Capitol Federal Financial, Inc. 10-Q

Item 1. Financial Statements CAPITOL FEDERAL FINANCIAL, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars in thousands, except per share amounts) June 30, September 30, 2020 2019 ASSETS: Cash and cash equivalents (includes interest-earning deposits of $ 381,946 and $ 198,809 ) $ 396,219 $ 220,370 Available-for-sale ("AFS") securities, at estimated fair value 1,220,054 1,204,863 Loans receivable, net (allowance for credit losses ("ACL") of $ 31,215 and $ 9,226 ) 7,388,090 7,416,747 Federal Home Loan Bank Topeka ("FHLB") stock, at cost 102,782 98,456 Premises and equipment, net 98,953 96,784 Income taxes receivable, net 1,655 2 Other assets 351,061 302,796 TOTAL ASSETS $ 9,558,814 $ 9,340,018 LIABILITIES: Deposits $ 6,069,684 $ 5,581,867 Borrowings 1,989,089 2,239,989 Advance payments by borrowers for taxes and insurance 39,125 65,686 Deferred income tax liabilities, net 10,942 14,282 Accounts payable and accrued expenses 149,454 101,868 Total liabilities 8,258,294 8,003,692 STOCKHOLDERS' EQUITY: Preferred stock, $ .01 par value; 100,000,000 shares authorized, no shares issued or outstanding — — Common stock, $ .01 par value; 1,400,000,000 shares authorized, 141,511,716 and 141,440,030 shares issued and outstanding as of June 30, 2020 and September 30, 2019, respectively 1,415 1,414 Additional paid-in capital 1,211,653 1,210,226 Unearned compensation, Employee Stock Ownership Plan ("ESOP") ( 33,453 ) ( 34,692 ) Retained earnings 138,496 174,277 Accumulated other comprehensive (loss) income ("AOCI"), net of tax ( 17,591 ) ( 14,899 ) Total stockholders' equity 1,300,520 1,336,326 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 9,558,814 $ 9,340,018 See accompanying notes to consolidated financial statements. 3 CAPITOL FEDERAL FINANCIAL, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollars in thousands, except per share amounts) For the Three Months Ended For the Nine Months Ended June 30, June 30, 2020 2019 2020 2019 INTEREST AND DIVIDEND INCOME: Loans receivable $ 66,652 $ 71,434 $ 206,179 $ 213,863 Mortgage-backed securities ("MBS") 5,616 6,613 17,584 19,437 FHLB stock 1,207 1,865 4,747 5,667 Investment securities 847 1,835 3,736 4,781 Cash and cash equivalents 59 464 1,126 2,921 Total interest and dividend income 74,381 82,211 233,372 246,669 INTEREST EXPENSE: Deposits 16,533 16,909 52,299 48,730 Borrowings 11,561 13,621 37,421 41,360 Total interest expense 28,094 30,530 89,720 90,090 NET INTEREST INCOME 46,287 51,681 143,652 156,579 PROVISION FOR CREDIT LOSSES — 450 22,300 450 NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 46,287 51,231 121,352 156,129 NON-INTEREST INCOME: Deposit service fees 2,539 3,131 8,384 9,581 Insurance commissions 671 905 1,762 2,072 Other non-interest income 1,229 1,638 4,468 4,446 Total non-interest income 4,439 5,674 14,614 16,099 NON-INTEREST EXPENSE: Salaries and employee benefits 13,059 13,454 39,765 39,205 Information technology and related expense 4,285 4,652 12,694 13,535 Occupancy, net 3,556 3,224 10,212 9,768 Regulatory and outside services 1,548 1,425 4,188 4,247 Advertising and promotional 1,004 1,447 3,773 3,597 Deposit and loan transaction costs 697 681 2,086 1,882 Office supplies and related expense 475 689 1,586 1,884 Federal insurance premium 287 600 287 1,787 Other non-interest expense 1,253 1,519 4,237 4,709 Total non-interest expense 26,164 27,691 78,828 80,614 INCOME BEFORE INCOME TAX EXPENSE 24,562 29,214 57,138 91,614 INCOME TAX EXPENSE 5,088 6,317 10,877 19,780 NET INCOME $ 19,474 $ 22,897 $ 46,261 $ 71,834 Basic earnings per share ("EPS") $ 0.14 $ 0.17 $ 0.34 $ 0.52 Diluted EPS $ 0.14 $ 0.17 $ 0.34 $ 0.52 Basic weighted average common shares 138,018,052 137,720,480 137,961,231 137,635,099 Diluted weighted average common shares 138,018,052 137,787,528 137,992,978 137,690,434 See accompanying notes to consolidated financial statements. 4 CAPITOL FEDERAL FINANCIAL, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (Dollars in thousands) For the Three Months Ended For the Nine Months Ended June 30, June 30, 2020 2019 2020 2019 Net income $ 19,474 $ 22,897 $ 46,261 $ 71,834 Other comprehensive income (loss), net of tax: Unrealized gains (losses) on AFS securities arising during the period, net of taxes of $( 1,775 ), $( 1,317 ), $( 4,962 ) and $( 3,432 ) 5,533 4,102 15,459 10,690 Changes in unrealized gains (losses) on cash flow hedges, net of taxes of $ 367 , $ 3,601 , $ 5,826 and $ 8,847 ( 1,146 ) ( 11,218 ) ( 18,151 ) ( 27,562 ) Comprehensive (loss) income $ 23,861 $ 15,781 $ 43,569 $ 54,962 See accompanying notes to consolidated financial statements. 5 CAPITOL FEDERAL FINANCIAL, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited) (Dollars in thousands, except per share amounts) For the Nine Months Ended June 30, 2020 Additional Unearned Total Common Paid-In Compensation Retained Stockholders' Stock Capital ESOP Earnings AOCI Equity Balance at September 30, 2019 $ 1,414 $ 1,210,226 $ ( 34,692 ) $ 174,277 $ ( 14,899 ) $ 1,336,326 Cumulative effect of adopting Accounting Standards Update ("ASU") 2016-02 88 88 Net income 22,511 22,511 Other comprehensive income, net of tax 4,972 4,972 ESOP activity 169 413 582 Restricted stock activity, net ( 1 ) ( 1 ) Stock-based compensation 166 166 Stock options exercised 1 612 613 Cash dividends to stockholders ($ 0.425 per share) ( 58,663 ) ( 58,663 ) Balance at December 31, 2019 $ 1,415 $ 1,211,172 $ ( 34,279 ) $ 138,213 $ ( 9,927 ) $ 1,306,594 Net income 4,276 4,276 Other comprehensive loss, net of tax ( 12,051 ) ( 12,051 ) ESOP activity 117 413 530 Stock-based compensation 152 152 Stock options exercised 25 25 Cash dividends to stockholders ($ 0.085 per share) ( 11,733 ) ( 11,733 ) Balance at March 31, 2020 1,415 1,211,466 ( 33,866 ) 130,756 ( 21,978 ) 1,287,793 Net income 19,474 19,474 Other comprehensive income, net of tax 4,387 4,387 ESOP activity 61 413 474 Restricted stock activity, net ( 6 ) ( 6 ) Stock-based compensation 132 132 Cash dividends to stockholders ($ 0.085 per share) ( 11,734 ) ( 11,734 ) Balance at June 30, 2020 $ 1,415 $ 1,211,653 $ ( 33,453 ) $ 138,496 $ ( 17,591 ) $ 1,300,520 (Continued) 6 For the Nine Months Ended June 30, 2019 Additional Unearned Total Common Paid-In Compensation Retained Stockholders' Stock Capital ESOP Earnings AOCI Equity Balance at September 30, 2018 $ 1,412 $ 1,207,644 $ ( 36,343 ) $ 214,569 $ 4,340 $ 1,391,622 Cumulative effect of adopting ASU 2014-09 394 394 Net income 24,383 24,383 Other comprehensive loss, net of tax ( 6,217 ) ( 6,217 ) ESOP activity 118 413 531 Stock-based compensation 95 95 Stock options exercised 1 466 467 Cash dividends to stockholders ($ 0.475 per share) ( 65,362 ) ( 65,362 ) Balance at December 31, 2018 $ 1,413 $ 1,208,323 $ ( 35,930 ) $ 173,984 $ ( 1,877 ) $ 1,345,913 Net income 24,554 24,554 Other comprehensive loss, net of tax ( 3,539 ) ( 3,539 ) ESOP activity 134 413 547 Stock-based compensation 90 90 Stock options exercised 118 118 Cash dividends to stockholders ($ 0.085 per share) ( 11,700 ) ( 11,700 ) Balance at March 31, 2019 1,413 1,208,665 ( 35,517 ) 186,838 ( 5,416 ) 1,355,983 Net income 22,897 22,897 Other comprehensive loss, net of tax ( 7,116 ) ( 7,116 ) ESOP activity 147 413 560 Stock-based compensation 167 167 Stock options exercised 1 761 762 Cash dividends to stockholders ($ 0.335 per share) ( 46,154 ) ( 46,154 ) Balance at June 30, 2019 $ 1,414 $ 1,209,740 $ ( 35,104 ) $ 163,581 $ ( 12,532 ) $ 1,327,099 See accompanying notes to consolidated financial statements. 7 CAPITOL FEDERAL FINANCIAL, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands) For the Nine Months Ended June 30, 2020 2019 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 46,261 $ 71,834 Adjustments to reconcile net income to net cash provided by operating activities: FHLB stock dividends ( 4,747 ) ( 5,667 ) Provision for credit losses 22,300 450 Amortization and accretion of premiums and discounts on securities 999 959 Depreciation and amortization of premises and equipment 6,812 6,907 Amortization of intangible assets 1,493 1,766 Amortization of deferred amounts related to FHLB advances, net 315 6 Common stock committed to be released for allocation - ESOP 1,586 1,638 Stock-based compensation 450 352 Changes in: Unrestricted cash collateral (provided to)/received from derivative counterparties, net — ( 9,970 ) Other assets, net 5,049 2,962 Income taxes payable/receivable, net ( 1,649 ) 1,679 Deferred income tax liabilities, net ( 2,507 ) ( 699 ) Accounts payable and accrued expenses ( 7,225 ) ( 16,691 ) Net cash provided by operating activities 69,137 55,526 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of AFS securities ( 465,764 ) ( 286,488 ) Proceeds from calls, maturities and principal reductions of AFS securities 469,995 246,648 Proceeds from calls, maturities and principal reductions of held-to-maturity ("HTM") securities — 126,684 Proceeds from the redemption of FHLB stock 421 102,554 Purchase of FHLB stock — ( 97,270 ) Net change in loans receivable 6,120 5,533 Purchase of premises and equipment ( 9,422 ) ( 8,846 ) Proceeds from sale of other real estate owned ("OREO") 993 1,624 Proceeds from bank-owned life insurance ("BOLI") death benefit 490 — Net cash provided by investing activities 2,833 90,439 (Continued) 8 CAPITOL FEDERAL FINANCIAL, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands) For the Nine Months Ended June 30, 2020 2019 CASH FLOWS FROM FINANCING ACTIVITIES: Cash dividends paid ( 82,130 ) ( 123,216 ) Net change in deposits 487,817 ( 22,483 ) Proceeds from borrowings 1,325,600 3,043,700 Repayments on borrowings ( 1,572,600 ) ( 3,088,752 ) Change in advance payments by borrowers for taxes and insurance ( 26,561 ) ( 25,495 ) Payment of FHLB prepayment penalties ( 4,215 ) — Stock options exercised 638 1,347 Net cash provided by (used in) financing activities 128,549 ( 214,899 ) NET INCREASE (DECREASE) IN CASH, CASH EQUIVALENTS, RESTRICTED CASH AND RESTRICTED CASH EQUIVALENTS 200,519 ( 68,934 ) CASH, CASH EQUIVALENTS, RESTRICTED CASH AND RESTRICTED CASH EQUIVALENTS: Beginning of period 253,700 139,055 End of period $ 454,219 $ 70,121 SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Operating lease right-of-use assets obtained $ 16,841 $ — Operating lease liabilities obtained $ 16,726 $ — See accompanying notes to consolidated financial statements. (Concluded) 9 Notes to Consolidated Financial Statements (Unaudited) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation - The consolidated financial statements include the accounts of Capitol Federal Financial, Inc.® (the "Company") and its wholly-owned subsidiary, Capitol Federal Savings Bank (the "Bank"). The Bank has two wholly-owned subsidiaries, Capitol Funds, Inc. and Capital City Investments, Inc. Capitol Funds, Inc. has a wholly-owned subsidiary, Capitol Federal Mortgage Reinsurance Company. Capital City Investments, Inc. is a real estate and investment holding company. All intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted 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 Annual Report on Form 10-K for the fiscal year ended September 30, 2019, filed with the Securities and Exchange Commission ("SEC"). Interim results are not necessarily indicative of results for a full year. Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents - Cash, cash equivalents, restricted cash and restricted cash equivalents reported in the statement of cash flows include cash and cash equivalents of $ 396.2 million and $ 220.4 million at June 30, 2020 and September 30, 2019, respectively, and restricted cash and cash equivalents of $ 58.0 million and $ 33.3 million at June 30, 2020 and September 30, 2019, respectively, which was included in other assets on the consolidated balance sheet. The restricted cash and cash equivalents relate to the collateral postings to/from the Bank's derivative counterparties associated with the Bank's interest rate swaps. See additional discussion regarding the interest rate swaps in Note 5. Borrowed Funds. Net Presentation of Cash Flows Related to Borrowings - At times, the Bank enters into certain FHLB advances with contractual maturities of 90 days or less. Cash flows related to these advances are reported on a net basis in the consolidated statements of cash flows. There was no FHLB advance activity reported on a net basis in the consolidated statements of cash flows during the nine months ended June 30, 2020 and 2019. Leases - The Company leases real estate property for branches, ATMs, and certain equipment. All of the leases in which the Company is the lessee are classified as operating leases. The Company determines if an arrangement is a lease at inception and if the lease is an operating lease or a finance lease. Operating lease right-of-use assets represent the Company's right to use an underlying asset during the lease term and operating lease liabilities represent the Company's obligation to make lease payments arising from the lease. The right-of-use assets associated with operating leases are recorded in other assets in the Company's consolidated balance sheets. The lease liabilities associated with operating leases are included in accounts payable and accrued expenses on the consolidated balance sheets. The period over which the right-of-use asset is amortized is generally the lesser of the expected remaining term or the remaining useful life of the leased asset. The lease liability is decreased as periodic lease payments are made. The Company performs impairment assessments for right-of-use assets when events or changes in circumstances indicate that their carrying values may not be recoverable. The calculated amount of the right-of-use assets and lease liabilities are impacted by the length of the lease term and the discount rate used to calculate the present value of the minimum remaining lease payments. The Company's lease agreements often include one or more options to renew at the Company's discretion. If, at lease inception, the Company considers the exercising of a renewal option to be reasonably certain, the Company includes the extended term in the calculation of the right-of-use asset and lease liability. Generally, the Company cannot practically determine the interest rate implicit in the lease so the Company's incremental borrowing rate is used as the discount rate for the lease. The Company uses FHLB advance interest rates, which have been deemed as the Company's incremental borrowing rate, at lease inception based upon the term of the lease. For operating leases existing prior to October 1, 2019, the rate for the remaining lease term as of October 1, 2019 was applied. The Company's lease agreements do not contain any material residual value guarantees or material restrictive covenants. Lease expense, variable lease expense and short-term lease expense are included in occupancy expense in the Company's consolidated statements of income. For facility-related leases, the Company elected, by lease class, to not separate lease and non-lease components. Lease expense is recognized on a straight-line basis over the lease term. Variable lease expense primarily represents payments such as common area maintenance and utilities and are recognized as expense in the period when those payments are incurred. Short-term lease expense relates to leases with an initial term of 12 months or less. The Company has elected to not record a right-of-use asset or lease liability for short-term leases. Recent Accounting Pronouncements - In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-02, Leases . The ASU, as amended, revises lease accounting guidance by requiring that lessees recognize the assets and liabilities arising 10 from leases on the balance sheet. Additionally, the ASU requires entities to disclose both quantitative and qualitative information regarding their leasing activities. The accounting applied by a lessor is largely unchanged from that applied under the previous guidance. In July 2018, the FASB issued ASU 2018-11, Leases , which provides entities with relief from the costs of implementation by allowing the option to not restate comparative periods as part of the transition. The ASU, as amended, became effective for the Company on October 1, 2019. Upon adoption, the Company elected the modified retrospective approach and the optional transition method under which the Company used the effective date as the date of initial application of the amendments. The optional practical expedients the Company elected include: (1) not reassessing whether any expired or existing contracts are or contain leases, (2) not reassessing the classification of any expired or existing contracts, (3) not reassessing initial direct costs for existing leases, and (4) using hindsight for leases existing at adoption date. For leases with an initial term of 12 months or less, the Company elected the short-term lease option, which entails not recognizing right-of-use assets and lease liabilities for these leases. Additionally, the Company elected, for facility-related leases, the practical expedient that allows an entity to elect, by lease class, the ability to not separate lease and non-lease components. Upon adoption, the Company recognized a right-of-use asset of $ 15.7 million and a lease liability of $ 15.5 million, related to the Company's non-cancellable operating lease commitments based on the present value of the expected remaining lease payments as of October 1, 2019. The cumulative-effect adjustment to retained earnings at the time of adoption totaled $ 88 thousand. These ASUs did not have a material impact on the Company's results of operations and cash flows at the time of adoption. The disclosures required by