Capitol Federal Financial 10-Q 2009
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2009
Commission file number: 000-25391
Capitol Federal Financial
(Exact name of registrant as specified in its charter)
United States 48-1212142
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
700 Kansas Avenue, Topeka, Kansas 66603
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer, large accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ Accelerated filer ¨ Non-accelerated filer ¨ Smaller Reporting Company ¨
(do not check if a smaller
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of April 27, 2009, there were 74,091,055 shares of Capitol Federal Financial Common Stock outstanding.
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
CAPITOL FEDERAL FINANCIAL AND SUBSIDIARY
See accompanying notes to consolidated interim financial statements.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(Dollars and share counts in thousands except per share data)
See accompanying notes to consolidated interim financial statements.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Dollars in thousands except per share data and amounts)
See accompanying notes to consolidated interim financial statements.
CAPITOL FEDERAL FINANCIAL AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
See accompanying notes to consolidated interim financial statements.
1. Basis of Financial Statement Presentation
The accompanying consolidated financial statements of Capitol Federal Financial (“CFFN”) and subsidiary (the “Company”) have been prepared in accordance with generally accepted accounting principles 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 2008 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”). Interim results are not necessarily indicative of results for a full year.
In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting periods. Significant estimates include the allowance for loan losses, other-than-temporary declines in the fair value of securities and other financial instruments. Actual results could differ from those estimates. See “Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies.”
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Capitol Federal Savings Bank (the “Bank”). The Bank has a wholly owned subsidiary, Capitol Funds, Inc. Capitol Funds, Inc. has a wholly owned subsidiary, Capitol Federal Mortgage Reinsurance Company. All intercompany accounts and transactions have been eliminated.
2. Earnings Per Share (“EPS”)
The Company accounts for the 3,024,574 shares acquired by its ESOP in accordance with Statement of Position (“SOP”) 93-6 and the shares awarded pursuant to its RRP in a manner similar to the ESOP shares. Shares acquired by the ESOP and shares awarded pursuant to the RRP are not considered in the basic average shares outstanding until the shares are committed for allocation or vested to an employee’s individual account. The following is a reconciliation of the numerators and denominators of the basic and diluted EPS calculations.
(1) Options to purchase 55,800 shares of common stock at prices between $38.77 per share and $43.46 per share were outstanding as of March 31, 2009, but were not included in the computation of diluted EPS because they were anti-dilutive for the three and six months ended March 31, 2009.
(2) Options to purchase 217,800 shares of common stock at prices between $32.13 per share and $38.77 were outstanding as of March 31, 2008, but were not included in the computation of diluted EPS because they were anti-dilutive for the three and six months ended March 31, 2008.
(3) At March 31, 2008, there were 6,000 unvested RRP shares at $32.30 per share that were excluded from the computation of diluted EPS because they were anti-dilutive for the three months and the six months ended March 31, 2008.
3. Fair Value Measurements
Effective October 1, 2008, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 157 “Fair Value Measurements” which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The statement applies whenever other standards require or permit assets or liabilities to be measured at fair value. The statement does not require new fair value measurements, but rather provides a definition and framework for measuring fair value which will result in greater consistency and comparability among financial statements prepared under GAAP. The Company’s adoption of SFAS No. 157 did not have a material impact on its financial condition or results of operations. The following disclosures, which include certain disclosures which are generally not required in interim period financial statements, are included herein as a result of the Company’s adoption of SFAS No. 157.
The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. The Company did not have any liabilities that were measured at fair value at March 31, 2009. The Company’s AFS securities 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 assets or liabilities on a non-recurring basis, such as REO, loans held-for-sale, and impaired loans. These non-recurring fair value adjustments involve the application of lower-of-cost-or-fair value accounting or write-downs of individual assets.
In accordance with SFAS No. 157, the Company groups its assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:
The Company bases its fair values on the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. SFAS No. 157 requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The following is a description of valuation methodologies used for assets measured at fair value on a recurring basis.
