TFS Financial CORP 10-Q

Item 3. Quantitative and Qualitative Disclosures About Market Risk General . The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk has historically been interest rate risk. In general, our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits and advances from the FHLB of Cincinnati. As a result, a fundamental component of our business strategy is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates. Accordingly, our Board of Directors has established risk parameter limits deemed appropriate given our business strategy, operating environment, capital, liquidity and performance objectives. Additionally, our Board of Directors has authorized the formation of an Asset/Liability Management Committee comprised of key operating personnel, which is responsible for managing this risk in a matter that is consistent with the guidelines and risk limits approved by the Board of Directors. Further, the Board has established the Directors Risk Committee, which, among other responsibilities, conducts regular oversight and review of the guidelines, policies and deliberations of the Asset/Liability Management Committee. We manage our interest rate risk in order to control the exposure of our earnings and capital to changes in interest rates. Refer to the Overview section of Item 2 for additional discussion on how we manage interest rate risk. Economic Value of Equity. Using customized modeling software, the Company and Association prepare periodic estimates of the amounts by which the net present value of cash flows from assets, liabilities and off-balance sheet items (the institution's EVE) would change in the event of a range of assumed changes in market interest rates. The simulation model uses a discounted cash flow analysis and an option-based pricing approach in measuring the interest rate sensitivity of EVE. The model estimates the economic value of each type of asset, liability, and off-balance sheet contract under the assumption that instantaneous changes (measured in basis points) occur at all maturities along the United States Treasury yield curve and other relevant market interest rates. A basis point equals one, one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 2% to 3% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. The model is tailored specifically to our organization, which, we believe, improves its predictive accuracy. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. The following table presents the estimated changes in the Company’s EVE at December 31, 2023, that would result from the indicated instantaneous changes in the United States Treasury yield curve and other relevant market interest rates. TFS Financial Corporation EVE as a Percentage of Present Value of Assets (3) Change in Interest Rates (basis points) (1) Estimated EVE (2) Estimated Increase (Decrease) in EVE EVE Ratio (4) Increase (Decrease) (basis points) Amount Percent (Dollars in thousands) +300 $ 868,860 $ (442,279) (33.73) % 5.99 % (233) +200 1,051,954 (259,185) (19.77) % 7.05 % (127) +100 1,201,813 (109,326) (8.34) % 7.84 % (48) 0 1,311,139 — — % 8.32 % — -100 1,377,655 66,516 5.07 % 8.52 % 20 -200 1,379,224 68,085 5.19 % 8.33 % 1 -300 1,296,714 (14,425) (1.10) % 7.67 % (65) 58 Table of Contents The following table presents the estimated changes in the Association’s EVE at December 31, 2023, that would result from the indicated instantaneous changes in the United States Treasury yield curve and other relevant market interest rates. Third Federal Savings and Loan Association EVE as a Percentage of Present Value of Assets (3) Change in Interest Rates (basis points) (1) Estimated EVE (2) Estimated Increase (Decrease) in EVE EVE Ratio (4) Increase (Decrease) (basis points) Amount Percent (Dollars in thousands) +300 $ 661,613 $ (442,049) (40.05) % 4.57 % (244) +200 844,633 (259,029) (23.47) % 5.67 % (134) +100 994,415 (109,247) (9.90) % 6.49 % (52) 0 1,103,662 — — % 7.01 % — -100 1,170,097 66,435 6.02 % 7.24 % 23 -200 1,171,582 67,920 6.15 % 7.08 % 7 -300 1,088,985 (14,677) (1.33) % 6.45 % (56) _________________ (1) Assumes an instantaneous uniform change in interest rates at all maturities. (2) EVE is the discounted present value of expected cash flows from assets, liabilities, and off-balance sheet contracts. (3) Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets. (4) EVE Ratio represents EVE divided by the present value of assets. The tables above indicate that at December 31, 2023, in the event of an increase of 200 basis points in all interest rates, the Company and Association would experience a 19.77% and 23.47% decrease in EVE, respectively. In the event of a 100 basis point decrease in interest rates, the Company and Association would experience a 5.07% and 6.02% increase in EVE, respectively. The following tables are based on the calculations contained in the previous tables, and set forth the change in the EVE at a +200 basis point rate of shock at December 31, 2023, with comparative information as of September 30, 2023. By regulation, the Association must measure and manage its interest rate risk for interest rate shocks relative to established risk tolerances in EVE. TFS Financial Corporation Risk Measure (+200 Basis Points Rate Shock) At December 31, 2023 At September 30, 2023 Pre-Shock EVE Ratio 8.32 % 8.21 % Post-Shock EVE Ratio 7.05 % 6.44 % Sensitivity Measure in basis points (127) (177) Percentage Change in EVE (19.77) % (25.92) % Third Federal Savings and Loan Association Risk Measure (+200 Basis Points Rate Shock) At December 31, 2023 At September 30, 2023 Pre-Shock EVE Ratio 7.01 % 6.77 % Post-Shock EVE Ratio 5.67 % 4.91 % Sensitivity Measure in basis points (134) (186) Percentage Change in EVE (23.47) % (31.45) % The manner in which actual yields, costs and consumer behavior respond to changes in market interest rates may vary from the inherent methodologies used to measure interest rate risk through changes in EVE. In this regard, the EVE tables presented above assume: • no new growth or business volumes; • that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured, except for reductions to reflect mortgage loan principal repayments, along with modeled prepayments and defaults, and deposit decays; and 59 Table of Contents • that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the EVE tables provide an indication of our interest rate risk exposure as of the indicated dates, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our EVE and will differ from actual results. In addition to our core business activities, which seek to originate Smart Rate (adjustable) loans, home equity