the ASU are included in Note 9. Leases. In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments . The ASU, as amended, replaces the incurred loss impairment methodology in current GAAP, which requires credit losses to be recognized when it is probable that a loss has been incurred, with a new impairment methodology. The new impairment methodology requires an entity to measure, at each reporting date, the expected credit losses of financial assets not measured at fair value, such as loans and loan commitments, over their contractual lives. Under the new impairment methodology, expected credit losses will be measured at each reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Additionally, the ASU amends the current credit loss measurements for AFS debt securities. Credit losses related to AFS debt securities will be recorded through the ACL rather than as a direct write-down as per current GAAP. The ASU also requires enhanced disclosures related to credit quality and significant estimates and judgments used by management when estimating credit losses. The ASU will become effective for the Company on October 1, 2020. Upon adoption, a cumulative-effect adjustment for the change in the allowance for credit losses and reserves on unfunded commitments will be recognized in retained earnings. The Company has been working with a software provider on the application and implementation of the new accounting guidance. The Company has determined its loan segmentation and the methodologies that will be utilized for each loan segment. Management is in the process of reviewing and selecting several assumptions including a reasonable and supportable forecast time period, a reversion methodology, prepayment and curtailment speeds, among others. Management is also in the process of preparing supporting documentation and developing internal controls, policies, and procedures. During the remainder of fiscal year 2020, the Company is planning more processing runs, as well as analyzing model sensitivity to various assumptions. At June 30, 2020, the Company ran the model using various assumptions and forecast scenarios. Preliminary results indicate that our ACL and reserves on unfunded commitments would be between $ 20 million and our current level of approximately $ 32 million. The ACL calculated under the new methodology could be lower than that under the existing incurred loss methodology due to having the ability to forecast improvement in economic conditions over a loan's contractual life rather than only being able to consider current conditions as is allowed under the incurred loss methodology. The preliminary results will likely change at adoption due to factors including, but not limited to, changes in current economic conditions, forecasted economic conditions, the Company's credit quality trends, and further refinement of model assumptions. In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement: Disclosure Framework - Changes to the Disclosures Requirements for Fair Value Measurement . This ASU eliminates, modifies and adds certain disclosure requirements for fair value measurements. The ASU adds disclosure requirements for the changes in unrealized gains and losses included in other comprehensive income for recurring Level 3 fair value measurements and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The effective date of this ASU for the Company is October 1, 2020, with early adoption permitted. Entities are allowed to elect early adoption of the eliminated or modified disclosure requirements and delay adoption of the new disclosure requirements until their effective date. Since this ASU only requires disclosure changes, it is not expected to have a significant impact on the Company's consolidated financial condition and results of operations. In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software: Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract . The ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include internal-use software license). The effective date of this ASU for the Company is October 1, 2020, with early adoption permitted. The Company is currently evaluating the effect of the ASU on the Company's consolidated financial condition, results of operations and disclosures. In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. This ASU makes clarifications and corrections to the 11 application of the guidance contained in each of the amended topics. According to the provisions of the ASU, entities that have not adopted ASU 2017-12 prior to the issuance of ASU 2019-04 shall adopt the provisions of both ASUs at the same time. The effective date of the non-hedging amendments contained in ASU 2019-04 for the Company is October 1, 2020. The Company is currently evaluating the effect of the non-hedging amendments contained in this ASU on the Company's consolidated financial condition, results of operations and disclosures. 12 2. EARNINGS PER SHARE Shares acquired by the ESOP are not included in basic average shares outstanding until the shares are committed for allocation or vested to an employee's individual account. Unvested shares awarded pursuant to the Company's restricted stock benefit plans are treated as participating securities in the computation of EPS pursuant to the two-class method as they contain nonforfeitable rights to dividends. The two-class method is an earnings allocation that determines EPS for each class of common stock and participating security. For the Three Months Ended For the Nine Months Ended June 30, June 30, 2020 2019 2020 2019 (Dollars in thousands, except per share amounts) Net income $ 19,474 $ 22,897 $ 46,261 $ 71,834 Income allocated to participating securities ( 16 ) ( 16 ) ( 38 ) ( 35 ) Net income available to common stockholders $ 19,458 $ 22,881 $ 46,223 $ 71,799 Average common shares outstanding 137,935,000 137,637,428 137,919,631 137,593,497 Average committed ESOP shares outstanding 83,052 83,052 41,600 41,602 Total basic average common shares outstanding 138,018,052 137,720,480 137,961,231 137,635,099 Effect of dilutive stock options — 67,048 31,747 55,335 Total diluted average common shares outstanding 138,018,052 137,787,528 137,992,978 137,690,434 Net EPS: Basic $ 0.14 $ 0.17 $ 0.34 $ 0.52 Diluted $ 0.14 $ 0.17 $ 0.34 $ 0.52 Antidilutive stock options, excluded from the diluted average common shares outstanding calculation 813,645 457,486 405,522 491,669 13 3. SECURITIES The following tables reflect the amortized cost, estimated fair value, and gross unrealized gains and losses of AFS securities at the dates presented. The majority of the MBS and investment securities portfolios are composed of securities issued by United States government-sponsored enterprises ("GSEs"). June 30, 2020 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value (Dollars in thousands) MBS $ 949,348 $ 33,304 $ 65 $ 982,587 GSE debentures 225,020 480 — 225,500 Municipal bonds 11,857 110 — 11,967 $ 1,186,225 $ 33,894 $ 65 $ 1,220,054 September 30, 2019 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value (Dollars in thousands) MBS $ 923,256 $ 15,571 $ 2,340 $ 936,487 GSE debentures 249,828 304 178 249,954 Municipal bonds 18,371 52 1 18,422 $ 1,191,455 $ 15,927 $ 2,519 $ 1,204,863 The following tables summarize the estimated fair value and gross unrealized losses of those AFS securities on which an unrealized loss at the dates presented was reported and the continuous unrealized loss position for less than 12 months and equal to or greater than 12 months as of the dates presented. June 30, 2020 Less Than 12 Months Equal to or Greater Than 12 Months Estimated Unrealized Estimated Unrealized Fair Value Losses Fair Value Losses MBS $ 37,115 $ 64 $ 147 $ 1 GSE debentures — — — — Municipal bonds — — — — $ 37,115 $ 64 $ 147 $ 1 September 30, 2019 Less Than 12 Months Equal to or Greater Than 12 Months Estimated Unrealized Estimated Unrealized Fair Value Losses Fair Value Losses MBS $ 111,368 $ 126 $ 199,442 $ 2,214 GSE debentures — — 74,812 178 Municipal bonds 1,755 1 — — $ 113,123 $ 127 $ 274,254 $ 2,392 14 The unrealized losses at June 30, 2020 and September 30, 2019 were a result of an increase in market yields from the time the securities were purchased. 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 market yields as temporary. Therefore, these securities have not been classified as other-than-temporarily impaired. 