The Company’s AFS securities portfolio is carried at estimated fair value on a recurring basis, with any unrealized gains and losses, net of taxes, reported as accumulated other comprehensive income/loss in stockholders' equity. Substantially all of the securities within the AFS portfolio consist of MBS and investment securities issued by U.S. Government sponsored enterprises or agencies. The fair values for all the AFS securities are obtained from independent nationally recognized pricing services. Various modeling techniques are used to determine pricing for the Company’s MBS and investment securities, including option pricing and discounted cash flow models. The inputs to these models may include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers and reference data. There are some AFS securities in the AFS portfolio that have significant unobservable input requiring the independent pricing services to use some judgment in pricing the related securities. These AFS securities are classified as Level 3. All other AFS securities are classified as Level 2.
The following table provides the level of valuation assumption used to determine the carrying value of the Company’s assets measured at fair value on a recurring basis at March 31, 2009:
(1) The Company’s Level 3 AFS securities were immaterial as of March 31, 2009 and had no material activity during the period ended March 31, 2009.
The following is a description of valuation methodologies used for significant assets measured at fair value on a non-recurring basis.
Loans which meet certain criteria are evaluated individually for impairment. A loan is considered impaired when, based upon current information and events, it is probable the Bank will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the loan agreement. Substantially all of the Bank’s impaired loans at March 31, 2009 are secured by real estate. These impaired loans are individually assessed to determine that the carrying value of the loan is not in excess of the fair value of the collateral, less estimated selling costs. Fair value is estimated through current appraisals, real estate brokers or listing prices. Fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3. Impaired loans at March 31, 2009 were $22.7 million. Based on this evaluation, the Company maintains an allowance for loan losses of $2.7 million at March 31, 2009 for such impaired loans.
REO 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 less estimated selling costs. Fair value is estimated through current appraisals, real estate brokers or listing prices. As these properties are actively marketed, estimated fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3. REO at March 31, 2009 was $5.8 million. During the quarter and six months ended March 31, 2009, charge-offs to the allowance for loan losses related to loans that were transferred to REO were $607 thousand and $697 thousand, respectively. Write downs related to REO that were charged to other expense were $396 thousand and $640 thousand for the quarter and six months ended March 31, 2009.
The following table provides the level of valuation assumption used to determine the carrying value of the Company’s assets measured at fair value on a non-recurring basis at March 31, 2009:
4. FHLB Advances
During the quarter ended March 31, 2009, the Bank prepaid $575.0 million of fixed-rate FHLB advances with a weighted average interest rate of 6.35% and a weighted average remaining term to maturity of 15 months. The prepaid FHLB advances were replaced with $575.0 million of fixed-rate FHLB advances, with a weighted average contractual interest rate of 3.70% and an average term of 65 months. This 265 basis point decrease in the contractual interest rate resulted in a $4.9 million decrease in FHLB interest expense for the quarter ended March 31, 2009 compared to the quarter ended March 31, 2008.The Bank paid a $36.2 million prepayment penalty to the FHLB as a result of prepaying the FHLB advances. In accordance with Emerging Issues Task Force (“EITF”) 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments”, the prepayment penalty was deferred as an adjustment to the carrying value of the new advances since the new FHLB advances were not “substantially different,” as defined within EITF 96-19, from the prepaid FHLB advances. The present value of the cash flows under the terms of the new FHLB advances was not more than 10% different from the present value of the cash flows under the terms of the prepaid FHLB advances (including the prepayment penalty) and there were no embedded conversion options in the prepaid FHLB advances or in the new FHLB advances. The deferred prepayment penalty will be recognized in interest expense over the life of the new FHLB advances. The following table presents the face value of FHLB advances and the maturities and rates for all FHLB advances outstanding at March 31, 2009.
5. Recent Accounting Pronouncements
In January 2009, the Financial Accounting Standards Board (“FASB”) issued Staff Position (“FSP”) EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20.” FSP EITF 99-20-1 eliminates the requirement that a security holder’s best estimate of cash flows be based upon those that “a market participant” would use. Instead, an other-than-temporary impairment (“OTTI”) should be recognized as a realized loss through earnings when it is probable there has been an adverse change in the security holder’s estimated cash flows from previous projections. This treatment is consistent with the impairment model in SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities.” FSP EITF 99-20-1 was effective for the Company for the period ending December 31, 2008, and did not have a material impact on the Company’s financial condition or results of operations.
