Capitol Federal Financial, Inc. 10-Q

Item 3. Quantitative and Qualitative Disclosures About Market Risk Asset and Liability Management and Market Risk For a complete discussion of the Bank's asset and liability management policies, as well as the potential impact of interest rate changes upon the market value of the Bank's portfolios, see "Part II, Item 7A. Quantitative and Qualitative Disclosures about Market Risk" in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2023. The analysis presented in the tables below reflects the level of market risk at the Bank, including the cash the holding company has on deposit at the Bank. The rates of interest the Bank earns on its assets and pays on its liabilities are generally established contractually for a period of time. Fluctuations in interest rates have a significant impact not only upon our net income, but also upon the cash flows and market values of our assets and liabilities. Our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our interest-earning assets and interest-bearing liabilities. Risk associated with changes in interest rates on the earnings of the Bank and the market value of its financial assets and liabilities is known as interest rate risk. Interest rate risk is our most significant market risk, and our ability to adapt to changes in interest rates is known as interest rate risk management. The general objective of our interest rate risk management program is to determine and manage an appropriate level of interest rate risk while maximizing net interest income in a manner consistent with our policy to manage, to the extent practicable, the exposure of net interest income to changes in market interest rates. The Board of Directors and Asset and Liability Management Committee ("ALCO") regularly review the Bank's interest rate risk exposure by forecasting the impact of hypothetical, alternative interest rate environments on net interest income and the market value of portfolio equity ("MVPE") at various dates. The MVPE is defined as the net of the present value of cash flows from existing assets, liabilities, and off-balance sheet instruments. The present values are determined based upon market conditions as of the date of the analysis, as well as in alternative interest rate environments providing potential changes in the MVPE under those alternative interest rate environments. Net interest income is projected in the same alternative interest rate environments with both a static balance sheet and one with management strategies considered. The MVPE and net interest income analyses are also conducted to estimate our sensitivity to rates for future time horizons based upon market conditions as of the date of the analysis. The MVPE ratio continues to be an important measurement for management as we consider the changes in market rates, liquidity needs, and portfolio balances. MVPE represents a long-term view of the interest sensitivity of the Bank's balance sheet while our net interest income projections inform management of the short-term impacts of pricing decisions. In addition to the interest rate environments presented below, management also reviews the impact of non-parallel rate shock scenarios on a quarterly basis. These scenarios consist of flattening and steepening the yield curve by changing short-term and long-term interest rates independent of each other, and simulating cash flows and determining valuations as a result of these hypothetical changes in interest rates to identify rate environments that pose the greatest risk to the Bank. This analysis helps management quantify the Bank's exposure to changes in the shape of the yield curve. Qualitative Disclosure about Market Risk Gap Table. The following gap table summarizes the anticipated maturities or repricing periods of the Bank's interest-earning assets and interest-bearing liabilities based on the information and assumptions set forth in the notes below. Cash flow projections for mortgage-related assets are calculated based in part on prepayment assumptions at current and projected interest rates. Prepayment projections are subjective in nature, involve uncertainties and assumptions and, therefore, cannot be determined with a high degree of accuracy. Although certain assets and liabilities may have similar maturities or periods to repricing, they may react differently to changes in market interest rates. Assumptions may not reflect how actual yields and costs respond to market interest rate changes. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. Certain assets, such as adjustable-rate loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayment rates would likely deviate significantly from those assumed in calculating the gap table below. A positive gap generally means more cash flows from assets are expected to reprice than cash flows from liabilities and suggests, in a rising rate environment, that earnings should increase. A negative gap generally means more cash flows from liabilities are expected to reprice than cash flows from assets and suggests, in a rising rate environment, that earnings should decrease. For additional information regarding the impact of changes in interest rates, see the following Change in Net Interest Income and Change in MVPE discussions and tables. 