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, nor is it more likely than not that the Company will be required to sell the securities, before the recovery of the remaining amortized cost amount, which could be at maturity. As a result of the analysis, management has concluded that no other-than-temporary impairments existed at June 30, 2020 or September 30, 2019. The amortized cost and estimated fair value of AFS debt securities as of June 30, 2020, by contractual maturity, are shown below. Actual principal repayments may differ from contractual maturities due to prepayment or early call privileges by the issuer. In the case of MBS, borrowers on the underlying loans generally have the right to prepay their loans without prepayment penalty. For this reason, MBS are not included in the maturity categories. Amortized Estimated Cost Fair Value (Dollars in thousands) One year or less $ 5,467 $ 5,497 One year through five years 231,410 231,970 236,877 237,467 MBS 949,348 982,587 $ 1,186,225 $ 1,220,054 The following table presents the taxable and non-taxable components of interest income on investment securities for the periods presented. For the Three Months Ended For the Nine Months Ended June 30, June 30, 2020 2019 2020 2019 (Dollars in thousands) Taxable $ 797 $ 1,749 $ 3,556 $ 4,516 Non-taxable 50 86 180 265 $ 847 $ 1,835 $ 3,736 $ 4,781 The following table summarizes the carrying value of securities pledged as collateral for the obligations indicated below as of the dates presented. June 30, 2020 September 30, 2019 (Dollars in thousands) Public unit deposits $ 340,751 $ 381,143 Federal Reserve Bank of Kansas City ("FRB of Kansas City") 315,149 6,636 Repurchase agreements 106,625 108,271 $ 762,525 $ 496,050 15 4. LOANS RECEIVABLE AND ALLOWANCE FOR CREDIT LOSSES Loans receivable, net at the dates presented is summarized as follows: June 30, 2020 September 30, 2019 (Dollars in thousands) One- to four-family: Originated $ 3,955,668 $ 3,873,851 Correspondent purchased 2,268,031 2,349,877 Bulk purchased 217,652 252,347 Construction 36,595 36,758 Total 6,477,946 6,512,833 Commercial: Commercial real estate 625,106 583,617 Commercial and industrial 99,735 61,094 Construction 87,448 123,159 Total 812,289 767,870 Consumer: Home equity 107,174 120,587 Other 10,033 11,183 Total 117,207 131,770 Total loans receivable 7,407,442 7,412,473 Less: ACL 31,215 9,226 Discounts/unearned loan fees 30,312 31,058 Premiums/deferred costs ( 42,175 ) ( 44,558 ) $ 7,388,090 $ 7,416,747 Lending Practices and Underwriting Standards - Originating and purchasing one- to four-family loans is the Bank's primary lending business. The Bank also originates consumer loans primarily secured by one- to four-family residential properties and originates and participates in commercial loans. The Bank has a loan concentration in one- to four-family loans and a geographic concentration of these loans in Kansas and Missouri. One- to four-family loans - Full documentation to support an applicant's credit and income, and sufficient funds to cover all applicable fees and reserves at closing, are required on all loans. Generally, loans are underwritten according to the "ability to repay" and "qualified mortgage" standards, as issued by the Consumer Financial Protection Bureau ("CFPB"). 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. The underwriting standards for loans purchased from correspondent lenders are generally similar to the Bank's internal underwriting standards. The underwriting of loans purchased from correspondent lenders on a loan-by-loan basis is performed by the Bank's underwriters. The Bank also originates owner-occupied construction-to-permanent loans secured by one- to four-family residential real estate. Construction draw requests and the supporting documentation are reviewed and approved by designated personnel. 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. Commercial loans - The Bank's commercial real estate and commercial construction loans are originated by the Bank or are in participation with a lead bank. When underwriting a commercial real estate or commercial construction loan, several factors are considered, such as the income producing potential of the property, cash equity provided by the borrower, the financial strength of the borrower, managerial expertise of the borrower or tenant, feasibility studies, lending experience with the borrower and the marketability of the property. For commercial real estate and commercial construction participation loans, the Bank performs the same underwriting procedures as if the loan was being originated by the Bank. At the time of origination, loan-to-value ("LTV") 16 ratios on commercial real estate loans generally do not exceed 85 % of the appraised value of the property securing the loans and the minimum debt service coverage ratio is generally 1.15 . For commercial construction loans, LTV ratios generally do not exceed 80 % of the projected appraised value of the property securing the loans and the minimum debt service coverage ratio is generally 1.15 , but it applies to the projected cash flows, and the borrower must have successful experience with the construction and operation of properties similar to the subject property. Appraisals on properties securing these loans are performed by independent state certified fee appraisers. The Bank's commercial and industrial loans are generally made in the Bank's market areas and are underwritten on the basis of the borrower's ability to service the debt from income. Working capital loans are primarily collateralized by short-term assets whereas term loans are primarily collateralized by long-term assets. In general, commercial and industrial loans involve more credit risk than commercial real estate loans due to the type of collateral securing these loans. As a result of these additional complexities, variables and risks, these loans require more thorough underwriting and servicing than other types of loans. Consumer loans - The Bank offers a variety of secured consumer loans, including home equity loans and lines of credit, home improvement loans, vehicle loans, and loans secured by deposits. The Bank also originates a very limited amount of unsecured loans. The majority of the consumer loan portfolio is comprised of home equity lines of credit for which the Bank also has the first mortgage or the home equity line of credit is in the first lien position. The underwriting standards for consumer loans include a determination of an applicant's payment history on other debts and an assessment of an applicant's ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of an 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. Credit Quality Indicators - Based on the Bank's lending emphasis and underwriting standards, management has segmented the loan portfolio into three segments: (1) one- to four-family; (2) consumer; and (3) commercial. These segments are further divided into classes for purposes of providing disaggregated information about the credit quality of the loan portfolio. The classes are: one- to four-family - originated, one- to four-family - correspondent purchased, one- to four-family - bulk purchased, consumer - home equity, consumer - other, commercial - commercial real estate, and commercial - commercial and industrial. One- to four-family construction loans are included in either the originated class or correspondent purchased class, and commercial construction loans are included in the commercial real estate class. The Bank's primary credit quality indicators for the one- to four-family and consumer - home equity loan portfolios are delinquency status, asset classifications, LTV ratios, and borrower credit scores. The Bank's primary credit quality indicators for the commercial and consumer - other loan portfolios are delinquency status and asset classifications. 17 The following tables present the recorded investment, by class, in loans 30 to 89 days delinquent, loans 90 or more days delinquent or in foreclosure, total delinquent loans, current loans, and total recorded investment at the dates presented. The recorded investment in loans is defined as the unpaid principal balance of a loan, less charge-offs and inclusive of unearned loan fees and deferred costs. At June 30, 2020 and September 30, 2019, all loans 90 or more days delinquent were on nonaccrual status. June 30, 2020 90 or More Days Total Total 30 to 89 Days Delinquent or Delinquent Current Recorded Delinquent in Foreclosure Loans Loans Investment (Dollars in thousands) One- to four-family: Originated $ 5,058 $ 4,012 $ 9,070 $ 3,969,051 $ 3,978,121 Correspondent purchased 2,963 2,781 5,744 2,291,891 2,297,635 Bulk purchased 4,579 1,305 5,884 212,753 218,637 Commercial: Commercial real estate 1,373 546 1,919 707,744 709,663 Commercial and industrial 169 165 334 97,823 98,157 Consumer: Home equity 393 249 642 106,448 107,090 Other 38 30 68 9,934 10,002 $ 14,573 $ 9,088 $ 23,661 $ 7,395,644 $ 7,419,305 September 30, 2019 90 or More Days Total Total 30 to 89 Days Delinquent or Delinquent Current Recorded Delinquent in Foreclosure Loans Loans Investment (Dollars in thousands) One- to four-family: Originated $ 7,187 $ 3,261 $ 10,448 $ 3,885,335 $ 3,895,783 Correspondent purchased 2,762 1,023 3,785 2,377,629 2,381,414 Bulk purchased 3,624 1,484 5,108 248,376 253,484 Commercial: Commercial real estate 762 — 762 702,377 703,139 Commercial and industrial 70 173 243 60,340 60,583 Consumer: Home equity 446 302 748 119,688 120,436 Other 78 21 99 11,035 11,134 $ 14,929 $ 6,264 $ 21,193 $ 7,404,780 $ 7,425,973 The recorded investment in mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process as of June 30, 2020 and September 30, 2019 was $ 2.6 million and $ 1.5 million, respectively, which is included in loans 90 or more days delinquent or in foreclosure in the table above. The carrying value of residential OREO held as a result of obtaining physical possession upon completion of a foreclosure or through completion of a deed in lieu of foreclosure was $ 183 thousand at June 30, 2020 and $ 745 thousand at September 30, 2019. 