In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” FSP FAS 157-4 provides additional guidance on valuation techniques for estimating the fair value of assets or liabilities in accordance with SFAS No. 157 “Fair Value Measurements” when there has been a significant decrease in volume and level of market activity. The FSP also provides guidance on identifying circumstances that indicate a transaction is not orderly. As part of the judgment involved with estimating fair value, the entity will need to determine which valuation technique or techniques are the most appropriate, and, within those techniques, which results are “most representative” of fair value under market conditions. The FSP emphasizes that the notion of exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions remains unchanged. FSP FAS 157-4 is effective for interim reporting periods after June 15, 2009, which is June 30, 2009 for the Company. The FSP is not expected to have a material impact on the Company’s financial condition or results of operations.
In April 2009, the FASB issued FSP FAS 115-2, “Recognition and Presentation of Other-Than-Temporary Impairments.” FSP FAS 115-2 amends existing OTTI guidance for debt securities by requiring the recognition of an OTTI if an entity has the intent to sell an impaired debt security, it is more likely than not the entity will be required to sell the debt security before recovery, or if the entity does not expect to recover the entire amortized cost basis of the debt security. The FSP also expands and increases the frequency of existing disclosures requirements of SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities.” FSP FAS 115-2 is effective for interim reporting periods after June 15, 2009, which is June 30, 2009 for the Company. FSP FAS 115-2 will affect certain interim reporting disclosures, but is not expected to have a material impact on the Company’s financial condition or results of operations.
In April 2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board (“APB”) Opinion No. 28-1, “Interim Disclosures About Fair Value of Financial Instruments” which amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments’ and APB No. 28, “Interim Financial Reporting” to require publicly traded companies to include fair value disclosures of its financial instruments whenever it issues summarized financial information for interim reporting periods. The FSP also requires entities to disclose the methods and significant assumptions used to estimate the fair value of financial instruments, and to disclose significant changes in methods or assumptions used to estimate fair values. FSP FAS 107-1 and APB 28-1 is effective for interim reporting periods after June 15, 2009, which is June 30, 2009 for the Company. The FSP will affect certain interim reporting disclosures, but is not expected to have a material impact on the Company’s financial condition or results of operations.
The Company and its wholly-owned subsidiary, the Bank, may from time to time make written or oral “forward-looking statements,” including statements contained in the Company’s filings with the SEC. These forward-looking statements may be included in this Quarterly Report on Form 10-Q and the exhibits attached to it, in the Company’s reports to stockholders and in other communications by the Company, which are made in good faith by us pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include statements about our beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors, some of which are beyond our control. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause our future results to differ materially from the plans, objectives, goals, expectations, anticipations, estimates and intentions expressed in the forward-looking statements:
This list of important factors is not all inclusive. We do not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company or the Bank.
As used in this Form 10-Q, unless we specify otherwise, “the Company,” “we,” “us,” and “our” refer to Capitol Federal Financial, a United States corporation. “Capitol Federal Savings,” and “the Bank,” refer to Capitol Federal Savings Bank, a federal savings bank and the wholly-owned subsidiary of Capitol Federal Financial. “MHC” refers to Capitol Federal Savings Bank MHC, a mutual holding company and majority-owner of Capitol Federal Financial.
The following discussion and analysis is intended to assist in understanding the financial condition and results of operations of the Company. It should be read in conjunction with the consolidated financial statements and notes presented in this report. The discussion includes comments relating to the Bank, since the Bank is wholly owned by the Company and comprises the majority of its assets and is the principal source of income for the Company. This discussion and analysis should be read in conjunction with the management discussion and analysis included in the Company’s 2008 Annual Report on Form 10-K filed with the SEC.
The following summary should be read in conjunction with our Management’s Discussion and Analysis of Financial Condition and Results of Operations in its entirety.
Our principal business consists of attracting deposits from the general public and investing those funds primarily in permanent loans secured by first mortgages on owner-occupied, one- to four-family residences. We also originate consumer loans, loans secured by first mortgages on non-owner-occupied one- to four-family residences, permanent and construction loans secured by one- to four-family residences, commercial real estate loans, and multi-family real estate loans. While our primary business is the origination of one- to four-family mortgage loans funded through retail deposits, we also purchase whole loans and invest in certain investment securities and MBS using FHLB advances and repurchase agreements as additional funding sources.