lines of credit (adjustable) and 10-year fixed-rate loans funded by borrowings from the FHLB and intermediate term CDs (including brokered CDs), and which are intended to have a favorable impact on our IRR profile, the impact of several other items and events resulted in the 11 and 24 basis point improvement in the Pre-Shock EVE Ratio (base valuation) measures at December 31, 2023, when compared to the measure at September 30, 2023, for the Company and Association, respectively. Factors contributing to these improvements included changes in market rates, capital actions by the Association and changes due to business activity. While our core business activities, as described at the beginning of this paragraph, are generally intended to have a positive impact on our IRR profile, the actual impact is determined by a number of factors, including the pace of mortgage asset additions to our balance sheet (including consideration of outstanding commitments to originate those assets) in comparison to the pace of the addition of duration extending funding sources. Our simulation model possesses random patterning capabilities and accommodates extensive regression analytics applicable to the prepayment and decay profiles of our borrower and depositor portfolios. The model facilitates the generation of alternative modeling scenarios and provides us with timely decision making data that is integral to our IRR management processes. Modeling our IRR profile and measuring our IRR exposure are processes that are subject to continuous revision, refinement, modification, enhancement, back testing, and validation. We continually evaluate, challenge, and update the methodology and assumptions used in our IRR model; including behavioral assumptions that have been derived based on third-party studies of our customer historical performance patterns. Changes to the methodology and/or assumptions used in the model will result in reported IRR profiles and reported IRR exposures that will be different, and perhaps significantly, from the results reported above. Earnings at Risk. In addition to EVE calculations, we use our simulation model to analyze the sensitivity of our net interest income to changes in interest rates (the institution’s EaR). Net interest income is the difference between the interest income that we earn on our interest-earning assets, such as loans and securities, and the interest that we pay on our interest-bearing liabilities, such as deposits and borrowings. In our model, we estimate what our net interest income would be for prospective 12 and 24 month periods using customized (based on our portfolio characteristics) assumptions with respect to loan prepayment rates, default rates and deposit decay rates, and the implied forward yield curve as of the market date for assumptions related to projected interest rates. We then calculate what the estimated net interest income would be for the same period under numerous interest rate scenarios. The simulation process is subject to continual enhancement, modification, refinement and adaptation. As of December 31, 2023, the estimated EaR for the 12 months ending December 31, 2024 would increase by 1.25% for the Company and 0.53% for the Association in the event that market interest rates used in the simulation were adjusted in incremental amounts (termed a "ramped" format) during the 12 month measurement period to an aggregate increase in 200 basis points. The Company and Association use the "ramped" assumption in preparing the EaR simulation estimates for use in its public disclosures. The Company and Association continue to calculate instantaneous scenarios, and as of December 31, 2023, the estimated EaR for the 12 months ending December 31, 2024 would increase by 2.98% and 0.85%, respectively, in the event of an instantaneous 200 basis point increase in market interest rates. The manner in which actual yields, costs and consumer behavior respond to changes in market interest rates may vary from the inherent methodologies used to measure interest rate risk through EaR. In this regard, the interest rate risk information presented above assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although interest rate risk calculations provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results. In addition to the preparation of computations as described above, we also formulate simulations based on a variety of non-linear changes in interest rates and a variety of non-constant balance sheet composition scenarios. Other Considerations. The EVE and EaR analyses are similar in that they both start with the same month-end balance sheet amounts, weighted average coupon and maturity. The underlying prepayment, decay and default assumptions are also the same and both start with the same month-end "markets" (Treasury and FHLB yield curves, etc.). From that similar starting point, the models follow divergent paths. EVE is a stochastic model using 150 different interest rate paths to compute market value at the account level for each of the categories on the balance sheet, whereas EaR uses the implied forward curve to compute interest income/expense at the account level for each of the categories on the balance sheet. EVE is considered as a point in time calculation with a "liquidation" view of the Company and Association where all the cash flows (including interest, principal and prepayments) are modeled and discounted using discount factors derived from the 60 Table of Contents current market yield curves. It provides a long term view and helps to define changes in equity and duration as a result of changes in interest rates. On the other hand, EaR is based on balance sheet projections going one year and two years forward and assumes new business volume and pricing to calculate net interest income under different interest rate environments. EaR is calculated to determine the sensitivity of net interest income under different interest rate scenarios. With each of these models, specific policy limits have been established for the Association that are compared with the actual month end results. These limits have been approved by the Association's Board of Directors and are used as benchmarks to evaluate and moderate interest rate risk. In the event that there is a breach of policy limits that extends beyond two consecutive quarter-end measurement periods, management is responsible for taking such action, similar to those described under the preceding heading of General , as may be necessary in order to return the Association's interest rate risk profile to a position that is in compliance with the policy.