18 The following table presents the recorded investment, by class, in loans classified as nonaccrual at the dates presented. June 30, 2020 September 30, 2019 (Dollars in thousands) One- to four-family: Originated $ 4,955 $ 4,436 Correspondent purchased 2,971 1,023 Bulk purchased 1,305 1,551 Commercial: Commercial real estate 546 — Commercial and industrial 165 173 Consumer: Home equity 282 337 Other 30 21 $ 10,254 $ 7,541 In accordance with the Bank's asset classification policy, management regularly reviews the problem loans in the Bank's portfolio to determine whether any loans require classification. Loan classifications are defined as follows: • Special mention - These loans are performing loans on which known information about the collateral pledged or the possible credit problems of the borrower(s) have caused management to have doubts as to the ability of the borrower(s) to comply with present loan repayment terms and which may result in the future inclusion of such loans in the non-performing loan categories. • Substandard - A loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans include those characterized by the distinct possibility the Bank will sustain some loss if the deficiencies are not corrected. • Doubtful - Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses present make collection or liquidation in full on the basis of currently existing facts and conditions and values highly questionable and improbable. • Loss - Loans classified as loss are considered uncollectible and of such little value that their continuance as assets on the books is not warranted. The following table sets forth the recorded investment in loans classified as special mention or substandard, by class, at the dates presented. Special mention and substandard loans are included in the ACL formula analysis model if the loans are not individually evaluated for loss. Loans classified as doubtful or loss are individually evaluated for loss. At the dates presented, there were no loans classified as doubtful, and all loans classified as loss were fully charged-off. June 30, 2020 September 30, 2019 Special Mention Substandard Special Mention Substandard (Dollars in thousands) One- to four-family: Originated $ 10,611 $ 16,401 $ 12,941 $ 15,628 Correspondent purchased 1,667 5,168 2,349 2,785 Bulk purchased — 5,102 102 5,294 Commercial: Commercial real estate 50,969 3,192 52,891 2,472 Commercial and industrial 1,072 1,931 1,215 3,057 Consumer: Home equity 318 534 280 696 Other — 30 2 24 $ 64,637 $ 32,358 $ 69,780 $ 29,956 19 The following table shows the weighted average credit score and weighted average LTV for one- to four-family loans and consumer home equity loans at the dates presented. Borrower credit scores are intended to provide an indication as to the likelihood that a borrower will repay their debts. Credit scores are updated at least annually, with the last update in June 2020, from a nationally recognized consumer rating agency. The LTV ratios provide an estimate of the extent to which the Bank may incur a loss on any given loan that may go into foreclosure. The consumer - home equity LTV does not take into account the first lien position, if applicable. The LTV ratios were based on the current loan balance and either the lesser of the purchase price or original appraisal, or the most recent Bank appraisal, if available. In most cases, the most recent appraisal was obtained at the time of origination. June 30, 2020 September 30, 2019 Credit Score LTV Credit Score LTV One- to four-family - originated 770 62 % 768 62 % One- to four-family - correspondent 765 64 765 65 One- to four-family - bulk purchased 768 60 762 61 Consumer - home equity 755 19 754 19 768 62 766 62 20 Troubled Debt Restructurings ("TDRs") - The following tables present the recorded investment prior to restructuring and immediately after restructuring in all loans restructured during the periods presented. These tables do not reflect the recorded investment at the end of the periods indicated. Any increase in the recorded investment at the time of the restructuring was generally due to the capitalization of delinquent interest and/or escrow balances. For the Three Months Ended For the Nine Months Ended June 30, 2020 June 30, 2020 Number Pre- Post- Number Pre- Post- of Restructured Restructured of Restructured Restructured Contracts Outstanding Outstanding Contracts Outstanding Outstanding (Dollars in thousands) One- to four-family: Originated — $ — $ — 5 $ 241 $ 242 Correspondent purchased — — — 1 192 191 Bulk purchased — — — 1 75 134 Commercial: Commercial real estate — — — 1 837 837 Commercial and industrial — — — — — — Consumer: Home equity — — — 2 45 44 Other — — — — — — — $ — $ — 10 $ 1,390 $ 1,448 For the Three Months Ended For the Nine Months Ended June 30, 2019 June 30, 2019 Number Pre- Post- Number Pre- Post- of Restructured Restructured of Restructured Restructured Contracts Outstanding Outstanding Contracts Outstanding Outstanding (Dollars in thousands) One- to four-family: Originated — $ — $ — 1 $ 117 $ 117 Correspondent purchased — — — — — — Bulk purchased 1 69 69 2 377 377 Commercial: Commercial real estate — — — — — — Commercial and industrial — — — — — — Consumer: Home equity — — — — — — Other — — — — — — 1 $ 69 $ 69 3 $ 494 $ 494 21 The following table provides information on TDRs that became delinquent during the periods presented within 12 months after being restructured. For the Three Months Ended For the Nine Months Ended June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019 Number of Recorded Number of Recorded Number of Recorded Number of Recorded Contracts Investment Contracts Investment Contracts Investment Contracts Investment (Dollars in thousands) One- to four-family: Originated — $ — — $ — 1 $ 38 1 $ 45 Correspondent purchased — — — — — — — — Bulk purchased — — — — 1 134 — — Commercial: Commercial real estate — — — — — — — — Commercial and industrial — — — — — — — — Consumer: Home equity — — — — 1 9 — — Other — — — — — — — — — $ — — $ — 3 $ 181 1 $ 45 In late March 2020, the Bank announced loan modification programs to support and provide relief for its borrowers during the Coronavirus Disease 2019 ("COVID-19") pandemic. Generally, loan modifications under these programs ("COVID-19 loan modifications") for one- to four-family loans and consumer loans consist of a three-month payment forbearance of principal, interest, and in some cases, escrow. COVID-19 loan modifications of commercial loans mainly consist of up to a six-month interest-only payment period, but an option for a three- to six-month forbearance of principal and interest was also available to our borrowers. The COVID-19 loan modification programs are consistent with the Coronavirus Aid, Relief, and Economic Security ("CARES") Act or interagency guidance from the federal banking agencies on such programs, and the Company has followed such guidance when determining if a borrower's modification is subject to TDR classification. If it is determined that the modification is not short-term, not related to financial hardship resulting from COVID-19, or the customer does not meet the criteria under the guidance to be excluded from TDR classification, the Company evaluates the loan modifications under its existing TDR framework. Loans subject to forbearance under the COVID-19 loan modification program are not reported as past due or placed on nonaccrual status during the forbearance time period. 