The Company is significantly affected by prevailing economic conditions including federal monetary and fiscal policies and federal regulation of financial institutions. Deposit balances are influenced by a number of factors including interest rates paid on competing personal investment products, the level of personal income, and the personal rate of savings within our market areas. Lending activities are influenced by the demand for housing and other loans, changing loan underwriting guidelines, as well as interest rate pricing competition from other lending institutions. The primary sources of funds for lending activities include deposits, loan repayments, investment income, borrowings, and funds provided from operations.
The Company’s results of operations are primarily dependent on net interest income, which is the difference between the interest earned on loans, MBS, investment securities, and cash, and the interest paid on deposits and borrowings. Net interest income is affected by the shape of the market yield curve, the re-pricing of interest-earning assets and interest-bearing liabilities on our balance sheet, and the prepayment rate on our loans and MBS as it relates to reinvestment opportunities. On a weekly basis, management reviews deposit flows, loan demand, cash levels, and changes in several market rates to assess all pricing strategies. We generally price our loan and deposit products based upon an analysis of our competition and changes in market rates. The Bank generally prices its first mortgage loan products based upon prices available in the secondary market while considering the demand for our products and our ability to service customers in a timely manner. Generally, deposit pricing is based upon a survey of peers in the Bank’s market areas, and the need to attract funding and retain maturing deposits. The majority of our loans are fixed-rate products with maturities up to 30 years, while the majority of our deposits have maturity or reprice dates of less than two years.
During fiscal year 2009, the financial services industry and the economy as a whole continued to experience turmoil in the wake of steep declines in credit quality and asset quality due largely to real estate devaluations and an increase in unemployment caused by the ongoing economic recession. The Bank has not experienced the same magnitude of adverse operational impacts felt by many financial institutions. However, we are not immune to negative consequences arising from the overall economic weakness and sharp downturn in the housing and real estate markets nationally. We have experienced an increase in the balance of non-performing loans, but the balance of our non-performing loans continues to remain at low levels relative to the size of our loan portfolio. During the current quarter, we modified our allowance for loan loss methodology in response to the continued deterioration of the housing and real estate markets, the increasing weakness in the overall economy, and the trends and composition of our delinquent and non-performing loans and losses on foreclosed property transactions, primarily related to purchased loans. As a result of the change in our allowance for loan loss methodology and charge-offs, primarily related to purchased loans, a $2.1 million provision for loan loss was recorded during the current quarter.
During late December 2008 and continuing into the second quarter of fiscal year 2009, mortgage rates declined to record lows in response to the Federal Reserve’s purchases of U.S. agency debt and MBS. The decline in mortgage rates has spurred an increased demand for our loan modification program and mortgage refinances. Our loan modification program allows existing loan customers, whose loans have not been sold to third parties and who have been current on their contractual loan payments for the previous 12 months, the opportunity to modify their original loan terms to current loan terms being offered. The volume and magnitude of these loan modifications and refinances will likely have a negative impact on our net interest margin in future periods as a result of loans repricing to lower market interest rates. During the quarter ended March 31, 2009 we modified $568.5 million and refinanced $92.0 million of our originated loans. The weighted average interest rate reduction for the modified loans is approximately 88 basis points. To help mitigate the impact to net interest income and interest rate risk as a result of loan modifications, the Bank sold $30.1 million of modified loans during the current quarter. The Bank is retaining the servicing on the sold modified loans. These modified loans are being sold on a bulk basis, and based upon past experience, we do not expect all modified loans held-for-sale as of the balance sheet date to be purchased
by the investor. Loans not purchased by the investor will be transferred back to the loans receivable portfolio at the lower of cost or market. Additionally, the Bank refinanced $575.0 million of FHLB advances during the quarter also in an effort to mitigate the net interest income impact of loan modifications and refinances and to extend maturities. As a result of refinancing the FHLB advances, the Bank was able lower its FHLB advance effective interest rate 118 basis points at the time of the refinance. See additional discussion regarding the FHLB advance refinance in “Notes to Financial Statements-- Note 4 – FHLB Advances.”
