Quarterly Report

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)

PART I -- FINANCIAL INFORMATION

Item 1. Financial Statements

CAPITOL FEDERAL FINANCIAL AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands except per share data and amounts)

		June 30,				September 30,
		2009				2008
ASSETS:		(Unaudited)
Cash and cash equivalents		$	74,101			$	87,138
Investment securities:
Available-for-sale (“AFS”) at estimated fair value (amortized cost of $260,886 and $51,700)			259,309				49,586
Held-to-maturity (“HTM”) at cost (estimated fair value of $63,757 and $92,211)			62,857				92,773
Mortgage-backed securities (“MBS”):
AFS, at estimated fair value (amortized cost of $1,433,171 and $1,491,536)			1,472,547				1,484,055
HTM, at cost (estimated fair value of $643,110 and $743,764)			628,451				750,284
Loans receivable, net			5,541,731				5,320,780
Capital stock of Federal Home Loan Bank (“FHLB”), at cost			132,071				124,406
Accrued interest receivable			32,828				33,704
Premises and equipment, net			35,008				29,874
Real estate owned (“REO”), net			5,077				5,146
Other assets			75,312				77,503
TOTAL ASSETS		$	8,319,292			$	8,055,249
LIABILITIES:
Deposits		$	4,175,251			$	3,923,883
Advances from FHLB			2,410,949				2,447,129
Other borrowings, net			713,609				713,581
Advance payments by borrowers for taxes and insurance			30,412				53,213
Income taxes payable			4,500				6,554
Deferred income tax liabilities, net			24,477				3,223
Accounts payable and accrued expenses			37,460				36,450
Total liabilities			7,396,658				7,184,033
STOCKHOLDERS' EQUITY:
Preferred stock ($0.01 par value) 50,000,000 shares authorized; none issued			--				--
Common stock ($0.01 par value) 450,000,000 shares authorized, 91,512,287
shares issued; 74,098,155 and 74,079,868 shares outstanding
as of June 30, 2009 and September 30, 2008, respectively			915				915
Additional paid-in capital			451,543				445,391
Unearned compensation, Employee Stock Ownership Plan (“ESOP”)			(8,569	)			(10,082	)
Unearned compensation, Recognition and Retention Plan (“RRP”)			(403	)			(553	)
Retained earnings			775,214				759,375
Accumulated other comprehensive gain (loss)			23,512				(5,968	)
Less shares held in treasury (17,414,132 and 17,432,419 shares as of
June 30, 2009 and September 30, 2008, respectively, at cost)			(319,578	)			(317,862	)
Total stockholders' equity			922,634				871,216
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		$	8,319,292			$	8,055,249

See accompanying notes to consolidated interim financial statements.

<Index>

 

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CAPITOL FEDERAL FINANCIAL AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars and share counts in thousands except per share data)

		For the Three Months Ended								For the Nine Months Ended
		June 30,								June 30,
		2009				2008				2009				2008
INTEREST AND DIVIDEND INCOME:
Loans receivable		$	76,745			$	74,651			$	230,907			$	226,190
MBS			24,211				24,869				75,701				62,242
Investment securities			1,279				1,298				3,560				8,489
Capital stock of FHLB			793				1,502				2,351				5,446
Cash and cash equivalents			50				465				167				3,262
Total interest and dividend income			103,078				102,785				312,686				305,629
INTEREST EXPENSE:
FHLB advances			25,307				30,248				81,505				96,205
Deposits			24,705				31,174				76,201				104,352
Other borrowings			7,144				4,682				21,978				10,762
Total interest expense			57,156				66,104				179,684				211,319
NET INTEREST AND DIVIDEND INCOME			45,922				36,681				133,002				94,310
PROVISION FOR LOAN LOSSES			3,112				1,602				5,768				1,721
NET INTEREST AND DIVIDEND INCOME
AFTER PROVISION FOR LOAN LOSSES			42,810				35,079				127,234				92,589
OTHER INCOME:
Retail fees and charges			4,671				4,566				13,271				13,150
Gains on sale of loans held-for-sale (“LHFS”), net			1,629				244				2,169				501
Insurance commissions			528				486				1,892				1,661
Loan fees			564				572				1,730				1,751
Income from bank-owned life insurance (“BOLI”)			262				577				887				1,810
Other, net			578				900				1,900				3,565
Total other income			8,232				7,345				21,849				22,438
OTHER EXPENSES:
Salaries and employee benefits			10,715				11,021				32,447				31,729
Occupancy of premises			3,936				3,750				11,428				10,384
Federal insurance premium			5,307				116				5,700				350
Advertising			1,704				1,216				5,393				3,433
Deposit and loan transaction fees			1,276				1,364				3,998				3,935
Regulatory and other services			857				1,267				2,986				4,345
Office supplies and related expense			582				493				2,030				1,614
Other, net			2,034				609				6,650				4,404
Total other expenses			26,411				19,836				70,632				60,194
INCOME BEFORE INCOME TAX EXPENSE			24,631				22,588				78,451				54,833
INCOME TAX EXPENSE			9,155				8,233				28,991				19,638
NET INCOME		$	15,476			$	14,355			$	49,460			$	35,195
Basic earnings per common share		$	0.21			$	0.20			$	0.68			$	0.48
Diluted earnings per common share		$	0.21			$	0.20			$	0.68			$	0.48
Dividends declared per public share		$	0.50			$	0.50			$	1.61			$	1.50
Basic weighted average common shares			73,173				72,933				73,116				72,922
Diluted weighted average common shares			73,232				73,021				73,190				72,985

