average lives.

The MVPE decreased in all interest rate shock scenarios as of June 30, 2009 and became more sensitive to changes in interest rates compared to March 31, 2009.  The changes from March 31, 2009 were primarily driven by the increase in interest rates between the two periods.  This increase resulted in a significant increase in the WAL of all mortgage-related assets as borrowers have less economic incentive to lower their mortgage payment.  This caused an increase in the price sensitivity of all mortgage-related assets, and as a result, in interest-earning assets as a whole.  At June 30, 2009, interest-earning assets were more price sensitive than interest-bearing liabilities, resulting in a decrease in the MVPE in all interest rate shock scenarios presented.  At March 31, 2009, interest rates were at levels low enough that interest-earning assets did not become more sensitive to changes in interest rates compared to interest-bearing liabilities until the +200 basis point scenario.

Gap Table:  The following gap table summarizes the anticipated maturities or repricing of our interest-earning assets and interest-bearing liabilities as of June 30, 2009, based on the information and assumptions set forth in the notes below.  Cash flow projections for mortgage loans and MBS are calculated based on current interest rates.  Prepayment projections are subjective in nature, involve uncertainties and assumptions and, therefore, cannot be determined with a high degree of accuracy. For additional information regarding the impact of changes in interest rates, see the Percentage Change in Net Interest Income and Percentage Change in MVPE tables above.

 
58

 


June 30, 2009
Within Three Months
   
Three Months To One Year
   
More Than One Year to Three Years
   
More Than Three Years to Five Years
   
Over Five Years
   
Total
Interest-earning assets:
 
(Dollars in thousands)
 
Loans receivable(1):
                                   
Mortgage loans:
                                   
Fixed
  $ 379,571     $ 515,468     $ 928,803     $ 608,368     $ 1,732,246     $ 4,164,456  
Adjustable
    152,489       532,585       437,234       46,526       9,673       1,178,507  
Other loans
    135,765       23,193       23,583       8,787       12,312       203,640  
Securities:
                                               
Non-mortgage securities(2)
    30,726       29,727       194,890       39,772       28,628       323,743  
MBS(3)
    380,617       579,306       454,749       246,449       400,501       2,061,622  
Other interest-earning assets
    65,204       --       --       --       --       65,204  
Total interest-earning assets
    1,144,372       1,680,279       2,039,259       949,902       2,183,360       7,997,172  
                                                 
Interest-bearing liabilities:
                                               
Deposits:
                                               
Savings (4)
    104,187       8,395       19,356       15,013       83,210       230,161  
Checking (4)
    10,474       31,745       107,525       61,871       234,816       446,431  
Money market (4)
    36,972       102,233       193,969       164,375       343,973       841,522  
Certificates
    441,632       1,193,397       924,348       96,690       1,070       2,657,137  
Borrowings (5)
    73,608       100,000       1,171,000       1,220,000       595,000       3,159,608  
Total interest-bearing liabilities
    666,873       1,435,770       2,416,198       1,557,949       1,258,069       7,334,859  
                                                 
Excess (deficiency) of interest-earning assets over interest bearing liabilities
  $ 477,499     $ 244,509     $ (376,939 )   $ (608,047 )   $ 925,291     $ 662,313  
                                                 
                                                 
Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities
  $ 477,499     $ 722,008     $ 345,069     $ (262,978 )   $ 662,313          
                                                 
Cumulative excess (deficiency) of interest-earning
                                               
  assets over interest-bearing liabilities as a
                                               
   percent of total assets at June 30, 2009
    5.74 %     8.68 %     4.15 %     (3.16 )%     7.96 %        
Cumulative excess (deficiency) at September 30, 2008
    (0.10 )%     1.90 %     (1.19 )%     (4.16 )%     9.05 %        

 
59

 

