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) December 31, September 30, 2023 2023 ASSETS: Cash and cash equivalents (includes interest-earning deposits of $ 287,748 and $ 213,830 ) $ 320,357 $ 245,605 Available-for-sale ("AFS") securities, at estimated fair value (amortized cost of $ 721,612 and $ 1,385,992 ) 740,462 1,384,482 Loans receivable, net (allowance for credit losses ("ACL") of $ 24,178 and $ 23,759 ) 7,947,510 7,970,949 Federal Home Loan Bank Topeka ("FHLB") stock, at cost 110,166 110,714 Premises and equipment, net 91,475 91,531 Income taxes receivable, net 3,939 8,531 Deferred income tax assets, net 34,076 29,605 Other assets 328,079 336,044 TOTAL ASSETS $ 9,576,064 $ 10,177,461 LIABILITIES: Deposits $ 6,021,595 $ 6,051,220 Borrowings 2,373,064 2,879,125 Advances by borrowers 24,839 62,993 Other liabilities 122,445 140,069 Total liabilities 8,541,943 9,133,407 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, 133,908,375 and 135,936,375 shares issued and outstanding as of December 31, 2023 and September 30, 2023, respectively 1,339 1,359 Additional paid-in capital 1,154,655 1,166,643 Unearned compensation, Employee Stock Ownership Plan ("ESOP") ( 27,671 ) ( 28,083 ) Retained earnings ( 113,357 ) ( 104,565 ) Accumulated other comprehensive income ("AOCI"), net of tax 19,155 8,700 Total stockholders' equity 1,034,121 1,044,054 TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 9,576,064 $ 10,177,461 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 December 31, 2023 2022 INTEREST AND DIVIDEND INCOME: Loans receivable $ 75,941 $ 64,819 Mortgage-backed securities ("MBS") 5,859 4,811 Cash and cash equivalents 4,778 16,671 FHLB stock 2,586 4,158 Investment securities 2,528 881 Total interest and dividend income 91,692 91,340 INTEREST EXPENSE: Deposits 32,443 11,904 Borrowings 19,656 33,608 Total interest expense 52,099 45,512 NET INTEREST INCOME 39,593 45,828 PROVISION FOR CREDIT LOSSES 123 3,660 NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES 39,470 42,168 NON-INTEREST INCOME: Deposit service fees 2,575 3,461 Insurance commissions 863 795 Net loss from securities transactions ( 13,345 ) — Other non-interest income 1,013 1,096 Total non-interest income ( 8,894 ) 5,352 NON-INTEREST EXPENSE: Salaries and employee benefits 12,992 13,698 Information technology and related expense 5,369 5,070 Occupancy, net 3,372 3,474 Federal insurance premium 1,860 812 Regulatory and outside services 1,643 1,533 Advertising and promotional 988 833 Deposit and loan transaction costs 542 611 Office supplies and related expense 361 633 Other non-interest expense 1,381 1,109 Total non-interest expense 28,508 27,773 INCOME BEFORE INCOME TAX (BENEFIT) EXPENSE 2,068 19,747 INCOME TAX (BENEFIT) EXPENSE ( 475 ) 3,507 NET INCOME $ 2,543 $ 16,240 Basic earnings per share ("EPS") $ 0.02 $ 0.12 Diluted EPS $ 0.02 $ 0.12 Basic weighted average common shares 132,353,313 134,640,932 Diluted weighted average common shares 132,353,313 134,640,932 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 December 31, 2023 2022 Net income $ 2,543 $ 16,240 Other comprehensive income, net of tax: Unrealized gains on AFS securities arising during the period, net of taxes of $( 5,350 ) and $( 4,211 ) 16,581 13,050 Reclassification adjustment for gross gains on AFS securities included in net income, net of taxes of $ 383 and $ 0 ( 1,188 ) — Unrealized gains (losses) on cash flow hedges arising during the period, net of taxes of $ 967 and $( 232 ) ( 2,998 ) 715 Reclassification adjustment for cash flow hedge amounts included in net income, net of taxes of $ 626 and $ 237 ( 1,940 ) ( 734 ) Comprehensive income $ 12,998 $ 29,271 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 Three Months Ended December 31, 2023 Additional Unearned Total Common Paid-In Compensation Retained Stockholders' Stock Capital ESOP Earnings AOCI Equity Balance at September 30, 2023 $ 1,359 $ 1,166,643 $ ( 28,083 ) $ ( 104,565 ) $ 8,700 $ 1,044,054 Net income 2,543 2,543 Cumulative effect of adopting Accounting Standards Update ("ASU") 2022-02, net of tax ( 27 ) ( 27 ) Other comprehensive income, net of tax 10,455 10,455 ESOP activity ( 190 ) 412 222 Restricted stock activity, net ( 6 ) ( 6 ) Stock-based compensation 87 87 Repurchase of common stock ( 20 ) ( 11,879 ) ( 11,899 ) Cash dividends to stockholders ($ 0.085 per share) ( 11,308 ) ( 11,308 ) Balance at December 31, 2023 $ 1,339 $ 1,154,655 $ ( 27,671 ) $ ( 113,357 ) $ 19,155 $ 1,034,121 For the Three Months Ended December 31, 2022 Additional Unearned Total Common Paid-In Compensation Retained Stockholders' Stock Capital ESOP Earnings AOCI Equity Balance at September 30, 2022 $ 1,388 $ 1,190,213 $ ( 29,735 ) $ 80,266 $ ( 145,633 ) $ 1,096,499 Net income 16,240 16,240 Other comprehensive income, net of tax 13,031 13,031 ESOP activity ( 72 ) 413 341 Stock-based compensation 89 89 Repurchase of common stock ( 27 ) ( 22,169 ) ( 22,196 ) Cash dividends to stockholders ($ 0.365 per share) ( 49,209 ) ( 49,209 ) Balance at December 31, 2022 $ 1,361 $ 1,168,061 $ ( 29,322 ) $ 47,297 $ ( 132,602 ) $ 1,054,795 See accompanying notes to consolidated financial statements. 6 CAPITOL FEDERAL FINANCIAL, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands) For the Three Months Ended December 31, 2023 2022 CASH FLOWS FROM OPERATING ACTIVITIES: Net income 2,543 16,240 Adjustments to reconcile net income to net cash provided by operating activities: FHLB stock dividends ( 2,586 ) ( 4,158 ) Provision for credit losses 123 3,660 Originations of loans receivable held-for-sale ("LHFS") ( 425 ) — Proceeds from sales of LHFS 433 — Amortization and accretion of premiums and discounts on securities ( 2,771 ) 837 Depreciation and amortization of premises and equipment 2,040 2,298 Amortization of intangible assets 199 274 Amortization of deferred amounts related to FHLB advances, net 383 459 Common stock committed to be released for allocation - ESOP 222 341 Stock-based compensation 87 89 Net loss from securities transactions 13,345 — Changes in: Unrestricted cash collateral from derivative counterparties, net ( 6,830 ) 530 Other assets, net 