 

See accompanying notes to consolidated interim financial statements.

 

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CAPITOL FEDERAL FINANCIAL AND SUBSIDIARY

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited)

(Dollars in thousands)

																						Accumulated
						Additional				Unearned				Unearned								Other
		Common				Paid-In				Compensation				Compensation				Retained				Comprehensive				Treasury
		Stock				Capital				ESOP				RRP				Earnings				Gain (Loss)				Stock				Total
Balance at October 1, 2008		$	915			$	445,391			$	(10,082	)		$	(553	)		$	759,375			$	(5,968	)		$	(317,862	)		$	871,216
Comprehensive income:
Net income																			49,460												49,460
Changes in unrealized gains (losses) on
securities AFS, net of deferred income
taxes of $17,914																							29,480								29,480
Total comprehensive income																															78,940
ESOP activity, net							4,653				1,513																				6,166
RRP activity, net							128								(100	)											24				52
Stock based compensation - stock options and RRP							225								250																475
Acquisition of treasury stock																											(2,426	)			(2,426	)
Stock options exercised							1,146																				686				1,832
Dividends on common stock to public
stockholders ($1.61 per public share)																			(33,621	)											(33,621	)
Balance at June 30, 2009		$	915			$	451,543			$	(8,569	)		$	(403	)		$	775,214			$	23,512			$	(319,578	)		$	922,634

See accompanying notes to consolidated interim financial statements.

<Index>

 

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CAPITOL FEDERAL FINANCIAL AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

		For the Nine Months Ended
		June 30,
		2009				2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	49,460			$	35,195
Adjustments to reconcile net income to net cash provided by
operating activities:
FHLB stock dividends			(2,351	)			(5,446	)
Provision for loan losses			5,768				1,721
Originations of LHFS			(858	)			(32,555	)
Proceeds from sales of LHFS			97,838				31,220
Amortization and accretion of premiums and discounts on
MBS and investment securities			1,377				496
Depreciation and amortization of premises and equipment			3,751				3,934
Amortization of deferred amounts related to FHLB advances, net			2,208				1,294
Common stock committed to be released for allocation - ESOP			6,166				5,350
Stock based compensation - stock options and RRP			475				575
Other, net			(1,432	)			(442	)
Changes in:
Accrued interest receivable			876				3,561
Other assets			2,052				(2,185	)
Income taxes payable/receivable			1,840				15,583
Accounts payable and accrued expenses			1,010				(4,362	)
Net cash provided by operating activities			168,180				53,939
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities or calls of investment securities AFS			45,032				99,791
Purchases of investment securities AFS			(255,046	)			(49,248	)
Proceeds from maturities or calls of investment securities HTM			39,600				514,108
Purchases of investment securities HTM			(10,116	)			(185,138	)
Principal collected on MBS AFS			227,574				171,534
Purchases of MBS AFS			(169,452	)			(1,044,847	)
Principal collected on MBS HTM			125,176				215,767
Purchases of MBS HTM			(3,217	)			(5,483	)
Proceeds from the redemption of capital stock of FHLB			3,688				28,861
Purchases of capital stock of FHLB			(9,002	)			(12,926	)
Loan originations, net of principal collected			(196,002	)			(85,692	)
Loan purchases, net of principal collected			(133,849	)			45,015
Net deferred fee activity			1,330				463
Purchases of premises and equipment			(8,944	)			(5,113	)
Proceeds from sales of REO			6,047				4,084
Net cash used in investing activities			(337,181	)			(308,824	)

