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, 2024. 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 that in a rising rate environment 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. 65 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) $ 1,790,078 $ 1,853,078 $ 1,349,762 $ 2,975,431 $ 7,968,349 Securities (2) 220,491 181,092 219,228 229,759 850,570 Other interest-earning assets 140,131 — — — 140,131 Total interest-earning assets 2,150,700 2,034,170 1,568,990 3,205,190 8,959,050 Interest-bearing liabilities: Non-maturity deposits (3) 830,127 489,314 387,903 1,623,363 3,330,707 Certificates of deposit 2,174,280 666,857 73,128 199 2,914,464 Borrowings (4) 731,264 1,213,157 228,685 25,186 2,198,292 Total interest-bearing liabilities 3,735,671 2,369,328 689,716 1,648,748 8,443,463 Excess (deficiency) of interest-earning assets over interest-bearing liabilities $ (1,584,971) $ (335,158) $ 879,274 $ 1,556,442 $ 515,587 Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities $ (1,584,971) $ (1,920,129) $ (1,040,855) $ 515,587 Cumulative excess (deficiency) of interest-earning assets over interest-bearing liabilities as a percent of total Bank assets at: December 31, 2024 (16.6) % (20.1) % (10.9) % 5.4 % September 30, 2024 (15.9) Cumulative one-year gap - interest rates +200 bps at: December 31, 2024 (18.4) September 30, 2024 (17.9) Cumulative one-year gap - interest rates -200 bps at: December 31, 2024 (12.3) September 30, 2024 (12.5) (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 December 31, 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 $4.09 billion, for a cumulative one-year gap of (42.8)% of total assets. (4) Borrowings exclude deferred prepayment penalty costs. Included in this line item are $200.0 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 December 31, 2024, the Bank's gap between the amount of interest-earning assets and interest-bearing liabilities projected to reprice within one year was $(1.58) billion, or (16.6)% of total assets, compared to $(1.51) billion, or (15.8)% of total assets, at September 30, 2024. The change in the one-year gap amount was due to an increase in the amount of projected liability cash flows coming due in one year, as of December 31, 2024, partially offset by an increase in the amount of asset cash flows coming due during the same time period, as compared to September 30, 2024. The increase in liability cash flows was due primarily to a net increase in non-maturity deposits between periods. The increase in projected asset cash flows was due primarily to an increase in the balance of adjustable-rate loans, partially offset by a decrease in the balance of cash and a decrease in the projected amount of fixed-rate mortgage-related asset cash flows due to a decrease in projected prepayment speeds from September 30, 2024, as a result of an increase in intermediate and long-term interest and mortgage rates. 66 The amount of interest-bearing liabilities expected to reprice in a given period typically is not 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 December 31, 2024, the Bank's one-year gap would have been projected to be $(1.75) billion, or (18.4)% of total assets. If interest rates were to decrease 200 basis points, as of December 31, 2024, the Bank's one-year gap would have been projected to be $(1.17) billion, or (12.3)% of total assets. The changes in the gap amounts compared to when there is no change in rates was due to changes in the anticipated net cash flows primarily as a result of projected prepayments on mortgage-related assets in each rate environment. In higher rate environments, prepayments on mortgage-related assets are projected to be lower and, in lower rate environments, prepayments are projected to be higher. This compares to a projected one-year gap of $(1.71) billion, or (17.9)% of total assets, if interest rates were to have increased 200 basis points as of September 30, 2024, and a projected one-year gap of $(1.19) billion, or (12.5)% of total assets, if interest rates were to have decreased 200 basis points as of the same date. Change in Net Interest Income. For each date presented in the following table, the estimated change in the Bank's net interest income is based on the indicated instantaneous, parallel and permanent change in interest rates. The change in each interest rate environment represents the difference between estimated net interest income in the zero basis point interest rate environment ("base case," assumes the forward market and product interest rates implied by the yield curve are realized) and the estimated net interest income in each alternative interest rate environment (assumes market and product interest rates have a parallel shift in rates across all maturities by the indicated change in rates). Projected cash flows for each scenario are based upon varying prepayment assumptions to model anticipated customer behavior changes as market rates change. Estimations of net interest income used in preparing the table below were based upon the assumptions that the total composition of interest-earning assets and interest-bearing liabilities do not change materially and that any repricing of assets or liabilities occurs at anticipated product and market rates for the alternative rate environments as of the dates presented. The estimation of net interest income does