22 Impaired loans - The following information pertains to impaired loans, by class, as of the dates presented. June 30, 2020 September 30, 2019 Unpaid Unpaid Recorded Principal Related Recorded Principal Related Investment Balance ACL Investment Balance ACL (Dollars in thousands) With no related allowance recorded One- to four-family: Originated $ 13,306 $ 13,781 $ — $ 14,683 $ 15,241 $ — Correspondent purchased 1,951 2,054 — 1,763 1,868 — Bulk purchased 4,573 5,293 — 4,943 5,661 — Commercial: Commercial real estate 1,733 2,060 — — — — Commercial and industrial 103 248 — 60 184 — Consumer: Home equity 289 393 — 345 462 — Other — 35 — — 29 — 21,955 23,864 — 21,794 23,445 — With an allowance recorded One- to four-family: Originated — — — — — — Correspondent purchased — — — — — — Bulk purchased — — — — — — Commercial: Commercial real estate — — — — — — Commercial and industrial 1,771 1,770 240 — — — Consumer: Home equity — — — — — — Other — — — — — — 1,771 1,770 240 — — — Total One- to four-family: Originated 13,306 13,781 — 14,683 15,241 — Correspondent purchased 1,951 2,054 — 1,763 1,868 — Bulk purchased 4,573 5,293 — 4,943 5,661 — Commercial: Commercial real estate 1,733 2,060 — — — — Commercial and industrial 1,874 2,018 240 60 184 — Consumer: Home equity 289 393 — 345 462 — Other — 35 — — 29 — $ 23,726 $ 25,634 $ 240 $ 21,794 $ 23,445 $ — 23 The following information pertains to impaired loans, by class, for the periods presented. For the Three Months Ended For the Nine Months Ended June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019 Average Interest Average Interest Average Interest Average Interest Recorded Income Recorded Income Recorded Income Recorded Income Investment Recognized Investment Recognized Investment Recognized Investment Recognized (Dollars in thousands) With no related allowance recorded One- to four-family: Originated $ 13,865 $ 150 $ 15,235 $ 163 $ 14,273 $ 472 $ 16,450 $ 515 Correspondent purchased 1,949 19 2,007 20 1,855 56 2,162 65 Bulk purchased 4,814 46 5,114 48 4,910 148 5,350 134 Commercial: Commercial real estate 817 5 — — 494 9 — — Commercial and industrial 26 — — — 24 — — — Consumer: Home equity 319 4 381 6 329 15 435 22 Other 1 — — — — — — — 21,791 224 22,737 237 21,885 700 24,397 736 With an allowance recorded One- to four-family: Originated — — — — — — — — Correspondent purchased — — — — — — — — Bulk purchased — — — — — — — — Commercial: Commercial real estate — — — — — — — — Commercial and industrial 1,875 24 — — 1,440 78 — — Consumer: Home equity — — — — — — — — Other — — — — — — — — 1,875 24 — — 1,440 78 — — Total One- to four-family: Originated 13,865 150 15,235 163 14,273 472 16,450 515 Correspondent purchased 1,949 19 2,007 20 1,855 56 2,162 65 Bulk purchased 4,814 46 5,114 48 4,910 148 5,350 134 Commercial: Commercial real estate 817 5 — — 494 9 — — Commercial and industrial 1,901 24 — — 1,464 78 — — Consumer: Home equity 319 4 381 6 329 15 435 22 Other 1 — — — — — — — $ 23,666 $ 248 $ 22,737 $ 237 $ 23,325 $ 778 $ 24,397 $ 736 24 Allowance for Credit Losses - The Bank maintains an ACL to absorb inherent losses in the loan portfolio based on quarterly assessments of the loan portfolio. Each quarter a formula analysis model is prepared which segregates the loan portfolio into categories based on certain risk characteristics. Historical loss factors and qualitative factors are applied to each loan category in the formula analysis model. The factors are reviewed by management quarterly to assess whether the factors adequately cover probable and estimable losses inherent in the loan portfolio. Due to the deterioration of economic conditions as a result of the COVID-19 pandemic, management increased some of the historical loss factors and qualitative factors in the formula analysis model to account for the increase in the estimated inherent losses in the loan portfolio at March 31, 2020. The significant deterioration of economic conditions at March 31, 2020 due to the COVID-19 pandemic carried into the June 30, 2020 quarter. The increase in the historical loss factors and qualitative factors due to the deterioration of economic conditions accounts for the majority of the increase in the ACL during the current fiscal year. Management will continue to closely monitor economic conditions and will work with borrowers as necessary to assist them through this challenging economic climate. If economic conditions worsen or do not improve in the near term, and if future government programs, if any, do not provide adequate relief to borrowers, it is possible the Bank's ACL will need to increase in future periods. The following is a summary of ACL activity, by loan portfolio segment, for the periods presented, and the ending balance of ACL based on the Company's impairment methodology. For the Three Months Ended June 30, 2020 One- to Four-Family Correspondent Bulk Originated Purchased Purchased Total Commercial Consumer Total (Dollars in thousands) Beginning balance $ 6,467 $ 3,355 $ 557 $ 10,379 $ 20,328 $ 489 $ 31,196 Charge-offs — — — — — ( 5 ) ( 5 ) Recoveries — — — — 17 7 24 Provision for credit losses ( 121 ) ( 166 ) ( 51 ) ( 338 ) 359 ( 21 ) — Ending balance $ 6,346 $ 3,189 $ 506 $ 10,041 $ 20,704 $ 470 $ 31,215 For the Nine Months Ended June 30, 2020 One- to Four-Family Correspondent Bulk Originated Purchased Purchased Total Commercial Consumer Total (Dollars in thousands) Beginning balance $ 2,000 $ 1,203 $ 687 $ 3,890 $ 5,171 $ 165 $ 9,226 Charge-offs ( 64 ) — — ( 64 ) ( 349 ) ( 15 ) ( 428 ) Recoveries 3 — — 3 98 16 117 Provision for credit losses 4,407 1,986 ( 181 ) 6,212 15,784 304 22,300 Ending balance $ 6,346 $ 3,189 $ 506 $ 10,041 $ 20,704 $ 470 $ 31,215 25 For the Three Months Ended June 30, 2019 One- to Four-Family Correspondent Bulk Originated Purchased Purchased Total Commercial Consumer Total (Dollars in thousands) Beginning balance $ 2,173 $ 1,392 $ 802 $ 4,367 $ 4,088 $ 164 $ 8,619 Charge-offs ( 45 ) — — ( 45 ) — ( 16 ) ( 61 ) Recoveries 3 — — 3 17 8 28 Provision for credit losses ( 95 ) ( 117 ) ( 60 ) ( 272 ) 727 ( 5 ) 450 Ending balance $ 2,036 $ 1,275 $ 742 $ 4,053 $ 4,832 $ 151 $ 9,036 For the Nine Months Ended June 30, 2019 One- to Four-Family Correspondent Bulk Originated Purchased Purchased Total Commercial Consumer Total (Dollars in thousands) Beginning balance $ 2,953 $ 1,861 $ 925 $ 5,739 $ 2,556 $ 168 $ 8,463 Charge-offs ( 75 ) — ( 26 ) ( 101 ) — ( 28 ) ( 129 ) Recoveries 8 — 106 114 44 94 252 Provision for credit losses ( 850 ) ( 586 ) ( 263 ) ( 1,699 ) 2,232 ( 83 ) 450 Ending balance $ 2,036 $ 1,275 $ 742 $ 4,053 $ 4,832 $ 151 $ 9,036 The following is a summary of the loan portfolio and related ACL balances, at the dates presented, by loan portfolio segment disaggregated by the Company's impairment method. June 30, 2020 One- to Four-Family Correspondent Bulk Originated Purchased Purchased Total Commercial Consumer Total (Dollars in thousands) Recorded investment in loans: Collectively evaluated for impairment $ 3,964,815 $ 2,295,684 $ 214,064 $ 6,474,563 $ 804,213 $ 116,803 $ 7,395,579 Individually evaluated for impairment 13,306 1,951 4,573 19,830 3,607 289 23,726 $ 3,978,121 $ 2,297,635 $ 218,637 $ 6,494,393 $ 807,820 $ 117,092 $ 7,419,305 ACL for loans: Collectively evaluated for impairment $ 6,346 $ 3,189 $ 506 $ 10,041 $ 20,464 $ 470 $ 30,975 Individually evaluated for impairment — — — — 240 — 240 $ 6,346 $ 3,189 $ 506 $ 10,041 $ 20,704 $ 470 $ 31,215 26 September 30, 2019 One- to Four-Family Correspondent Bulk Originated Purchased Purchased Total Commercial Consumer Total (Dollars in thousands) Recorded investment in loans: Collectively evaluated for impairment $ 3,881,100 $ 2,379,651 $ 248,541 $ 6,509,292 $ 763,662 $ 131,225 $ 7,404,179 Individually evaluated for impairment 14,683 1,763 4,943 21,389 60 345 21,794 $ 3,895,783 $ 2,381,414 $ 253,484 $ 6,530,681 $ 763,722 $ 131,570 $ 7,425,973 ACL for loans: Collectively evaluated for impairment $ 2,000 $ 1,203 $ 687 $ 3,890 $ 5,171 $ 165 $ 9,226 Individually evaluated for impairment — — — — — — — $ 2,000 $ 1,203 $ 687 $ 3,890 $ 5,171 $ 165 $ 9,226 27 5. BORROWED FUNDS FHLB Borrowings and Interest Rate Swaps - At June 30, 2020 and September 30, 2019, the Bank had entered into interest rate swap agreements with a total notional amount of $ 640.0 million in order to hedge the variable cash flows associated with $ 640.0 million of adjustable-rate FHLB advances. At June 30, 2020 and September 30, 2019, the interest rate swap agreements had an average remaining term to maturity of 3.8 years and 4.5 years, respectively. The interest rate swaps were designated as cash flow hedges and involve the receipt of variable amounts from a counterparty in exchange for the Bank making fixed-rate payments over the life of the interest rate swap agreements. At June 30, 2020 and September 30, 2019, the interest rate swaps were in a loss position with a total fair value of $ 57.1 million and $ 33.1 million, respectively, which was reported in accounts payable and accrued expenses on the consolidated balance sheet. During the three and nine months ended June 30, 2020, $ 1.7 million and $ 3.4 million, respectively, was reclassified from AOCI as an increase to interest expense. During the three and nine months ended June 30, 2019, $ 55 thousand and $ 106 thousand, respectively, was reclassified from AOCI as an increase to interest expense. At June 30, 2020, the Company estimated that $ 15.4 million of interest expense associated with the interest rate swaps will be reclassified from AOCI as an increase to interest expense on FHLB borrowings during the next 12 months. The Bank has minimum collateral posting thresholds with its derivative counterparties and posts collateral on a daily basis. The Bank posted cash collateral of $ 58.0 million at June 30, 2020 and $ 33.3 million at September 30, 2019. During the current nine month period, the Bank prepaid fixed-rate FHLB advances totaling $ 350.0 million with a weighted average contractual interest rate of 2.42 % and a weighted average remaining term of 1.0 years, and replaced these advances with $ 350.0 million of fixed-rate FHLB advances with a weighted average contractual interest rate of 1.43 % and a weighted average term of 4.7 years. The Bank paid penalties totaling $ 4.2 million to FHLB as a result of prepaying the FHLB advances. The prepayment penalties are being recognized in interest expense over the life of the new FHLB advances. 