73 More Than More Than Within One Year to Three Years Over One Year Three Years to Five Years Five Years Total Interest-earning assets: (Dollars in thousands) Loans receivable (1) $ 1,634,849 $ 1,821,014 $ 1,384,363 $ 3,110,031 $ 7,950,257 Securities (2) 252,423 175,566 188,413 177,154 793,556 Other interest-earning assets 292,786 — — — 292,786 Total interest-earning assets 2,180,058 1,996,580 1,572,776 3,287,185 9,036,599 Interest-bearing liabilities: Non-maturity deposits (3) 609,489 422,480 366,080 1,850,853 3,248,902 Certificates of deposit 2,198,453 606,664 124,496 197 2,929,810 Borrowings (4) 776,214 1,177,580 347,644 27,000 2,328,438 Total interest-bearing liabilities 3,584,156 2,206,724 838,220 1,878,050 8,507,150 Excess (deficiency) of interest-earning assets over interest-bearing liabilities $ (1,404,098) $ (210,144) $ 734,556 $ 1,409,135 $ 529,449 Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities $ (1,404,098) $ (1,614,242) $ (879,686) $ 529,449 Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities as a percent of total Bank assets at: June 30, 2024 (14.6) % (16.8) % (9.2) % 5.5 % March 31, 2024 (11.3) September 30, 2023 (11.7) Cumulative one-year gap - interest rates +200 bps at: June 30, 2024 (16.6) March 31, 2024 (12.5) September 30, 2023 (11.9) (1) Adjustable-rate loans are included in the period in which the rate is next scheduled to adjust or in the period in which repayments are expected to occur, or prepayments are expected to be received, prior to their next rate adjustment, rather than in the period in which the loans are due. Fixed-rate loans are included in the periods in which they are scheduled to be repaid, based on scheduled amortization and prepayment assumptions. Balances are net of undisbursed amounts and deferred fees and exclude loans 90 or more days delinquent or in foreclosure. (2) MBS reflect projected prepayments at amortized cost. All other securities are presented based on contractual maturities, term to call dates or pre-refunding dates as of June 30, 2024, at amortized cost. (3) Although the Bank's checking, savings, and money market accounts are subject to immediate withdrawal, management considers a substantial amount of these accounts to be core deposits having significantly longer effective maturities. The decay rates (the assumed rates at which the balances of existing accounts decline) used on these accounts are based on assumptions developed from our actual experiences with these accounts. If all of the Bank's checking, savings, and money market accounts had been assumed to be subject to repricing within one year, interest-bearing liabilities estimated to mature or reprice within one year would have exceeded interest-earning assets with comparable characteristics by $4.04 billion, for a cumulative one-year gap of (42.1)% of total assets. (4) Borrowings exclude deferred prepayment penalty costs. Included in this line item are $300.0 million of FHLB adjustable-rate advances tied to interest rate swaps. The repricing of these liabilities is projected to occur at the maturity date of each interest rate swap. At June 30, 2024, the Bank's gap between the amount of interest-earning assets and interest-bearing liabilities projected to reprice within one year was $(1.40) billion, or (14.6)% of total assets, compared to $(1.19) billion, or (11.7)% of total assets, at September 30, 2023. The change in the one-year gap amount was due to a net increase in the amount of liability cash flows coming due in one year, partially offset by an increase in the amount of interest-earning asset cash flows coming due in one year as of June 30, 2024, compared to September 30, 2023. The net increase in liability cash flows coming due in one year primarily related to the Bank's retail certificate of deposit portfolio, partially offset by a decrease in borrowings coming due in one year as the Bank repaid its BTFP amount outstanding in conjunction with the securities strategy. The increase in the one-year cash flow for retail certificates of deposit was due to the Bank continuing to offer higher rates on shorter-term certificates of deposit. The increase in interest-earning assets projected to mature or reprice within one year was due primarily to an increase in the amount of loans expected to mature or reprice, as well as to an increase in the balance of cash between periods. 