(Continued)

 

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		For the Nine Months Ended
		June 30,
		2009				2008
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid		$	(33,621	)		$	(31,091	)
Deposits, net of withdrawals			251,368				38,761
Proceeds from advances/line of credit from FHLB			1,561,102				725,000
Repayments on advances/line of credit from FHLB			(1,561,102	)			(925,000	)
Deferred FHLB prepayment penalty			(38,388	)			--
Proceeds from repurchase agreements			--				400,000
Change in advance payments by borrowers for taxes and insurance			(22,801	)			(22,208	)
Acquisitions of treasury stock			(2,426	)			(7,307	)
Stock options exercised and excess tax benefits from stock options			1,832				376
Net cash provided by financing activities			155,964				178,531
NET DECREASE IN CASH AND CASH EQUIVALENTS			(13,037	)			(76,354	)
CASH AND CASH EQUIVALENTS:
Beginning of period			87,138				162,791
End of period		$	74,101			$	86,437
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Income tax payments, net of refund		$	27,116			$	4,003
Interest payments, net of interest credited to deposits		$	103,229			$	106,659
SUPPLEMENTAL DISCLOSURE OF NON-CASH
INVESTING AND FINANCING ACTIVITIES:
Loans transferred to REO		$	7,320			$	4,188
Fair value change related to fair value hedge:
Interest rate swaps hedging FHLB advances		$	--			$	(13,817	)
Transfer of loans receivable to LHFS, net		$	94,672			$	--

(Concluded)

See accompanying notes to consolidated interim financial statements.

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Notes to Consolidated Interim Financial Statements (Unaudited)

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 (“ALLL”), 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.

		For the Three Months Ended								For the Nine Months Ended
		June 30,								June 30,
		2009 (1) (2)				2008 (3)				2009 (1)(2)				2008 (4)(5)
		(Dollars in thousands, except per share amounts)
Net income		$	15,476			$	14,355			$	49,460			$	35,195
Average common shares outstanding			73,071,448				72,832,039				73,065,433				72,870,800
Average committed ESOP shares outstanding			101,374				101,374				50,779				50,778
Total basic average common shares outstanding			73,172,822				72,933,413				73,116,212				72,921,578
Effect of dilutive RRP shares			3,842				5,240				5,626				4,295
Effect of dilutive stock options			55,832				82,132				67,663				58,784
Total diluted average common shares outstanding			73,232,496				73,020,785				73,189,501				72,984,657
Net earnings per share:
Basic		$	0.21			$	0.20			$	0.68			$	0.48
Diluted		$	0.21			$	0.20			$	0.68			$	0.48

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(1) Options to purchase 72,050 shares of common stock at prices between $38.77 per share and $43.46 per share were outstanding as of June 30, 2009, but were not included in the computation of diluted EPS because they were anti-dilutive for the three and nine months ended June 30, 2009.

(2) At June 30, 2009, there were 2,000 unvested RRP shares at $39.95 per share that were excluded from the computation of diluted EPS because they were anti-dilutive for the three and nine months ended June 30, 2009.

(3) Options to purchase 31,500 shares of common stock at $38.77 per share were outstanding as of June 30, 2008, but were not included in the computation of diluted EPS because they were anti-dilutive for the three months ended June 30, 2008.

(4) Options to purchase 128,055 shares of common stock at prices between $32.23 per share and $38.77 per share were outstanding as of June 30, 2008, but were not included in the computation of diluted EPS because they were anti-dilutive for the nine months ended June 30, 2008.

(5) At June 30, 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 nine months ended June 30, 2008.