(1)  Adjustable-rate loans are included in the period in which the rate is next scheduled to adjust or in the period in which repayments are expected to occur prior to their next rate adjustment, rather than in the period in which the loans are due.  Fixed-rate loans are included in the periods in which they are scheduled to be repaid, based on scheduled amortization and prepayment assumptions.  Balances have been reduced for non-performing loans, which totaled $29.1 million at June 30, 2009.
(2)  Based on contractual maturities, or terms to call date or pre-refunding dates as of June 30, 2009, and excludes the unrealized loss adjustment of $1.6 million on AFS investment securities.
(3)  Reflects estimated prepayments of MBS in our portfolio, and excludes the unrealized gain adjustment of $39.4 million on AFS MBS.
(4)  Although our checking, savings and money market accounts are subject to immediate withdrawal, management considers a substantial amount of such accounts to be core deposits having significantly longer effective maturities.  The decay rates (the assumed rate at which the balance of existing accounts would decline) used on these accounts are based on assumptions developed based upon our actual experience with these accounts.  If all of our checking, savings and money market accounts had been assumed to be subject to repricing within one year, interest-bearing liabilities which were estimated to mature or reprice within one year would have exceeded interest-earning assets with comparable characteristics by $502.1 million, for a cumulative one-year gap of (6.04)% of total assets.
(5)  Borrowings exclude $35.9 million of deferred prepayment penalty costs and $837 thousand of deferred gain on the terminated interest rate swaps.

The change in the one-year gap to 8.68% at June 30, 2009 from 1.90% at September 30, 2008 was a result of a significant decrease in interest rates, particularly mortgage interest rates, and to the extension in the maturity of borrowings.  The decrease in mortgage interest rates increased projected cash flows from mortgage loan prepayments which resulted in shorter average lives and quicker repricing of interest-earning assets at June 30, 2009 compared to September 30, 2008.






 
60

 


Changes in portfolio composition.  The following table presents the distribution of our investment and MBS portfolios, at cost, at the dates indicated.  Overall, fixed-rate securities comprised 56% of these portfolios at June 30, 2009.  The WAL is the estimated remaining maturity after historical prepayment speeds and projected call option assumptions have been applied.  The decrease in the WAL between September 30, 2008 and June 30, 2009 was due to faster prepayment speeds and purchases of securities with WALs shorter than the portfolio, maturity of securities, and to calls with WALs longer than the portfolio.  The decrease in the yield between September 30, 2008 and June 30, 2009 was a result of a decrease in the yield of adjustable-rate MBS that reset during the year to lower market rates, calls and maturities of higher yielding investment securities, and purchases of securities with yields lower than the overall securities portfolio.


   
June 30, 2009
   
March 31, 2009
   
December 31, 2008
   
September 30, 2008
 
   
Balance
   
WAL
   
Yield
   
Balance
   
WAL
   
Yield
   
Balance
   
WAL
   
Yield
   
Balance
   
WAL
   
Yield
 
   
(Dollars in thousands)
                   
Fixed-rate investments:
                                                                       
U.S. government-sponsored agencies
  $ 254,424       1.01       1.49 %   $ 152,067       0.75       1.68 %   $ 45,036       0.24       3.22 %   $ 82,552       5.55       4.28 %
MBS
    1,025,056       3.07       4.84       1,105,095       4.03       4.84       1,164,744       5.08       4.88       1,207,086       4.92       4.88  
Municipal bonds
    65,530       4.02       3.23       60,537       4.27       3.31       58,806       4.17       3.41       58,062       4.81       3.39  
   Total fixed-rate investments
    1,345,010       2.73       4.13       1,317,699       3.66       4.41       1,268,586       4.87       4.75       1,347,700       4.95       4.78  
                                                                                                 
Adjustable-rate investments:
                                                                                               
MBS
    1,036,566       6.03       4.34       1,057,683       7.15       4.60       986,908       6.68       4.75       1,034,734       5.21       4.76  
Trust preferred securities
    3,789       27.98       2.29       3,812       28.23       2.98       3,842       28.48       3.66       3,859       28.73       4.48  
   Total adjustable-rate investments
    1,040,355       6.11       4.33       1,061,495       7.25       4.59       990,750       6.79       4.75       1,038,593       5.32       4.76  
     Total investment portfolio, at cost
  $ 2,385,365       4.20       4.22 %   $ 2,379,194       5.26       4.49 %   $ 2,259,336       5.71       4.75 %   $ 2,386,293       5.11       4.77 %


 

 
61

 


 
The certificate of deposit portfolio increased $138.1 million from September 30, 2008 to June 30, 2009, and the average cost of the portfolio decreased 61 basis points between the two reporting dates due to certificates repricing to lower market rates.  Retail certificates, public units, and brokered deposits maturing in one year or less at June 30, 2009 were $1.64 billion with an average cost of 3.10%.  The following table presents the maturity of certificates of deposit at the dates indicated.