461 ( 2,527 ) Income taxes payable/receivable, net 4,584 1,117 Deferred income tax liabilities, net ( 7,836 ) ( 245 ) Other liabilities ( 9,306 ) ( 4,314 ) Net cash (used in) provided by operating activities ( 5,334 ) 14,601 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of AFS securities ( 668,310 ) — Proceeds from calls, maturities and principal reductions of AFS securities 49,604 51,045 Proceeds from sale of AFS securities 1,272,512 — Proceeds from the redemption of FHLB stock 3,134 90,423 Purchase of FHLB stock — ( 109,760 ) Net change in loans receivable 22,815 ( 327,583 ) Proceeds from sale of participating interest in loans receivable — 5,563 Purchase of premises and equipment ( 1,261 ) ( 1,093 ) Proceeds from sale of other real estate owned ("OREO") — 296 Net cash provided by (used in) investing activities 678,494 ( 291,109 ) (Continued) 7 CAPITOL FEDERAL FINANCIAL, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands) For the Three Months Ended December 31, 2023 2022 CASH FLOWS FROM FINANCING ACTIVITIES: Cash dividends paid ( 11,308 ) ( 49,209 ) Net change in deposits ( 29,625 ) ( 120,317 ) Proceeds from borrowings 175,100 2,000,100 Repayments on borrowings ( 682,521 ) ( 1,487,518 ) Change in advances by borrowers ( 38,154 ) ( 43,860 ) Repurchase of common stock ( 11,900 ) ( 22,196 ) Net cash (used in) provided by financing activities ( 598,408 ) 277,000 NET INCREASE IN CASH, CASH EQUIVALENTS AND RESTRICTED CASH 74,752 492 CASH, CASH EQUIVALENTS AND RESTRICTED CASH: Beginning of period 245,605 49,194 End of period $ 320,357 $ 49,686 See accompanying notes to consolidated financial statements. (Concluded) 8 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, 2023, filed with the Securities and Exchange Commission ("SEC"). Interim results are not necessarily indicative of results for a full year. Cash, Cash Equivalents and Restricted Cash - Cash, cash equivalents and restricted cash reported in the statement of cash flows consisted entirely of cash and cash equivalents at December 31, 2023 and September 30, 2023, respectively. At times, the Company holds restricted cash, which is reported in other assets on the consolidated balance sheet, related to collateral postings to/from the Bank's derivative counterparties associated with the Bank's interest rate swaps. There was no restricted cash at December 31, 2023 or September 30, 2023. 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 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. Recent Accounting Pronouncements - In March 2022, the Financial Accounting Standards Board ("FASB") issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings ("TDRs") and Vintage Disclosures . This ASU eliminates the accounting guidance for TDRs by creditors, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. Additionally, this ASU requires that an entity disclose current-period gross write-offs by year of origination for financing receivables within the scope of Accounting Standards Codification ("ASC") 326-20, Financial Instruments-Credit Losses-Measured at Amortized Cost . The Company adopted the ASU on October 1, 2023 on a prospective basis, except for the amendments impacting the measurement of the ACL for TDRs, which were adopted on a modified retrospective approach. Upon adoption, the Company recorded a $ 20 thousand increase in ACL, a $ 16 thousand increase in reserves for off-balance sheet exposures, and a cumulative effect-adjustment to retained earnings of $ 27 thousand, net of tax. The adjustments are attributable to including TDRs in the ACL model, as of October 1 2023. The new disclosure requirements associated with this ASU are included below and in Note 4. Loans Receivable and Allowance for Credit Losses. The following significant accounting policies have been updated since the Company's 2023 Annual Report on Form 10- K to reflect the adoption of ASU 2022-02. Troubled debt restructurings - Prior to the Company's adoption of ASU 2022-02, a loan was accounted for as a TDR if the Bank granted a concession to a borrower experiencing financial difficulties. Such concessions generally involve extensions of loan maturity dates, the granting of periods during which reduced payment amounts are required, and/or reductions in interest rates. The Bank does not forgive principal or interest, nor does it commit to lend additional funds to these borrowers, except for situations generally involving the capitalization of delinquent interest and/or escrow on one- to four-family loans and consumer loans, not to exceed the original loan amount. In the case of commercial loans, the Bank generally does not forgive principal or interest or commit to lend additional funds unless the borrower provides additional collateral or other enhancements to improve the credit quality. Loan modifications - The TDR policy outlined above regarding Bank concessions to a borrower experiencing financial difficulty continues to apply for loan modifications upon adoption of ASU 2022-02 on October 1, 2023. If the change in the loan terms resulting from the modification is deemed to be more than minor, all existing unamortized deferred loan origination fees and costs are recognized at the time of modification. Modifications of loans to borrowers experiencing financial difficulty that are in the form of principal forgiveness, interest rate reductions, other-than-insignificant payment delays, or a term extension (or a combination thereof) require disclosure in the Company's footnotes. The Company's modification disclosures are included in Note 4. Loans Receivable and Allowance for Credit Losses. Modified loans are included in the Company's ACL model based on the risk characteristics of the loan. If a modified loan is deemed uncollectible and no longer shares similar risk characteristics within the respective loan pool in the ACL model, the loan is evaluated on an individual basis and any loss is charged-off against the related ACL. 9 In October 2023, the FASB issued ASU 2023-06, Disclosure Improvements - Codification Amendments in Response to the SEC's Disclosure Update and Simplification Initiative. This ASU