not include any projected gains or losses related to the sale of loans or securities, or income derived from non-interest income sources, but does include the use of different prepayment assumptions in the alternative interest rate environments. It is important to consider that estimated changes in net interest income are for a cumulative four-quarter period. These do not reflect the earnings expectations of management. Change Net Interest Income At (in Basis Points) December 31, 2024 September 30, 2024 in Interest Rates (1) Amount ($) Change ($) Change (%) Amount ($) Change ($) Change (%) (Dollars in thousands) -300 bp $ 192,673 $ 8,239 4.5 % $ 188,322 $ 11,696 6.6 % -200 bp 191,188 6,754 3.7 183,769 7,143 4.0 -100 bp 188,784 4,350 2.4 180,936 4,310 2.4 000 bp 184,434 — — 176,626 — — +100 bp 179,684 (4,750) (2.6) 171,222 (5,404) (3.1) +200 bp 173,515 (10,919) (5.9) 165,422 (11,204) (6.3) +300 bp 167,343 (17,091) (9.3) 158,758 (17,868) (10.1) (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 in which cash flows are realized and the rates projected to be earned on funds received through loan and securities repayments, in each scenario, are greater/(less) than the rates projected to be paid on deposits and borrowings in the next 12 months. The net interest income projection was higher in the base case scenario at December 31, 2024 compared to September 30, 2024, due primarily to a steepening of the yield curve between the two periods. The benchmark U.S. Treasury yield curve dis-inverted during the current quarter and was largely positively sloped as of December 31, 2024. As a result, interest income projections associated with the Bank's interest-earning asset cashflows, primarily the loan portfolio, increased by more than increases in interest expense projections on its interest-bearing liability cashflows. 67 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. Change Market Value of Portfolio Equity At (in Basis Points) December 31, 2024 September 30, 2024 in Interest Rates (1) Amount ($) Change ($) Change (%) Amount ($) Change ($) Change (%) (Dollars in thousands) -300 bp $ 1,378,031 $ 377,739 37.8 % $ 1,460,440 $ 359,922 32.7 % -200 bp 1,248,615 248,323 24.8 1,345,708 245,190 22.3 -100 bp 1,128,689 128,397 12.8 1,218,938 118,420 10.8 000 bp 1,000,292 — — 1,100,518 — — +100 bp 833,039 (167,253) (16.7) 962,354 (138,164) (12.6) +200 bp 663,504 (336,788) (33.7) 797,497 (303,021) (27.5) +300 bp 507,232 (493,060) (49.3) 634,145 (466,373) (42.4) (1) Assumes an instantaneous, parallel, and permanent change in interest rates at all maturities. The Bank's MVPE decreased from $1.10 billion at September 30, 2024 to $1.00 billion at December 31, 2024. The decrease was due primarily to an increase in market interest rates between the two periods across the intermediate and long-term tenors of the curve as the yield curve steepened. These increases in market interest rates resulted in a decrease in the estimated values of the Bank's interest-earning assets by more than it decreased the estimated values 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. Conversely, as interest rates decrease, borrowers who obtained or issued credit in a higher rate environment have more economic incentive to prepay or to refinance their mortgages, and agency debt issuers have more economic incentive and opportunity to exercise their call options in order to re-issue debt at lower interest rates, resulting in higher projected cash flows on these assets. The then shorter expected average lives of these assets decrease the sensitivity of their market value to changes in interest rates. In the increasing interest rate scenarios, the sensitivity reflects the negative impacts of rates on the market value of the Bank's loan and securities portfolios more so than on its deposit and borrowing portfolios. In the decreasing interest rate scenarios, the Bank's MVPE increases due to a larger increase in the market value of the Bank's assets than its liabilities. This is because the Bank's mortgage-related assets continue to have longer duration in these rate scenarios, which equates to greater market value sensitivity as interest rates change. 68 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 December 31, 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 $ 861,501 5.62 % 3.7 9.5 % Loans receivable: Fixed-rate one- to four-family 5,303,313 3.44 6.8 66.5 % 58.2 Fixed-rate commercial 519,277 4.96 2.8 6.5 5.7 All other fixed-rate loans 37,899 7.06 7.3 0.5 0.4 Total fixed-rate loans 5,860,489 3.60 6.4 73.5 64.3 Adjustable-rate one- to four-family 891,372 4.21 4.5 11.2 9.8 Adjustable-rate commercial 1,127,216 6.03 5.1 14.1 12.4 All other adjustable-rate loans 93,952 8.10 3.1 1.2 1.0 Total adjustable-rate loans 2,112,540 5.35 4.8 26.5 23.2 Total loans receivable 7,973,029 4.06 6.0 100.0 % 87.5 FHLB stock 100,364 9.47 1.9 1.1 Cash and cash equivalents 170,324 3.62 — 1.9 Total interest-earning assets $ 9,105,218 4.26 5.6 100.0 % Non-maturity deposits $ 2,735,138 0.88 5.6 48.4 % 35.0 % Retail certificates of deposit 2,799,418 4.14 0.8 49.6 35.8 Commercial certificates of deposit 56,564 4.26 0.6 1.0 0.7 Public unit certificates of deposit 58,482 4.48 0.6 1.0 0.8 Total interest-bearing deposits 5,649,602 2.57 3.1 100.0 % 72.3 Term borrowings 2,165,561 3.37 1.6 27.7 Total interest-bearing liabilities $ 7,815,163 2.79 2.7 100.0 %