74 The amount of interest-bearing liabilities expected to reprice in a given period is not typically significantly impacted by changes in interest rates because the Bank's borrowings and certificate of deposit portfolios have contractual maturities and generally cannot be terminated early without a prepayment penalty. If interest rates were to increase 200 basis points, as of June 30, 2024, the Bank's one-year gap is projected to be $(1.59) billion, or (16.6)% of total assets. The change in the gap compared to when there is no change in rates was due to lower anticipated net cash flows primarily as a result of lower prepayments on mortgage-related assets in the higher rate environment. This compares to a one-year gap of $(1.21) billion, or (11.9)% of total assets, if interest rates were to have increased 200 basis points as of September 30, 2023. Change in Net Interest Income. For each date presented in the following table, the estimated change in the Bank's net interest income is based on the indicated instantaneous, parallel and permanent change in interest rates. The change in each interest rate environment represents the difference between estimated net interest income in the zero basis point interest rate environment ("base case," assumes the forward market and product interest rates implied by the yield curve are realized) and the estimated net interest income in each alternative interest rate environment (assumes market and product interest rates have a parallel shift in rates across all maturities by the indicated change in rates). Projected cash flows for each scenario are based upon varying prepayment assumptions to model anticipated customer behavior changes as market rates change. Estimations of net interest income used in preparing the table below were based upon the assumptions that the total composition of interest-earning assets and interest-bearing liabilities does not change materially and that any repricing of assets or liabilities occurs at anticipated product and market rates for the alternative rate environments as of the dates presented. The estimation of net interest income does not include any projected gains or losses related to the sale of loans or securities, or income derived from non-interest income sources, but does include the use of different prepayment assumptions in the alternative interest rate environments. It is important to consider that estimated changes in net interest income are for a cumulative four-quarter period. These do not reflect the earnings expectations of management. Estimates for the -300 basis point scenario were not prepared at September 30, 2023. Change Net Interest Income At (in Basis Points) June 30, 2024 September 30, 2023 in Interest Rates (1) Amount ($) Change ($) Change (%) Amount ($) Change ($) Change (%) (Dollars in thousands) -300 bp $ 159,739 $ (7,258) (4.4) % N/A N/A N/A -200 bp 162,853 (4,144) (2.5) $ 126,495 $ (6,963) (5.2) % -100 bp 165,289 (1,708) (1.0) 130,374 (3,084) (2.3) 000 bp 166,997 — — 133,458 — — +100 bp 167,667 670 0.4 136,147 2,689 2.0 +200 bp 167,454 457 0.3 138,804 5,346 4.0 +300 bp 167,481 484 0.3 141,494 8,036 6.0 (1) Assumes an instantaneous, parallel, and permanent change in interest rates at all maturities. In general, increases/(decreases) in the Bank's net interest income projections under the various interest rate scenarios presented are due to the degree to which rates earned on funds received through loan and securities repayments, in each scenario, are greater/(less) than the projected change in deposit and borrowing rates in the next 12 months. The net interest income projection was higher in the base case scenario at June 30, 2024 compared to September 30, 2023, due primarily to transactions associated with the securities strategy, which resulted in a decrease in interest expense on borrowings due to the Bank repaying the BTFP borrowing and an increase in interest income on cash and securities. These interest income benefits were partially offset by higher interest expense projections on the Bank's deposit portfolio, primarily on its retail certificate of deposit portfolio, due to increases in both the balance and rate between the two periods. 75 Change in MVPE. The following table sets forth the estimated change in the MVPE for each date presented based on the indicated instantaneous, parallel, and permanent change in interest rates. The change in each interest rate environment represents the difference between the MVPE in the base case (assumes the forward market interest rates implied by the yield curve are realized) and the MVPE in each alternative interest rate environment (assumes market interest rates have a parallel shift in rates). Projected cash flows for each scenario are based upon varying prepayment assumptions to model anticipated customer behavior as market rates change. The estimations of the MVPE used in preparing the table below were based upon the assumption that the total composition of interest-earning assets and interest-bearing liabilities do not change, that any repricing of assets or liabilities occurs at current product or market rates for the alternative rate environments as of the dates presented, and that different prepayment rates were used in each alternative interest rate environment. The estimated MVPE results from the valuation of cash flows from financial assets and liabilities over the anticipated lives of each for each interest rate environment. The table below