incorporates a variety of Topics into the Codification that are currently included in SEC Regulations S-X and S-K. The ASU is intended to align the accounting standards of GAAP with SEC Regulations S-X and S-K. Each amendment in the ASU will only become effective for the Company if the SEC removes the related disclosure or presentation requirement from its existing regulations by June 30, 2027. This may result in disclosures currently presented outside of the Company's financial statements being relocated to the Company's financial statements. The amendments will be applied prospectively by the Company. The ASU is not expected to have a material impact to the Company's disclosures as the Company is currently subject to SEC Regulations S-X and S-K. In November 2023, the FASB issued ASU 2023-07, Segment Reporting (Topic 280) - Improvements to Reportable Segment Disclosures. This ASU requires enhanced disclosures of segment information for all public entities, including those that have a single reportable segment, primarily in the area of segment revenues and expenses. Entities that have a single reportable segment, like the Company, will be required to provide all the disclosures required by this ASU and all existing segment disclosures requirements in ASC 280, Segment Reporting . This ASU is effective for the Company on October 1, 2024. The Company is currently evaluating the effect this ASU will have on the Company's segment disclosures. In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740) - Improvements to Income Tax Disclosures . This ASU requires public entities to provide additional annual disclosures regarding specific categories of the income tax rate reconciliation and additional information for reconciling items within the income tax rate reconciliation that meet a certain quantitative threshold. This ASU is effective for the Company on October 1, 2025. The Company is currently evaluating the effect this ASU will have on the Company's income tax disclosures. 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 December 31, 2023 2022 (Dollars in thousands, except per share amounts) Net income $ 2,543 $ 16,240 Income allocated to participating securities ( 2 ) ( 7 ) Net income available to common stockholders $ 2,541 $ 16,233 Total basic average common shares outstanding 132,353,313 134,640,932 Effect of dilutive stock options — — Total diluted average common shares outstanding 132,353,313 134,640,932 Net EPS: Basic $ 0.02 $ 0.12 Diluted $ 0.02 $ 0.12 Antidilutive stock options, excluded from the diluted average common shares outstanding calculation 335,461 378,026 10 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. December 31, 2023 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value (Dollars in thousands) MBS $ 503,912 $ 19,599 $ 291 $ 523,220 U.S. Treasury bills 213,700 58 — 213,758 Corporate bonds 4,000 — 516 3,484 $ 721,612 $ 19,657 $ 807 $ 740,462 September 30, 2023 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value (Dollars in thousands) MBS $ 901,440 $ 113 $ 819 $ 900,734 Government-sponsored enterprise ("GSE") debentures 479,610 — 182 479,428 Corporate bonds 4,000 — 622 3,378 Municipal bonds 942 — — 942 $ 1,385,992 $ 113 $ 1,623 $ 1,384,482 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. December 31, 2023 Less Than 12 Months Equal to or Greater Than 12 Months Estimated Unrealized Estimated Unrealized Fair Value Losses Fair Value Losses (Dollars in thousands) MBS $ 14,485 $ 13 $ 24,191 $ 278 Corporate bonds — — 3,484 516 $ 14,485 $ 13 $ 27,675 $ 794 September 30, 2023 Less Than 12 Months Equal to or Greater Than 12 Months Estimated Unrealized Estimated Unrealized Fair Value Losses Fair Value Losses (Dollars in thousands) MBS $ 6,179 $ 109 $ 34,555 $ 710 GSE debentures — — 24,818 182 Corporate bonds — — 3,378 622 $ 6,179 $ 109 $ 62,751 $ 1,514 11 The unrealized losses at December 31, 2023 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 did not record an ACL on securities in an unrealized loss position at December 31, 2023 because scheduled coupon payments have been made, management anticipates that the entire principal balance will be collected as scheduled, and neither does the Company intend 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. The amortized cost and estimated fair value of AFS debt securities as of December 31, 2023, 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 penalty. For this reason, MBS are not included in the maturity categories. Amortized Estimated Cost Fair Value (Dollars in thousands) One year or less $ 213,700 $ 213,758 Five years through ten years 4,000 3,484 217,700 217,242 MBS 503,912 523,220 $ 721,612 $ 740,462 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 December 31, 2023 2022 (Dollars in thousands) Taxable $ 2,526 $ 874 Non-taxable 2 7 $ 2,528 $ 881 The following table summarizes the carrying value of securities pledged as collateral for the obligations indicated below as of the dates presented. December 31, 2023 September 30, 2023 (Dollars in thousands) Public unit deposits $ 148,330 $ 178,396 Federal Reserve Bank of Kansas City ("FRB of Kansas City") borrowings 124,292 519,195 $ 272,622 $ 697,591 . During the quarter ended December 31, 2023, the Bank sold $ 1.30 billion of AFS securities. The Bank received gross proceeds of $ 1.27 billion from the sale and realized gross losses of $ 14.9 million and gross gains of $ 1.6 million, resulting in a net loss of $ 13.3 million on the sale during the quarter. 12 4. LOANS RECEIVABLE AND ALLOWANCE FOR CREDIT LOSSES Loans receivable, net at the dates presented is summarized as follows: December 31, 2023 September 30, 2023 (Dollars in thousands) One- to four-family: Originated $ 3,986,479 $ 3,978,837 Correspondent purchased 2,360,843 2,405,911 Bulk purchased 134,504 137,193 Construction 43,631 69,974 Total 6,525,457 6,591,915 Commercial: Commercial real estate 1,019,431 995,788 Commercial and industrial 113,686 112,953 Construction 196,493 178,746 Total 1,329,610 1,287,487 Consumer: Home equity 96,952 95,723 Other 9,670 9,256 Total 106,622 104,979 Total loans receivable 7,961,689 7,984,381 Less: ACL 24,178 23,759 Deferred loan fees/discounts 30,653 31,335 Premiums/deferred costs ( 40,652 ) ( 41,662 ) $ 7,947,510 $ 7,970,949 Lending Practices and Underwriting Standards - Originating one- to four-family loans is the Bank's primary lending business. The Bank also purchases one- to four-family loans from correspondent lenders and 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. 