The Bank continues to maintain access to liquidity in excess of forecasted needs by diversifying its funding sources and maintaining a strong retail oriented deposit portfolio. We believe the turmoil in the credit and equity markets has made deposit products in strong financial institutions desirable for many customers. We also believe that our strong capital position (the Bank’s tangible equity ratio at March 31, 2009 was 10%), lending policies, and underwriting standards have helped position us to withstand these adverse economic conditions. In addition, the investments of the Bank are government-agency backed securities which are highly liquid and have not been credit impaired, and are therefore available as collateral for additional borrowings or for sale if the need or unforeseen conditions warrant. See additional discussion regarding liquidity in the section entitled “Liquidity and Capital Resources.”
In fiscal year 2009, the Bank has opened two branches and has plans to open two additional branches in our Kansas City market area. The Bank has preliminary plans to open three additional branches in our market areas in Kansas City and Wichita during fiscal year 2010.
Company and financial information, including press releases, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports can be obtained free of charge from our investor relations website, http://ir.capfed.com. SEC filings are available on our website immediately after they are electronically filed with or furnished to the SEC, and are also available on the SEC’s website at www.sec.gov.
Critical Accounting Policies
Our most critical accounting policies are the methodologies used to determine the allowance for loan losses and other-than-temporary declines in the value of securities. These policies are important to the presentation of our financial condition and results of operations, involve a high degree of complexity, and require management to make difficult and subjective judgments that may require assumptions or estimates about highly uncertain matters. The use of different judgments, assumptions, and estimates could cause reported results to differ materially. These critical accounting policies and their application are reviewed at least annually by our audit committee. The following is a description of our critical accounting policies and an explanation of the methods and assumptions underlying their application.
Allowance for Loan Losses. >Management maintains an allowance for loan losses to absorb known and inherent losses in the loan portfolio based upon ongoing quarterly assessments of the loan portfolio. Our methodology for assessing the appropriateness of the allowance for loan losses consists of a formula analysis for general valuation allowances and specific valuation allowances for identified problem loans and portfolio segments. The allowance for loan losses is maintained through provisions for loan losses which are charged to income. The provision for loan losses is established after considering the results of management’s quarterly assessment of the allowance for loan losses.
All loans that are not impaired, as defined in SFAS No. 114, “Accounting by Creditors for Impairment of a Loan, an Amendment of FASB Statements No. 5 and 15” and No. 118 “Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosures, an Amendment of FASB Statement No. 114,” are included in a formula analysis, as permitted by SFAS No. 5, “Accounting for Contingencies.” Each quarter, the loan portfolio is segregated into categories in the formula analysis based upon certain risk characteristics such as loan type (one- to four-family, multi-family, etc.), interest payments (fixed-rate, adjustable-rate), loan source (originated or purchased), and payment status (i.e. current or number of days delinquent). Loss factors are assigned to each category in the formula analysis based on management’s assessment of the potential risk inherent in each category. The greater the risks associated with a particular category, the higher the loss factor. Loss factors increase as individual loans become classified, delinquent, the foreclosure process begins or as economic and market conditions and trends warrant.
The loss factors applied in the formula analysis are periodically reviewed by management to assess whether the factors adequately cover probable and estimable losses inherent in the loan portfolio. The review considers such
factors as the trends and composition of delinquent and non-performing loans, the results of foreclosed property transactions, and the status and trends of the local and national economies and housing markets. Our allowance for loan loss methodology permits modifications to any loss factor used in the computation of the formula analysis in the event that, in management’s judgment, significant factors which affect the collectibility of the portfolio or any category of the loan portfolio, as of the evaluation date, are not reflected in the current loss factors. Management’s evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with a specific problem loan or portfolio segments. As such, the amounts actually observed with respect to these losses can vary significantly from the estimated amounts. By assessing the estimated losses inherent in our loan portfolio on a quarterly basis, management can adjust specific and inherent loss estimates based upon more current information.