28 6. FAIR VALUE OF FINANCIAL INSTRUMENTS Fair Value Measurements - The Company uses fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures in accordance with Accounting Standards Codification ("ASC") 820 and ASC 825. The Company's AFS securities and interest rate swaps 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 financial instruments on a non-recurring basis, such as OREO and loans individually evaluated for impairment. These non-recurring fair value adjustments involve the application of lower of cost or fair value accounting or write-downs of individual financial instruments. The Company groups its financial instruments at fair value in three levels based on the markets in which the financial instruments 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 financial instrument. 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 financial instrument. The Company bases its fair values on the price that would be received from the sale of a financial instrument in an orderly transaction between market participants at the measurement date under current market conditions. The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. The following is a description of valuation methodologies used for financial instruments measured at fair value on a recurring basis. AFS Securities - The Company's AFS securities portfolio is carried at estimated fair value. The majority of the securities within the AFS portfolio were issued by GSEs. The Company primarily uses prices obtained from third party pricing services to determine the fair value of its securities. On a quarterly basis, management corroborates a sample of prices obtained from the third party pricing service for Level 2 securities by comparing them to an independent source. If the price provided by the independent source varies by more than a predetermined percentage from the price received from the third party pricing service, then the variance is researched by management. The Company did not have to adjust prices obtained from the third party pricing service when determining the fair value of its securities during the nine months ended June 30, 2020 or during fiscal year 2019. The Company's major security types, based on the nature and risks of the securities, are: • GSE Debentures - Estimated fair values are based on a discounted cash flow method. Cash flows are determined by taking any embedded options into consideration and are discounted using current market yields for similar securities. (Level 2) • MBS - Estimated fair values are based on a discounted cash flow method. Cash flows are determined based on prepayment projections of the underlying mortgages and are discounted using current market yields for benchmark securities. (Level 2) • Municipal Bonds - Estimated fair values are based on a discounted cash flow method. Cash flows are determined by taking any embedded options into consideration and are discounted using current market yields for securities with similar credit profiles. (Level 2) Interest Rate Swaps - The Company's interest rate swaps are designated as cash flow hedges and are reported at fair value in other assets on the consolidated balance sheet if in a gain position, and in accounts payable and accrued expenses if in a loss position, with any unrealized gains and losses, net of taxes, reported as AOCI in stockholders' equity. See "Note 5. Borrowed Funds" for additional information. The estimated fair values of the interest rates swaps are obtained from the counterparty and are determined by a discounted cash flow analysis using observable market-based inputs. On a quarterly basis, management corroborates the estimated fair values by internally calculating the estimated fair value using a discounted cash flow analysis with independent observable market-based inputs from a third party. No adjustments were made to the estimated fair values during the nine months ended June 30, 2020 or during fiscal year 2019. (Level 2) 29 The following tables provide the level of valuation assumption used to determine the carrying value of the Company's financial instruments measured at fair value on a recurring basis at the dates presented. The Company did no t have any Level 3 financial instruments measured at fair value on a recurring basis at June 30, 2020 or September 30, 2019. June 30, 2020 Quoted Prices Significant Significant in Active Markets Other Observable Unobservable Carrying for Identical Assets Inputs Inputs Value (Level 1) (Level 2) (Level 3) (Dollars in thousands) Assets: AFS Securities: MBS $ 982,587 $ — $ 982,587 $ — GSE debentures 225,500 — 225,500 — Municipal bonds 11,967 — 11,967 — $ 1,220,054 $ — $ 1,220,054 $ — Liabilities: Interest rate swaps $ 57,067 $ — $ 57,067 $ — September 30, 2019 Quoted Prices Significant Significant in Active Markets Other Observable Unobservable Carrying for Identical Assets Inputs Inputs Value (Level 1) (Level 2) (Level 3) (Dollars in thousands) Assets: AFS Securities: MBS $ 936,487 $ — $ 936,487 $ — GSE debentures 249,954 — 249,954 — Municipal bonds 18,422 — 18,422 — $ 1,204,863 $ — $ 1,204,863 $ — Liabilities: Interest rate swaps $ 33,090 $ — $ 33,090 $ — The following is a description of valuation methodologies used for significant financial instruments measured at fair value on a non-recurring basis. Loans Receivable - The fair value of impaired loans individually evaluated for impairment on a non-recurring basis during the nine months ended June 30, 2020 and 2019 that were still held in the portfolio as of June 30, 2020 and 2019 was $ 6.0 million and $ 4.6 million, respectively. The one- to four-family loans included in this amount were individually evaluated to determine if the carrying value of the loan was in excess of the fair value of the collateral, less estimated selling costs of 10 %. Fair values were estimated through current appraisals. Management does not adjust or apply a discount to the appraised value of one- to four-family loans, except for the estimated sales cost noted above, and the primary unobservable input for these loans was the appraisal. For commercial loans, if the most recent appraisal or book value of the collateral does not reflect current market conditions due to the passage of time and/or other factors, management will make adjustments to the existing appraised or book value based on knowledge of local market conditions, recent transactions, and estimated selling costs, if applicable. Adjustments to appraised or book values are generally based on assumptions not observable in the marketplace. The primary significant unobservable inputs for impaired 30 commercial loans individually evaluated for impairment during the nine months ended June 30, 2020 were downward adjustments to the book value of the collateral for lack of marketability. The adjustments ranged from 4 % to 50 %, with a weighted average of 17 %. There were no impaired commercial loans individually evaluated during the nine months ended June 30, 2019. Fair values of impaired loans individually evaluated for impairment cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the loan and, as such, are classified as Level 3. OREO - OREO primarily represents real estate acquired as a result of foreclosure or by deed in lieu of foreclosure and is carried at lower of cost or fair value. The fair value for OREO is estimated through current appraisals or listing prices, less estimated selling costs of 10 %. Management does not adjust or apply a discount to the appraised value or listing price, except for the estimated sales costs noted above. The primary significant unobservable input for OREO was the appraisal or listing price. Fair values of foreclosed property cannot be determined with precision and may not be realized in an actual sale of the property and, as such, are classified as Level 3. The fair value of OREO measured on a non-recurring basis during the nine months