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 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 13 was being originated by the Bank. At the time of origination, loan-to-value ("LTV") 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 commercial and industrial loans. As a result of these additional complexities, variables and risks, commercial and industrial loans generally require more thorough underwriting and servicing than other types of loans. Consumer loans - The Bank offers a variety of consumer loans, the majority of which are home equity loans and lines of credit for which the Bank also has the first mortgage or 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 credit quality information about 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 the originated class and commercial construction loans are included in the commercial real estate class. As part of the on-going monitoring of the credit quality of the Company's loan portfolio, management tracks certain credit quality indicators including trends related to loan classification and delinquency status. Loan Classification - In accordance with the Bank's asset classification policy, management regularly reviews the problem loans in the Bank's portfolio to determine whether any 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 nonaccrual 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. 14 The following tables set forth, as of the dates indicated, the amortized cost of loans by class of financing receivable, year of origination or most recent credit decision, and loan classification. All revolving lines of credit and revolving lines of credit converted to term loans are presented separately, regardless of origination year. Loans classified as doubtful or loss are individually evaluated for loss. At December 31, 2023 and September 30, 2023, there were no loans classified as doubtful, and all loans classified as loss were fully charged-off. December 31, 2023 Revolving Line of Current Fiscal Fiscal Fiscal Fiscal Revolving Credit Fiscal Year Year Year Year Prior Line of Converted Year 2023 2022 2021 2020 Years Credit to Term Total (Dollars in thousands) One- to four-family: Originated Pass $ 50,552 $ 323,563 $ 599,827 $ 858,168 $ 556,619 $ 1,600,122 $ — $ — $ 3,988,851 Special Mention — — 2,102 1,893 992 9,101 — — 14,088 Substandard — — — 691 1,051 9,809 — — 11,551 Correspondent purchased Pass 1,718 343,733 505,493 597,360 242,658 685,581 — — 2,376,543 Special Mention — 939 916 2,018 420 1,203 — — 5,496 Substandard — — 1,562 — — 6,299 — — 7,861 Bulk purchased Pass — — — — — 131,789 — — 131,789 Special Mention — — — — — — — — — Substandard — — — — — 3,180 — — 3,180 52,270 668,235 1,109,900 1,460,130 801,740 2,447,084 — — 6,539,359 Commercial: Commercial real estate Pass 124,327 398,195 313,127 148,827 80,194 131,801 11,725 — 1,208,196 Special Mention — 2,473 — — — — — — 2,473 Substandard — 67 — — 594 474 — — 1,135 Commercial and industrial Pass 3,795 31,101 21,344 10,790 2,711 3,039 28,209 — 100,989 Special Mention — 12,593 — — — — — — 12,593 Substandard — — — — — 82 — — 82 128,122 444,429 334,471 159,617 83,499 135,396 39,934 — 1,325,468 Consumer: Home equity Pass 2,552 5,341 5,444 1,723 1,031 2,724 71,875 5,995 96,685 Special Mention — — 46 — — 16 43 226 331 Substandard — — — — — 3 58 114 175 Other Pass 1,551 4,181 2,439 640 253 191 412 — 9,667 Special Mention — — — — 3 — — — 3 Substandard — — — — — — — — — 4,103 9,522 7,929 2,363 1,287 2,934 72,388 6,335 106,861 Total $ 184,495 $ 1,122,186 $ 1,452,300 $ 1,622,110 $ 886,526 $ 2,585,414 $ 112,322 $ 6,335 $ 7,971,688 15 September 30, 2023 Revolving Line of Fiscal Fiscal Fiscal Fiscal Fiscal Revolving Credit Year Year Year Year Year Prior Line of Converted 2023 2022 2021 2020 2019 Years Credit to Term Total (Dollars in thousands) One- to four-family: Originated Pass $ 318,569 $ 597,298 $ 874,518 $ 568,081 $ 251,773 $ 1,398,616 $ — $ — $ 4,008,855 Special Mention — 1,883 1,468 767 1,863 8,067 — — 14,048 Substandard 292 155 221 564 939 7,954 — — 10,125 Correspondent purchased Pass 346,084 517,976 607,968 246,926 62,744 643,520 — — 2,425,218 Special Mention 308 674 1,674 420 357 1,133 — — 4,566 Substandard — — — 564 — 5,402 — — 5,966 Bulk purchased Pass — — — — — 134,464 — — 134,464 Special Mention — — — — — — — — — Substandard — — — — — 3,208 — — 3,208 665,253 1,117,986 1,485,849 817,322 317,676 2,202,364 — — 6,606,450 Commercial: Commercial real estate Pass 403,269 301,164 208,942 81,478 82,027 79,170 10,448 — 1,166,498 Special Mention 2,483 — — — — — — — 2,483 Substandard 67 — — 594 219 255 — — 1,135 Commercial and industrial Pass 30,206 23,166 11,740 3,228 2,693 748 27,104 — 98,885 Special Mention 13,191 — — — — — 699 — 13,890 Substandard — — — 73 — 82 — — 155 449,216 324,330 220,682 85,373 84,939 80,255 38,251 — 1,283,046 Consumer: Home equity Pass 5,501 5,624 1,955 1,069 746 2,224 72,119 6,205 95,443 Special Mention — 46 — — — 21 62 195 324 Substandard — — — — — 15 125 48 188 Other Pass 4,758 2,693 787 338 133 129 412 — 9,250 Special Mention — — — 4 — — — 1 5 Substandard 2 — — — — — — — 2 10,261 8,363 2,742 1,411 879 2,389 72,718 6,449 105,212 Total $ 1,124,730 $ 1,450,679 $ 1,709,273 $ 904,106 $ 403,494 $ 2,285,008 $ 110,969 $ 6,449 $ 7,994,708 16 Delinquency Status - The following tables set forth, as of the dates indicated, the amortized cost of current loans, loans 30 to 89 days delinquent, and loans 90 or more days delinquent or in foreclosure ("90+/FC"), by class of financing receivable and year of origination or most recent credit decision as of the dates indicated. All revolving lines of credit and revolving lines of credit converted to term loans are presented separately, regardless of origination year. December 