   
June 30, 2009
   
March 31, 2009
   
December 31, 2008
   
September 30, 2008
 
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
   
Amount
   
Rate
 
   
(Dollars in thousands)
 
Retail certificates maturing within:
                                               
0 to 3 months
  $ 395,427       3.24 %   $ 347,478       3.08 %   $ 333,638       3.14 %   $ 409,684       4.39 %
3 to 6 months
    407,767       3.02       386,295       3.29       339,065       3.14       327,479       3.26  
6 months to one year
    683,179       3.08       623,949       3.11       670,432       3.37       634,102       3.36  
One year to two years
    504,788       3.64       579,138       3.98       496,201       4.15       559,607       4.15  
After two years
    514,320       3.61       484,315       3.69       493,310       3.90       407,549       3.93  
    $ 2,505,481       3.31 %   $ 2,421,175       3.46 %   $ 2,332,646       3.58 %   $ 2,338,421       3.81 %
                                                                 
Average maturity (in years)
    1.12               1.16               1.16               1.13          
                                                                 
Public unit and brokered deposits maturing within:
                                                               
0 to 3 months
  $ 46,206       1.11 %   $ 70,910       2.70 %   $ --       0.00 %   $ 84,686       5.21 %
3 to 6 months
    86,450       4.58       27,500       1.38       24,434       5.21       --       0.00  
6 months to one year
    16,000       1.09       89,450       4.48       71,449       5.20       24,435       5.21  
One year to two years
    3,000       1.76       3,000       1.76       --       0.00       71,454       5.20  
    $ 151,656       3.10 %   $ 190,860       3.33 %   $ 95,883       5.20 %   $ 180,575       5.21 %
                                                                 
Average maturity (in years)
    0.34               0.43               0.76               0.61          
                                                                 
Total retail certificates, public unit,
   and brokered deposits
  $ 2,657,137       3.30 %   $ 2,612,035       3.45 %   $ 2,428,529       3.64 %   $ 2,518,996       3.91 %
                                                                 
Total average maturity (in years)
    1.08               1.11               1.15               1.09          

 
62

 

Item 4.  Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934, as amended, the “Act”) as of June 30, 2009.  Based upon this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that as of June 30, 2009, such disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Act is accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) to allow timely decisions regarding required disclosure, and is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Changes in Internal Control Over Financial Reporting
During the quarter ended June 30, 2009, there were no changes in the Company’s internal control over financial reporting as defined by Rule 13a-15(d) of the Act that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II -   OTHER INFORMATION

Item 1.  Legal Proceedings
We are not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business.  We believe that these routine legal proceedings, in the aggregate, are immaterial to our financial condition and results of operations.

Item 1A.  Risk Factors
There have been no material changes to our risk factors since September 30, 2008.  For a summary of other risk factors relevant to our operations, see Part I, Item 1A in our 2008 Annual Report on Form 10-K.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
See “Liquidity and Capital Resources - Capital” in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” regarding the OTS restrictions on dividends from the Bank to the Company.

The following table summarizes our share repurchase activity during the three months ended June 30, 2009 and additional information regarding our share repurchase program.   Our current repurchase plan of 500,000 shares was announced on May 26, 2006.  The plan has no expiration date and had 130,368 shares remaining as of June 30, 2009.  The Company intends to repurchase shares from time to time, depending on market conditions, at prevailing market prices in open-market and other transactions.  The shares would be held as treasury stock for general corporate use.
 
   
Total
         
Total Number of
   
Maximum Number
 
   
Number of
   
Average
   
Shares Purchased as
   
of Shares that May
 
   
Shares
   
Price Paid
   
Part of Publicly
   
Yet Be Purchased
 
Period
 
Purchased
   
per Share
   
Announced Plans
   
Under the Plan
 
April 1, 2009 through
                       
April 30, 2009
    --       --       --       130,368  
May 1, 2009 through
                               
May 31, 2009
    --       --       --       130,368  
June 1, 2009 through
                               
June 30, 2009
    --       --       --       130,368  
     Total
    --               --          

<Index>
Item 3.  Defaults Upon Senior Securities
Not applicable.

<Index>
Item 4.  Submission of Matters to a Vote of Security Holders
None.

<Index>


63

Item 5.  Other Information
Not applicable.