ended June 30, 2020 and 2019 that was still held in the portfolio as of June 30, 2020 and 2019 was $ 183 thousand and $ 333 thousand, respectively. The carrying value of the properties equaled the fair value of the properties at June 30, 2020 and 2019. Fair Value Disclosures - The Company estimated fair value amounts using available market information and a variety of valuation methodologies as of the dates presented. Considerable judgment is required to interpret market data to develop the estimates of fair value. The estimates presented are not necessarily indicative of amounts the Company would realize from a current market exchange at subsequent dates. The carrying amounts and estimated fair values of the Company's financial instruments by fair value hierarchy, at the dates presented, were as follows: June 30, 2020 Carrying Estimated Fair Value Amount Total Level 1 Level 2 Level 3 (Dollars in thousands) Assets: Cash and cash equivalents $ 396,219 $ 396,219 $ 396,219 $ — $ — AFS securities 1,220,054 1,220,054 — 1,220,054 — Loans receivable 7,388,090 7,845,259 — — 7,845,259 FHLB stock 102,782 102,782 102,782 — — Liabilities: Deposits 6,069,684 6,155,296 3,036,524 3,118,772 — Borrowings 1,989,089 2,042,101 — 2,042,101 — Interest rate swaps 57,067 57,067 — 57,067 — September 30, 2019 Carrying Estimated Fair Value Amount Total Level 1 Level 2 Level 3 (Dollars in thousands) Assets: Cash and cash equivalents $ 220,370 $ 220,370 $ 220,370 $ — $ — AFS securities 1,204,863 1,204,863 — 1,204,863 — Loans receivable 7,416,747 7,654,586 — — 7,654,586 FHLB stock 98,456 98,456 98,456 — — Liabilities: Deposits 5,581,867 5,614,895 2,594,242 3,020,653 — Borrowings 2,239,989 2,253,353 100,001 2,153,352 — Interest rate swaps 33,090 33,090 — 33,090 — 31 7. ACCUMULATED OTHER COMPREHENSIVE INCOME The following tables present the changes in the components of AOCI, net of tax, for the periods indicated. For the Three Months Ended June 30, 2020 Unrealized Unrealized Gains (Losses) Gains (Losses) on AFS on Cash Flow Total Securities Hedges AOCI (Dollars in thousands) Beginning balance $ 20,076 $ ( 42,054 ) $ ( 21,978 ) Other comprehensive income (loss), before reclassifications 5,533 ( 2,856 ) 2,677 Amount reclassified from AOCI — 1,710 1,710 Other comprehensive income (loss) 5,533 ( 1,146 ) 4,387 Ending balance $ 25,609 $ ( 43,200 ) $ ( 17,591 ) For the Nine Months Ended June 30, 2020 Unrealized Unrealized Gains (Losses) Gains (Losses) on AFS on Cash Flow Total Securities Hedges AOCI (Dollars in thousands) Beginning balance $ 10,150 $ ( 25,049 ) $ ( 14,899 ) Other comprehensive income (loss), before reclassifications 15,459 ( 21,553 ) ( 6,094 ) Amount reclassified from AOCI — 3,402 3,402 Other comprehensive income (loss) 15,459 ( 18,151 ) ( 2,692 ) Ending balance $ 25,609 $ ( 43,200 ) $ ( 17,591 ) For the Three Months Ended June 30, 2019 Unrealized Unrealized Gains (Losses) Gains (Losses) on AFS on Cash Flow Total Securities Hedges AOCI (Dollars in thousands) Beginning balance $ 3,598 $ ( 9,014 ) $ ( 5,416 ) Other comprehensive income (loss), before reclassifications 4,102 ( 11,273 ) ( 7,171 ) Amount reclassified from AOCI — 55 55 Other comprehensive income (loss) 4,102 ( 11,218 ) ( 7,116 ) Ending balance $ 7,700 $ ( 20,232 ) $ ( 12,532 ) For the Nine Months Ended June 30, 2019 Unrealized Unrealized Gains (Losses) Gains (Losses) on AFS on Cash Flow Total Securities Hedges AOCI (Dollars in thousands) Beginning balance $ ( 2,990 ) $ 7,330 $ 4,340 Other comprehensive income (loss), before reclassifications 10,690 ( 27,668 ) ( 16,978 ) Amount reclassified from AOCI — 106 106 Other comprehensive income (loss) 10,690 ( 27,562 ) ( 16,872 ) Ending balance $ 7,700 $ ( 20,232 ) $ ( 12,532 ) 32 8. REVENUE RECOGNITION Details of the Company's primary types of non-interest income revenue streams by financial statement line item reported in the consolidated statements of income that are within the scope of ASC Topic 606 are below. During the nine months ended June 30, 2020 and 2019, revenue from contracts with customers totaled $ 10.9 million and $ 12.4 million, respectively. Deposit Service Fees Interchange Transaction Fees - Interchange transaction fee income primarily consists of interchange fees earned on a transactional basis through card payment networks. The performance obligation for these types of transactions is satisfied as services are rendered for each transaction and revenue is recognized daily concurrently with the transaction processing services provided to the cardholder. In order to participate in the card payment networks, the Company must pay various transaction related costs established by the networks ("interchange network charges"), including membership fees and a per unit charge for each transaction. The Company is acting as an agent for its debit card customers when they are utilizing the card payment networks; therefore, interchange transaction fee income is reported net of interchange network charges. Interchange network charges totaled $ 2.4 million and $ 2.5 million for the nine months ended June 30, 2020 and 2019, respectively. Service Charges on Deposit Accounts - Service charges on deposit accounts consist of account maintenance and transaction-based fees such as overdrafts, insufficient funds, wire transfers and the use of out-of-network ATMs. The Company's performance obligation is satisfied over a period of time, generally a month, for account maintenance and at the time of service for transaction-based fees. Revenue is recognized after the performance obligation is satisfied. Payments are typically collected from the customer's deposit account at the time the transaction is processed and/or at the end of the customer's statement cycle (typically monthly). Insurance Commissions Commissions are received on insurance product sales. The Company acts in the capacity of an agent between the Company's customer and the insurance carrier. The Company's performance obligation is satisfied when the terms of the policy have been agreed upon and the insurance policy becomes effective. Additionally, the Company earns performance-based incentives ("contingent insurance commissions") based on certain criteria established by the insurance carriers. Other Non-Interest Income Trust Asset Management Income - The Company provides trust asset management services to customers. The Company primarily earns fees for these services over time as the monthly services are provided and the Company assesses revenue at each month end. Fees are charged based on a tiered scale of the market value of the individual trust asset accounts at the end of the month. 9. LEASES The Company leases real estate property for branches, ATMs, and certain equipment. These leases have remaining terms that range from one year to 47 years, some of which include the exercising of renewal options that the Company considers to be reasonably certain. As of June 30, 2020, a right-of-use asset of $ 15.5 million was included in other assets and a lease liability of $ 15.5 million was included in accounts payable and accrued expenses on the consolidated balance sheets. As of June 30, 2020, for the Company's operating leases, the weighted average remaining lease term was 22.0 years and the weighted average discount rate was 2.59 %. The following table presents lease expenses and supplemental cash flow information related to the Company's leases for the periods presented. For the Three Months Ended For the Nine Months Ended June 30, 2020 June 30, 2020 (Dollars in thousands) Operating lease expense $ 373 $ 1,138 Variable lease expense 50 158 Short-term lease expense 1 17 Cash paid for amounts included in the measurement of lease liabilities 345 1,028 33 The following table presents future minimum payments, rounded to the nearest thousand, for operating leases with initial or remaining terms in excess of one year as of June 30, 2020: Remainder of fiscal year 2020 $ 231 Fiscal year 2021 1,363 Fiscal year 2022 1,329 Fiscal year 2023 1,236 Fiscal year 2024 1,027 Fiscal year 2025 858 Thereafter 16,135 Total future minimum lease payments 22,179 Amounts representing interest ( 6,668 ) Present value of net future minimum lease payments $ 15,511 The Company elected the modified retrospective approach for its adoption of ASU 2016-02, and the optional transition method under which the Company used the effective date as the date of initial application of the amendments. These elections require the inclusion of ASC Topic 840 disclosures for periods that continue to be presented in accordance with ASC Topic 840. As of September 30, 2019, future minimum rental commitments, rounded to the nearest thousand, required under operating leases that had initial or remaining non-cancelable lease terms in excess of one year were as follows: 2020 $ 1,298 2021 1,187 2022 1,069 2023 930 2024 637 Thereafter 1,115 $ 6,236 34