31, 2023 Revolving Line of Current Fiscal Fiscal Fiscal Fiscal Revolving Credit Fiscal Year Year Year Year Prior Line of Converted Year 2023 2022 2021 2020 Years Credit to Term Total (Dollars in thousands) One- to four-family: Originated Current $ 50,552 $ 323,563 $ 601,737 $ 859,737 $ 557,404 $ 1,610,031 $ — $ — $ 4,003,024 30-89 — — 192 544 769 6,220 — — 7,725 90+/FC — — — 471 489 2,781 — — 3,741 Correspondent purchased Current 1,718 343,899 505,799 596,983 243,078 688,058 — — 2,379,535 30-89 — 773 610 2,395 — 2,362 — — 6,140 90+/FC — — 1,562 — — 2,663 — — 4,225 Bulk purchased Current — — — — — 133,440 — — 133,440 30-89 — — — — — 587 — — 587 90+/FC — — — — — 942 — — 942 52,270 668,235 1,109,900 1,460,130 801,740 2,447,084 — — 6,539,359 Commercial: Commercial real estate Current 123,381 399,539 313,127 148,827 80,136 130,629 11,475 — 1,207,114 30-89 946 1,129 — — 58 1,191 250 — 3,574 90+/FC — 67 — — 594 455 — — 1,116 Commercial and industrial Current 3,795 43,463 21,344 10,790 2,711 3,039 28,209 — 113,351 30-89 — 231 — — — — — — 231 90+/FC — — — — — 82 — — 82 128,122 444,429 334,471 159,617 83,499 135,396 39,934 — 1,325,468 Consumer: Home equity Current 2,552 5,341 5,452 1,706 1,031 2,676 71,483 6,207 96,448 30-89 — — 38 17 — 64 473 35 627 90+/FC — — — — — 3 20 93 116 Other Current 1,551 4,146 2,368 618 250 190 407 — 9,530 30-89 — 35 71 22 6 1 5 — 140 90+/FC — — — — — — — — — 4,103 9,522 7,929 2,363 1,287 2,934 72,388 6,335 106,861 Total $ 184,495 $ 1,122,186 $ 1,452,300 $ 1,622,110 $ 886,526 $ 2,585,414 $ 112,322 $ 6,335 $ 7,971,688 17 September 30, 2023 Revolving Line of Fiscal Fiscal Fiscal Fiscal Fiscal Revolving Credit Year Year Year Year Year Prior Line of Converted 2023 2022 2021 2020 2019 Years Credit to Term Total (Dollars in thousands) One- to four-family: Originated Current $ 318,211 $ 598,283 $ 875,563 $ 567,975 $ 253,546 $ 1,407,090 $ — $ — $ 4,020,668 30-89 358 898 644 1,437 820 5,960 — — 10,117 90+/FC 292 155 — — 209 1,587 — — 2,243 Correspondent purchased Current 346,084 518,650 608,573 247,346 62,652 643,739 — — 2,427,044 30-89 308 — 1,069 564 449 2,862 — — 5,252 90+/FC — — — — — 3,454 — — 3,454 Bulk purchased Current — — — — — 136,577 — — 136,577 30-89 — — — — — 153 — — 153 90+/FC — — — — — 942 — — 942 665,253 1,117,986 1,485,849 817,322 317,676 2,202,364 — — 6,606,450 Commercial: Commercial real estate Current 404,867 301,164 208,942 81,478 82,027 79,188 10,448 — 1,168,114 30-89 36 — — — — — — — 36 90+/FC 916 — — 594 219 237 — — 1,966 Commercial and industrial Current 43,397 23,166 11,740 3,228 2,690 748 27,684 — 112,653 30-89 — — — — 2 — 57 — 59 90+/FC — — — 73 1 82 62 — 218 449,216 324,330 220,682 85,373 84,939 80,255 38,251 — 1,283,046 Consumer: Home equity Current 5,428 5,631 1,955 990 746 2,195 71,986 6,312 95,243 30-89 73 39 — 79 — 50 239 125 605 90+/FC — — — — — 15 81 11 107 Other Current 4,737 2,613 765 338 132 129 412 — 9,126 30-89 17 80 22 4 1 — — 1 125 90+/FC 6 — — — — — — — 6 10,261 8,363 2,742 1,411 879 2,389 72,718 6,449 105,212 Total $ 1,124,730 $ 1,450,679 $ 1,709,273 $ 904,106 $ 403,494 $ 2,285,008 $ 110,969 $ 6,449 $ 7,994,708 18 Gross Charge-Offs - Upon adoption of ASU 2022-02 on October 1, 2023, the Company is required to present gross charge-offs by class of financing receivable and year of origination or most recent credit decision. The following table sets forth the required gross charge-off information for the three months ended December 31, 2023. Revolving Lines Current Fiscal Fiscal Fiscal Fiscal Revolving of Credit Fiscal Year Year Year Year Prior Lines of Converted to Year 2023 2022 2021 2020 Years Credit Term Total (Dollars in thousands) One- to four-family: Originated $ — $ — $ — $ — $ — $ — $ — $ — $ — Correspondent purchased — — — — — — — — — Bulk purchased — — — — — — — — — — — — — — — — — — Commercial: Commercial real estate — — — — — — — — — Commercial and Industrial — — — — — — — — — — — — — — — — — — Consumer: Home Equity 1 1 — — — — — — 2 Other — 5 — — — — — — 5 1 6 — — — — — — 7 Total $ 1 $ 6 $ — $ — $ — $ — $ — $ — $ 7 19 Delinquent and Nonaccrual Loans - The following tables present the amortized cost, at the dates indicated, by class, of loans 30 to 89 days delinquent, loans 90 or more days delinquent or in foreclosure, total delinquent loans, current loans, and total loans. At December 31, 2023 and September 30, 2023, all loans 90 or more days delinquent were on nonaccrual status. The increase in correspondent and bulk purchased one- to four-family loans 30 to 89 days delinquent and in nonaccrual one- to four-family loans was due mainly to delinquencies returning to more historical levels as government payment assistance programs expired. The increase in commercial loans 30 to 89 days delinquent was a mix of several different borrowers and property types. There was not one underlying reason for the increase in commercial loan delinquencies from September 30, 2023. Management is working closely with the borrowers to address payment issues. December 31, 2023 90 or More Days Total Total 30 to 89 Days Delinquent or Delinquent Current Amortized Delinquent in Foreclosure Loans Loans Cost (Dollars in thousands) One- to four-family: Originated $ 7,725 $ 3,741 $ 11,466 $ 4,003,024 $ 4,014,490 Correspondent purchased 6,140 4,225 10,365 2,379,535 2,389,900 Bulk purchased 587 942 1,529 133,440 134,969 Commercial: Commercial real estate 3,574 1,116 4,690 1,207,114 1,211,804 Commercial and industrial 231 82 313 113,351 113,664 Consumer: Home equity 627 116 743 96,448 97,191 Other 140 — 140 9,530 9,670 $ 19,024 $ 10,222 $ 29,246 $ 7,942,442 $ 7,971,688 September 30, 2023 90 or More Days Total Total 30 to 89 Days Delinquent or Delinquent Current Amortized Delinquent in Foreclosure Loans Loans Cost (Dollars in thousands) One- to four-family: Originated $ 10,117 $ 2,243 $ 12,360 $ 4,020,668 $ 4,033,028 Correspondent purchased 5,252 3,454 8,706 2,427,044 2,435,750 Bulk purchased 153 942 1,095 136,577 137,672 Commercial: Commercial real estate 36 1,966 2,002 1,168,114 1,170,116 Commercial and industrial 59 218 277 112,653 112,930 Consumer: Home equity 605 107 712 95,243 95,955 Other 125 6 131 9,126 9,257 $ 16,347 $ 8,936 $ 25,283 $ 7,969,425 $ 7,994,708 The amortized cost of mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process as of December 31, 2023 and September 30, 2023 was $ 2.8 million and $ 2.5 million, respectively, which is included in loans 90 or more days delinquent or in foreclosure in the tables 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 $ 444 thousand at December 31, 2023 and $ 219 thousand at September 30, 2023. 