<Index>
Item 6.  Exhibits
See Index to Exhibits.

 
64

 

SIGNATURES

Pursuant to the requirement 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.

CAPITOL FEDERAL FINANCIAL


Date:  August 4, 2009                                                By: /s/ John B. Dicus                        
                                                                                      John B. Dicus, Chairman, President and
                                                                                      Chief Executive Officer


Date:  August 4, 2009                                               By: /s/ Kent G. Townsend                 
                                                                                      Kent G. Townsend, Executive Vice President and
                                                                                      Chief Financial Officer


<Index>

 
65

 

INDEX TO EXHIBITS
Exhibit
Number
 
  Document
     2.0
 
Plan of Reorganization and Stock Issuance Plan*
     3(i)
 
Federal Stock Charter of Capitol Federal Financial*
     3(ii)
 
Bylaws of Capitol Federal Financial filed on November 29, 2007 as Exhibit 3(ii) to
   
the Annual Report on Form 10-K and incorporated herein by reference
     4(i)
 
Form of Stock Certificate of Capitol Federal Financial*
     4(ii)
 
The Registrant agrees to furnish to the Securities and Exchange Commission, upon request, the
   
instruments defining the rights of the holders of the Registrant’s long-term debt.
   10.1(i)
 
Registrant’s Thrift Plan filed on November 29, 2007 as Exhibit 10.1(i) to
   
the Annual Report on Form 10-K and incorporated herein by reference
   10.1(ii)
 
Registrant’s Stock Ownership Plan filed on November 29, 2007 as Exhibit 10.1(ii) to
   
the Annual Report on Form 10-K and incorporated herein by reference
   10.2
 
Registrant’s 2000 Stock Option and Incentive Plan (the “Stock Option Plan”) filed on April 13,
   
2000 as Appendix A to Registrant’s Revised Proxy Statement (File No. 000-25391) and incorporated herein by reference
 
   10.3
 
Registrant’s 2000 Recognition and Retention Plan (the “RRP”) filed on April 13, 2000 as
   
Appendix B to Registrant’s Revised Proxy Statement (File No. 000-25391) and incorporated herein by reference
   10.4
 
Capitol Federal Financial Deferred Incentive Bonus Plan, as amended, filed on May 5, 2009 as Exhibit 10.4 to the March 31, 2009 Form 10-Q and incorporated herein by reference
 
   10.5
 
Form of Incentive Stock Option Agreement under the Stock Option Plan filed on February 4, 2005
   
as Exhibit 10.5 to the December 31, 2004 Form 10-Q and incorporated herein by reference
   10.6
 
Form of Non-Qualified Stock Option Agreement under the Stock Option Plan filed on February 4,
   
2005 as Exhibit 10.6 to the December 31, 2004 Form 10-Q and incorporated herein by reference
   10.7
 
Form of Restricted Stock Agreement under the RRP filed on February 4, 2005 as Exhibit 10.7 to the
   
December 31, 2004 Form 10-Q and incorporated herein by reference
   10.8
 
Description of Named Executive Officer Salary and Bonus Arrangements filed on December 1,
   
2008 as Exhibit 10.8 to the Annual Report on Form 10-K and incorporated herein by reference
   10.9
 
Description of Director Fee Arrangements filed on February 4, 2009 as Exhibit 10.9 to the December 31, 2008 Form 10-Q and incorporated herein by reference
   10.10
 
Short-term Performance Plan filed on December 14, 2005 as Exhibit 10.10 to the Annual
   
Report on Form 10-K for the fiscal year ended September 30, 2005 and incorporated herein by reference
   11
 
Statement re: computation of earnings per share**
   31.1
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 made by John B. Dicus, Chairman, President and Chief Executive Officer
   31.2
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 made by Kent G. Townsend, Executive Vice President and Chief Financial Officer
 
   32
 
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 made by John B. Dicus, Chairman, President and Chief Executive Officer, and Kent G. Townsend, Executive Vice President and Chief Financial Officer

 *Incorporated by reference from Capitol Federal Financial’s Registration Statement on Form S-1 (File No. 333-68363) filed on February 11, 1999, as amended and declared effective on the same date.

  **No statement is provided because the computation of per share earnings on both a basic and fully diluted basis can be clearly determined from the Financial Statements included in this report.

 
65