The Bank has been experiencing an increase in delinquencies, non-performing loans, net loan charge-offs and losses on foreclosed property transactions, primarily on purchased loans, as a result of the decline in housing and real estate markets, as well as the ongoing economic recession. Management’s current quarter analysis of delinquency and non-performing loan trends, results of foreclosed property transactions and current status and trends of the local and national economies and housing markets indicated differences in the performance and loss experience, with respect to the ultimate disposition of the underlying collateral, of our originated and purchased loan portfolios. As a result of the analysis, loss factors on 30-89 day delinquent loans were modified based upon whether the loan is an originated or purchased loan. Based upon our experience with delinquent purchased loans, the loss factor for purchased loans is higher than that of originated loans. Management believes this modification to the formula analysis will result in a more accurate estimate of the inherent losses in the 30-89 day delinquent loan portfolio. Additionally, the real estate market factors used to calculate current loan-to-value (“LTV”) ratios in the formula analysis were adjusted as a result of management’s analysis. The real estate market factors used in the formula analysis are now based upon a nationally recognized source of indices that management believes will more accurately reflect the current market value of the underlying collateral and therefore allocate loans to a more appropriate LTV category in the formula analysis.
Specific valuation allowances are established in connection with individual loan reviews of specifically identified problem loans and the asset classification process, including the procedures for impairment recognition under SFAS No. 114 and SFAS No. 118. Evaluations of loans for which full collectability is not reasonably assured include evaluation of the estimated fair value of the underlying collateral based upon current appraisals, real estate broker values or listing prices. Additionally, trends and composition of non-performing loans, results of foreclosed property transactions and current status and trends in economic and market conditions are also evaluated. During management’s current quarter analysis of the results of foreclosed property transactions and the current status and trends of national housing markets, it was noted that the updated estimated fair values obtained from loan servicers when a loan became 90 days delinquent were not always an accurate representation of the fair value of the collateral once it was sold. The decline in fair value between the date the loan became 90 days delinquent and the time the property was sold was due to the continued decline in real estate values between those points in time, as it often takes several months for a loan to work through the foreclosure process. As a result of the analysis, management applied market value adjustments to non-performing purchased loans at March 31, 2009 to more accurately estimate the fair values of the underlying collateral based upon recent trends. The adjustments were determined based upon the location of the underlying collateral, losses recognized on foreclosed property transactions and trends of non-performing purchased loans entering REO. Specific valuations on non-performing loans were established if the adjusted estimated fair value was less than the current loan balance. Management intends to evaluate the appropriateness of the market value adjustments each quarter. The market value adjustments will continue to be applied to non-performing loans until the real estate markets and economy improve to such a level that the adjustments are no longer necessary.
Loans with an outstanding balance of $1.5 million or more are reviewed annually if secured by property in one of the following categories: multi-family (five or more units) property, unimproved land, other improved commercial property, acquisition and development of land projects, developed building lots, office building, single-use building, or retail building. Specific valuation allowances are established if the individual loan review determines a quantifiable impairment.
Management considers quantitative and qualitative factors when determining the appropriateness of the allowance for loan losses. Such factors include changes in underwriting standards, the trend and composition of delinquent and non-performing loans, results of foreclosed property transactions, historical charge-offs, the current status and trends of local and national economies and housing markets, changes in interest rates, and loan portfolio growth and concentrations. Our allowance for loan loss methodology is applied in a consistent manner; however, the methodology can be modified in response to changing conditions. The allowance for loan losses increased $1.4 million from $6.1 million at December 31, 2008 to $7.5 million at March 31, 2009, primarily due to the modification to the formula analysis and application of market value adjustments on non-performing purchased loans as discussed above. During the current quarter, a provision for loan loss of $2.1 million was recorded as a
result of the modifications to our allowance for loan loss methodology and current quarter charge-offs, primarily on purchased loans.
Assessing the adequacy of the allowance for loan losses is inherently subjective. Actual results could differ from our estimates as a result of changes in economic or market conditions. Changes in estimates could result in a material change in the allowance for loan losses. In the opinion of management, the allowance for loan losses, when taken as a whole, is adequate to absorb reasonable estimated losses inherent in our loan portfolio. However, future adjustments may be necessary if portfolio performance or economic or market conditions differ substantially from the conditions that existed at the time of the initial determinations.