20 The following table presents the amortized cost at December 31, 2023 and September 30, 2023, by class, of loans classified as nonaccrual. Additionally, the amortized cost of nonaccrual loans that had no related ACL is presented, all of which were individually evaluated for loss and any identified losses have been charged off. December 31, 2023 September 30, 2023 Nonaccrual Loans Nonaccrual Loans with No ACL Nonaccrual Loans Nonaccrual Loans with No ACL (Dollars in thousands) One- to four-family: Originated $ 3,741 $ 157 $ 2,457 $ 471 Correspondent purchased 4,225 — 3,739 285 Bulk purchased 942 630 942 630 Commercial: Commercial real estate 1,135 446 1,984 446 Commercial and industrial 82 83 218 155 Consumer: Home equity 116 — 107 3 Other — — 6 — $ 10,241 $ 1,316 $ 9,453 $ 1,990 Loan Modifications - The following table presents the amortized cost basis of loans as of December 31, 2023 that were both experiencing financial difficulties and modified during the three months ended December 31, 2023, by class of financing receivable and by type of modification. The percentage of the amortized cost basis of loans that were modified to borrowers experiencing financial difficulties as compared to the amortized cost basis of each class of financing receivable is also presented below. During the three months ended December 31, 2023, the Company did not charge-off any amounts related to the loans presented in the table below. The Company has not committed to lend additional amounts to borrowers included in this table. Combination- Total Term Extension Class of Principal Interest Rate Payment Term and Financing Forgiveness Reduction Delay Extension Payment Delay Total Receivable (Dollars in thousands) One- to four-family: Originated $ — $ — $ — $ — $ 4,405 $ 4,405 0.11 % Correspondent — — — — 1,247 1,247 0.05 Purchased — — — — — — — — — — — 5,652 5,652 0.09 Commercial: Commercial real estate — — — — — — — Commercial and industrial — — — — — — — — — — — — — — Consumer loans: Home equity — — — — — — — Other — — — — — — — — — — — — — — Total $ — $ — $ — $ — $ 5,652 $ 5,652 0.07 21 Financial effect of loan modifications - All loan modifications during the three months ended December 31, 2023 were a combination of term extensions and payment delays of one- to four-family originated loans or one- to four-family correspondent loans. The weighted average length of the term extensions was 23 months for one- to four-family originated loans and 12 months for one- to four-family correspondent loans. The weighted average payment delay was four months for both one- to four-family originated loans and one- to four-family correspondent loans. Performance of loan modifications - None of the loans modified during the three months ended December 31, 2023 defaulted through December 31, 2023. The Company considers "default" to mean 90 days or more past due under the modified terms. Of the loans modified during the three months ended December 31, 2023, $ 231 thousand of one-to four-family originated loans were 30-89 days delinquent at December 31, 2023. All other loans modified during the three months ended December 31, 2023 were current at December 31, 2023. TDRs - Prior to the adoption of ASU 2022-02 on October 1, 2023, loans were accounted for as TDRs if the Bank granted a concession to a borrower experiencing financial difficulties. There were no loans restructured during the three months ended December 31, 2022. During the three months ended December 31, 2022, there was one one-to four-family originated TDR with an amortized cost of $ 8 thousand that became delinquent within 12 months after being restructured. Allowance for Credit Losses - The following is a summary of ACL activity, by loan portfolio segment, for the periods presented. For the Three Months Ended December 31, 2023 One- to Four-Family Correspondent Bulk Originated Purchased Purchased Total Commercial Consumer Total (Dollars in thousands) Beginning balance $ 2,149 $ 2,972 $ 207 $ 5,328 $ 18,180 $ 251 $ 23,759 Adoption of ASU 2022-02 3 1 14 18 2 — 20 Balance at October 1, 2023 2,152 2,973 221 5,346 18,182 251 23,779 Charge-offs — — — — — ( 7 ) ( 7 ) Recoveries 5 — — 5 1 — 6 Provision for credit losses ( 63 ) ( 25 ) ( 15 ) ( 103 ) 495 8 400 Ending balance $ 2,094 $ 2,948 $ 206 $ 5,248 $ 18,678 $ 252 $ 24,178 For the Three Months Ended December 31, 2022 One- to Four-Family Correspondent Bulk Originated Purchased Purchased Total Commercial Consumer Total (Dollars in thousands) Beginning balance $ 2,066 $ 2,734 $ 206 $ 5,006 $ 11,120 $ 245 $ 16,371 Charge-offs — — — — — ( 4 ) ( 4 ) Recoveries 1 — — 1 — 1 2 Provision for credit losses 92 253 10 355 2,464 1 2,820 Ending balance $ 2,159 $ 2,987 $ 216 $ 5,362 $ 13,584 $ 243 $ 19,189 22 The key assumptions in the Company's ACL model include the economic forecast, the forecast and reversion to mean time periods, and prepayment and curtailment assumptions. Management also considered certain qualitative factors when evaluating the adequacy of the ACL at December 31, 2023. The key assumptions utilized in estimating the Company's ACL at December 31, 2023 are discussed below. • Economic Forecast - Management considered several economic forecasts provided by a third party and selected an economic forecast that was the most appropriate considering the facts and circumstances at December 31, 2023. The forecasted economic indices applied to the model at December 31, 2023 were the national unemployment rate, changes in commercial real estate price index, changes in home values, and changes in the U.S. gross domestic product. The economic index most impactful to all loan pools within the model at December 31, 2023 was the