presents the effects of the changes in interest rates on our assets and liabilities as they mature, repay, or reprice, as shown by the change in the MVPE for alternative interest rates. Estimates for the -300 basis point scenario were not prepared at September 30, 2023. Change Market Value of Portfolio Equity At (in Basis Points) June 30, 2024 September 30, 2023 in Interest Rates (1) Amount ($) Change ($) Change (%) Amount ($) Change ($) Change (%) (Dollars in thousands) -300 bp $ 1,193,185 $ 218,302 22.4 % N/A N/A N/A -200 bp 1,159,421 184,538 18.9 $ 1,302,781 $ 283,093 27.8 % -100 bp 1,080,349 105,466 10.8 1,145,404 125,716 12.3 000 bp 974,883 — — 1,019,688 — — +100 bp 860,101 (114,782) (11.8) 888,642 (131,046) (12.9) +200 bp 732,347 (242,536) (24.9) 757,870 (261,818) (25.7) +300 bp 598,219 (376,664) (38.6) 632,716 (386,972) (38.0) (1) Assumes an instantaneous, parallel, and permanent change in interest rates at all maturities. The Bank's MVPE decreased from $1.02 billion at September 30, 2023 to $974.9 million at June 30, 2024. The decrease was due primarily to model enhancements associated with the calculation of the Bank's estimated MVPE, partially offset by decreases in market interest rates between the two periods, most notably across the intermediate and long-term tenors of the yield curve, as well as to balance sheet composition changes resulting from the securities strategy. The decrease in market interest rates resulted in an increase in the value of the Bank's interest-earning assets more than it increased the value of its interest-bearing liabilities. As interest rates increase, borrowers have less economic incentive to prepay or to refinance their mortgages and agency debt issuers have less economic incentive or opportunity to exercise their call options in order to issue new debt at lower interest rates, resulting in lower projected cash flows on these assets. As interest rates increase in the rising interest rate scenarios, prepayments on mortgage-related assets are more likely to decrease and only be realized through significant changes in borrowers' lives such as divorce, death, job-related relocations, or other major events as there is less economic incentive for borrowers to prepay their debt, resulting in an increase in the average lives of mortgage-related assets. Similarly, call projections for callable agency debentures decrease as interest rates rise, which results in cash flows related to these assets moving closer to their contractual maturity dates. The longer expected average lives of these assets increases the sensitivity of their market value to changes in interest rates. In the increasing rate scenarios, the sensitivity reflects the negative impacts of rates on the value of the Bank's loan and securities portfolios more so than on its deposit and borrowings portfolios. In the decreasing interest rate scenarios, the Bank's MVPE increased due to a larger increase in the market value of the Bank's assets than the Bank's liabilities. This is because the Bank's mortgage-related assets continue to have a longer duration in these interest rate scenarios, which results in greater sensitivity in market value as interest rates change. 76 The following table presents the weighted average yields/rates and WALs (in years), after applying prepayment, call assumptions, and decay rates for our interest-earning assets and interest-bearing liabilities as of June 30, 2024. Yields presented for interest-earning assets include the amortization of fees, costs, premiums and discounts, which are considered adjustments to the yield. The interest rate presented for term borrowings is the effective rate, which includes the impact of interest rate swaps and the amortization of deferred prepayment penalties resulting from FHLB advances previously prepaid. The WAL presented for term borrowings includes the effect of interest rate swaps. Amount Yield/Rate WAL % of Category % of Total (Dollars in thousands) Securities $ 801,953 5.68 % 3.3 8.7 % Loans receivable: Fixed-rate one- to four-family 5,434,393 3.38 6.7 68.3 % 59.2 Fixed-rate commercial 497,635 4.68 2.9 6.3 5.4 All other fixed-rate loans 38,112 6.84 6.5 0.5 0.4 Total fixed-rate loans 5,970,140 3.51 6.4 75.1 65.0 Adjustable-rate one- to four-family 918,487 4.12 4.0 11.5 10.0 Adjustable-rate commercial 967,748 6.05 5.5 12.2 10.6 All other adjustable-rate loans 94,903 8.59 3.0 1.2 1.0 Total adjustable-rate loans 1,981,138 5.27 4.7 24.9 21.6 Total loans receivable 7,951,278 3.95 5.9 100.0 % 86.6 FHLB stock 106,309 9.47 1.9 1.2 Cash and cash equivalents 317,821 4.97 — 3.5 Total interest-earning assets $ 9,177,361 4.20 5.4 100.0 % Non-maturity deposits $ 2,651,090 1.00 6.5 47.5 % 33.7 % Retail certificates of deposit 2,773,048 4.18 0.9 49.7 35.2 Commercial certificates of deposit 59,372 4.35 0.6 1.1 0.8 Public unit certificates of deposit 97,390 4.67 0.5 1.7 1.2 Total interest-bearing deposits 5,580,900 2.68 3.5 100.0 % 70.9 Term borrowings 2,294,165 3.24 1.7 29.1 Total interest-bearing liabilities $ 7,875,065 2.84 3.0 100.0 %