Securities Impairment.> Management continually monitors the MBS and investment security portfolios for impairment on a security by security basis. Many factors are considered in determining whether the impairment is deemed to be other-than-temporary, including, but not limited to, the nature of the investment, the length of time the security has had a market value less than the cost basis, the cause(s), severity of the loss, the intent and ability of the Bank to hold the security for a period of time sufficient for a substantial recovery of its investment, expectation of an anticipated recovery period, recent events specific to the issuer or industry including the issuer’s financial condition and current ability to make future payments in a timely manner, external credit ratings and recent downgrades in such ratings. If management deems the decline to be other-than-temporary, the carrying value of the security is adjusted and an impairment amount is recorded in the consolidated statements of income. At March 31, 2009, no securities had been identified as other-than-temporarily impaired.
Total assets increased from $8.06 billion at September 30, 2008 to $8.27 billion at March 31, 2009. The $214.6 million increase in assets was primarily attributed to a $202.3 million increase in loans receivable and loans receivable held-for-sale. Total liabilities increased from $7.18 billion at September 30, 2008 to $7.35 billion at March 31, 2009. The $169.5 million increase in liabilities was primarily a result of an increase in deposits of $192.6 million, primarily in the certificate of deposit and money market portfolios. Stockholders’ equity increased $45.2 million to $916.4 million at March 31, 2009, from $871.2 million at September 30, 2008. A large component of this increase was related to an increase in accumulated other comprehensive gain (loss) due to an increase in the market value of AFS securities at March 31, 2009.
The following table presents selected balance sheet data for the Company at the dates indicated.
Loans Receivable. The loans receivable portfolio increased $56.9 million from $5.32 billion at September 30, 2008 to $5.38 billion at March 31, 2009. The increase was primarily a result of $191.6 million of loan purchases from nationwide lenders, partially offset by the transfer of $175.9 million of modified loans to the LHFS portfolio. The loans purchased from nationwide lenders during fiscal year 2009 had an average credit score of 745 at the time of origination and a current weighted average LTV ratio of 50%. The majority of the loans are seasoned loans and were originated in years outside of the years with peak real estate values and non-traditional underwriting standards. Approximately 80% were originated in 2004 or earlier and approximately 20% were originated in 2008. Additionally, states that have experienced high foreclosure rates were avoided. See additional discussion regarding the underwriting standards for purchased loans in “Lending Practices and Underwriting Standards.” Loans purchased from nationwide lenders represented 15% of the loan portfolio at March 31, 2009 compared to 14% at September 30, 2008. As of March 31, 2009, the average balance of a purchased nationwide mortgage loan was approximately $370 thousand while the average balance of an originated mortgage loan was approximately $140 thousand.
Included in the loan portfolio at March 31, 2009 were $303.8 million of interest-only loans, which were primarily purchased from nationwide lenders during fiscal year 2005. These loans do not typically require principal payments during their initial term, and have initial interest-only terms of either five or ten years. At March 31, 2009, $295.5 million, or 97%, of these loans were still in their interest-only payment term. As of March 31, 2009, $134.8 million will begin to amortize principal within two years, $21.0 million will begin amortizing principal within two-to-five years, and the remaining $139.7 million will begin to amortize principal within five-to-ten years. Loans of this type generally are considered to be of greater risk to the lender because of the possibility that the borrower may default once principal payments are required. The loans had an average credit score of 737 and an average LTV ratio of 80% or less at the time of purchase. The Bank has not purchased any interest-only loans since 2006.
The following table presents loan origination, refinance and purchase activity for the periods indicated. Loan originations, purchases and refinances are reported together. The fixed-rate one- to four-family loans less than or equal to 15 years have an original maturity at origination of less than or equal to 15 years, while fixed-rate one- to four-family loans greater than 15 years have an original maturity at origination of greater than 15 years. The adjustable-rate one- to four-family loans less than or equal to 36 months have a term to first reset of less than or equal to 36 months at origination and adjustable-rate one- to four-family loans greater than 36 months have a term to first reset of greater than 36 months at origination.