national unemployment rate. The forecasted national unemployment rate in the economic scenario selected by management at December 31, 2023 had the national unemployment rate gradually increasing to 4.0 % by December 31, 2024, which was the end of our four-quarter forecast time period. • Forecast and reversion to mean time periods - The forecasted time period and the reversion to mean time period were each four quarters for all of the economic indices at December 31, 2023. • Prepayment and curtailment assumptions - The assumptions used at December 31, 2023 were generally based on actual historical prepayment and curtailment speeds, adjusted by management as deemed necessary. The prepayment and curtailment assumptions vary for each respective loan pool in the model. • Qualitative factors - The qualitative factors applied by management at December 31, 2023 included the following: ◦ The economic uncertainties related to the unemployment rate, the labor force composition, and the labor participation rate that are not captured in the third-party economic forecast scenarios; and ◦ Other management considerations related to commercial loans to account for credit risks not fully reflected in the discounted cash flow model. Reserve for Off-Balance Sheet Credit Exposures - The following is a summary of the changes in reserve for off-balance sheet credit exposures during the periods indicated. At December 31, 2023 and September 30, 2023, the Bank's off-balance sheet credit exposures totaled $ 803.0 million and $ 837.7 million, respectively. For the Three Months Ended December 31, 2023 December 31, 2022 (Dollars in thousands) Beginning balance $ 4,095 $ 4,751 Adoption of ASU 2022-02 16 — Balance at October 1, 2023 4,111 4,751 (Release)/provision for credit losses ( 277 ) 840 Ending balance $ 3,834 $ 5,591 23 5. BORROWED FUNDS Borrowings - Borrowings at December 31, 2023 consisted of $ 2.38 billion in FHLB advances, of which $ 2.01 billion were fixed-rate advances and $ 365.0 million were variable-rate advances, and $ 974 thousand in finance leases. Borrowings at September 30, 2023 consisted of $ 2.38 billion in FHLB advances, of which $ 2.02 billion were fixed-rate advances and $ 365.0 million were variable-rate advances, and $ 500.0 million of borrowings from the Federal Reserve's Bank Term Funding Program ("BTFP"). During the current quarter, the Bank paid off the $ 500.0 million of BTFP borrowings. As of December 31, 2023 and September 30, 2023, the Bank held interest rate swap agreements with an aggregate notional amount of $ 365.0 million in order to hedge the variable cash flows associated with $ 365.0 million of adjustable-rate FHLB advances. At December 31, 2023 and September 30, 2023, the interest rate swap agreements had an average remaining term to maturity of 1.8 years and 2.1 years, respectively. The interest rate swaps were designated as cash flow hedges and involved 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 December 31, 2023 and September 30, 2023, the interest rate swaps were in a gain position with a total fair value of $ 6.5 million and $ 13.0 million respectively, which was reported in other assets on the consolidated balance sheet. During the three month periods ended December 31, 2023 and December 31, 2022, $ 1.9 million and $ 734 thousand, respectively, was reclassified from AOCI as a decrease to interest expense. At December 31, 2023, the Company estimated that $ 5.2 million of interest expense associated with the interest rate swaps would be reclassified from AOCI as a decrease 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 held cash collateral of $ 7.2 million and $ 14.0 million at December 31, 2023 and September 30, 2023, respectively, in compliance with its minimum posting requirements. At times, the Bank has utilized a leverage strategy to increase earnings which entails entering into short-term FHLB advances and depositing the proceeds from the borrowings, net of the required FHLB stock holdings, at the FRB of Kansas City. The borrowings are repaid prior to quarter end, or earlier if the strategy is suspended. The leverage strategy was not in place during the current quarter due to the strategy being unprofitable, but it was in place at points during the September 30, 2023 quarter. When the leverage strategy is in place, it reduces the net interest margin due to the amount of earnings from the transaction in comparison to the size of the transaction. Management continues to monitor the net interest rate spread and overall profitability of the leverage strategy. 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 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 the fair value of its financial instruments on the price that would be received from the sale of an 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 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 24 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 three months ended December 31, 2023 or during fiscal year 2023. The Company's major security types, based on the nature and risks of the securities, are: • U.S. Treasury bills - Estimated fair values are based on pricing data from active primary and secondary markets, and inter-dealer brokers. (Level 1) • 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 - The majority of these securities are issued by GSEs. 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) • Corporate Bonds and 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 other liabilities 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 obtained from the counterparty during the three months ended December 31, 2023 or during fiscal year 2023. (Level 2) 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 December 31, 2023 or September 30, 2023. 25 December 31, 2023 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 $ 523,220 $ — $ 523,220 $ — U.S. Treasury bills 213,758 213,758 — — Corporate bonds 3,484 — 3,484 — 740,462 213,758 526,704 — Interest rate swaps 6,487 — 6,487 — $ 746,949 $ 213,758 $ 533,191 $ — September 30, 2023 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 $ 900,734 $ — $ 900,734 $ — GSE debentures 479,428 — 479,428 — Corporate bonds 3,378 — 3,378 — Municipal bonds 942 — 942 — 1,384,482 — 1,384,482 — Interest rate swaps 13,018 — 13,018 — $ 1,397,500 $ — $ 1,397,500 $ — The following is a description of valuation methodologies used for significant financial instruments measured at fair value on a non-recurring basis. The significant unobservable inputs used in the determination of the fair value of assets classified as Level 3 have an inherent measurement uncertainty that, if changed, could result in higher or lower fair value measurements of these assets as of the reporting date . Loans Receivable - Collateral dependent assets are assets evaluated on an individual basis. Those collateral dependent assets that are evaluated on an individual basis are considered financial assets measured at fair value on a non-recurring basis. The fair value of collateral dependent loans/loans individually evaluated for loss on a non-recurring basis during the three months ended December 31, 2023 and 2022 that were still held in the portfolio as of December 31, 2023 and 2022 was $ 1.1 million and $ 4.1 million, respectively. Fair values of collateral dependent loans/loans individually evaluated for loss 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. 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 adjust 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 commercial loans individually evaluated during the three months ended December 31, 2023 and December 31, 2022 were downward adjustments to the book value of the collateral for lack of marketability. During the three months ended December 31, 2023, the adjustments ranged from 5 % to 100 %, with a weighted average of 17 %. During the three months ended December 31, 2022, the adjustments ranged from 8 % to 100 %, with a weighted average of 21 %. The basis utilized in calculating the weighted averages for these adjustments was the original unadjusted value of each collateral item. 26 OREO - OREO primarily 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. The fair value for one- to four-family 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 one- to four-family OREO was the appraisal or listing price. For commercial OREO, 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 adjust 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 input for commercial OREO is downward adjustments to book value of the collateral for lack of marketability. 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. There was $ 219 thousand and $ 93 thousand of one- to four-family OREO measured on a non-recurring basis during the three months ended December 31, 2023 and December 31, 2022, respectively. The carrying value of the properties equaled the fair value of the properties at December 31, 2023 and 2022. There was no commercial OREO measured on a non-recurring basis during the three months ended December 31, 2023 or 2022. 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: December 31, 2023 Carrying Estimated Fair Value Amount Total Level 1 Level 2 Level 3 (Dollars in thousands) Assets: Cash and cash equivalents $ 320,357 $ 320,357 $ 320,357 $ — $ — AFS securities 740,462 740,462 213,758 526,704 — Loans receivable 7,947,510 7,561,055 — — 7,561,055 FHLB stock 110,166 110,166 110,166 — — Interest rate swaps 6,487 6,487 — 6,487 — Liabilities: Deposits 6,021,595 6,003,615 3,282,768 2,720,847 — Borrowings 2,373,064 2,331,484 — 2,331,484 — September 30, 2023 Carrying Estimated Fair Value Amount Total Level 1 Level 2 Level 3 (Dollars in thousands) Assets: Cash and cash equivalents $ 245,605 $ 245,605 $ 245,605 $ — $ — AFS securities 1,384,482 1,384,482 — 1,384,482 — Loans receivable 7,970,949 7,358,462 — — 7,358,462 FHLB stock 110,714 110,714 110,714 — — Interest rate swaps 13,018 13,018 — 13,018 — Liabilities: Deposits 6,051,220 6,004,975 3,321,028 2,683,947 — Borrowings 2,879,125 2,802,849 — 2,802,849 — 27 7. INCOME TAXES At September 30, 2023, the Company recorded a deferred income tax asset of $ 47.0 million related to the net loss on a securities transaction. The related securities were sold during the current quarter which resulted in the Company reversing the $ 47.0 million deferred tax asset at September 30, 2023 and recognizing a $ 45.0 million net operating loss deferred income tax asset as of December 31, 2023. Additionally, the Company recorded a $ 4.6 million deferred tax asset at December 31, 2023 related to low income housing tax credits. The Company assesses the available positive and negative evidence surrounding the recoverability of its deferred tax assets and applies its judgment in estimating the amount of valuation allowance necessary under the circumstances. At December 31, 2023, the Company does not believe a valuation allowance is necessary on the deferred income tax assets recorded during the current quarter as it is more likely than not that these amounts will be realized through the reversal of the Company's existing taxable temporary differences and projected future taxable income. 8. 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 December 31, 2023 Unrealized Unrealized Gains (Losses) Gains (Losses) on AFS on Cash Flow Total Securities Hedges AOCI (Dollars in thousands) Beginning balance ( 1,142 ) 9,842 8,700 Other comprehensive income (loss), before reclassifications 16,581 ( 2,998 ) 13,583 Amount reclassified from AOCI, net of taxes of $ 626 — ( 1,940 ) ( 1,940 ) Reclassification adjustment for gross gains on AFS securities included in net income, net of taxes of $ 383 ( 1,188 ) — ( 1,188 ) Other comprehensive income (loss) 15,393 ( 4,938 ) 10,455 Ending balance 14,251 4,904 19,155 For the Three Months Ended December 31, 2022 Unrealized Unrealized Gains (Losses) Gains (Losses) on AFS on Cash Flow Total Securities Hedges AOCI (Dollars in thousands) Beginning balance $ ( 155,119 ) $ 9,486 $ ( 145,633 ) Other comprehensive income (loss), before reclassifications 13,050 715 13,765 Amount reclassified from AOCI, net of taxes of $ 237 — ( 734 ) ( 734 ) Other comprehensive income (loss) 13,050 ( 19 ) 13,031 Ending balance $ ( 142,069 ) $ 9,467 $ ( 132,602 ) 28