3.   Recent Accounting Pronouncements

In January 2009, the Financial Accounting Standards Board (“FASB”) issued Staff Position (“FSP”) Emerging Issues Task Force (“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 Statement of Financial Accounting Standards (“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 ended December 31, 2008.  The Company’s adoption of the FSP did not have a material impact on its 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.”  The FSP 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 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.  FSP FAS 157-4 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 was effective for the Company for the period ended June 30, 2009.  The Company’s adoption of the FSP did not have a material impact on its financial condition or results of operations.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.”  The FSP amends existing OTTI guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of OTTI on debt and equity securities in the financial statements.  An OTTI is present for a security which has a fair value less than amortized cost if an entity has the intent to sell the impaired security, it is more likely than not that the entity will be required to sell the impaired security before recovery, or if the entity does not expect to recover the entire amortized cost basis of the impaired security.  If the entity has the intent to sell the security or it is more likely than not that it will be required to sell the security, the entire impairment (amortized cost basis over fair value) should be recognized in earnings as a credit loss.  If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security, the credit component of the impairment should be recognized in earnings, and the non-credit component should be recognized in other comprehensive income.  The FSP does not amend existing recognition and measurement guidance related to OTTI of equity securities.  The FSP expands and increases the frequency of existing disclosures about OTTI for debt and equity securities and requires new disclosures to help users of financial statements understand the significant inputs used in determining credit losses, as well as a rollforward of that amount each period.  The FSP was effective for the Company for the period ended June 30, 2009.  The Company’s adoption of the FSP did not have a material impact on its financial condition or results of operations.

 

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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.”  The FSP amends the disclosure requirements of SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”, to require fair value disclosures of financial instruments in interim financial statements as well as in annual financial statements.  The FSP also amends APB No. 28,” Interim Financial Reporting”, to require such disclosures in all interim financial statements.  The FSP requires an entity to disclose in the body or in the accompanying footnotes of its interim financial statements and its annual financial statements the fair value of all financial instruments, whether recognized or not recognized in the consolidated balance sheet, as required by FAS No. 107.  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.  The FSP was effective for the Company for the period ended June 30, 2009.  Since the provisions of the FSP are disclosure related, the Company’s adoption of the FSP did not have an impact on its financial condition or results of operations.

 

In April 2009, the SEC issued Staff Accounting Bulletin (“SAB”) 111 which amends Topic 5.M “Other-Than-Temporary Impairment of Certain Investments in Debt and Equity Securities” to exclude investments in debt securities from the scope of the other-than-temporary impairment guidance.  SAB 111 was issued in response to the FASB’s issuance of FSB FAS 115-2 and FAS 124-2.  The SEC staff has not changed its views in SAB Topic 5.M on investments in equity securities.  SAB 111 was effective for the Company for the period ended June 30, 2009.  The Company’s adoption of SAB 111 did not have a material impact on its financial condition or results of operation.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” which is intended to assist management in assessing and disclosing subsequent events by establishing general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued.  Financial statements are considered to be available to be issued when they are complete in a form and format that complies with GAAP and all necessary approvals for issuance, such as from management, the board of directors, and/or significant shareholders, have been obtained.  The date through which an entity has evaluated subsequent events and the basis for that date should also be disclosed.   Management must perform its assessment of subsequent events for both interim and annual financial reporting periods.  SFAS No. 165 was effective for the Company for the period ended June 30, 2009.  The Company’s adoption of SFAS No. 165 did not have a material impact on its financial condition or results of operations.

 

In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets an Amendment of FASB Statement No. 140.”  The objective of SFAS No. 166 is to improve the relevance, representational faithfulness, and comparability of the information provided in the financial statements related to the transfer of financial assets; the effects of a transfer on the company’s financial position, financial performance and cash flows; and a transferor’s continuing involvement in transferred financial assets.  SFAS No. 166 is effective for financial asset transfers occurring after the beginning of an entity’s first fiscal year that begins after November 15, 2009, which for the Company is October 1, 2010.  Early adoption is prohibited.  The Company has not yet completed its assessment of the impact of SFAS No. 166.

 

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” to improve financial reporting by entities involved with variable interest entities.  SFAS No. 167 carries forward the scope of FASB Interpretation No. 46(R), with the addition of entities previously considered qualifying special-purpose entities, as the concept of these entities was eliminated in SFAS No. 166.  SFAS No. 167 is effective as of the beginning of the first fiscal year that begins after November 15, 2009, which for the Company is October 1, 2010.  Early adoption is prohibited.  The Company has not yet completed its assessment of the impact of SFAS No. 167.

 

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles” which replaces SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” as the source of authoritative accounting principles recognized by FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP.  SFAS No. 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009, which for the Company is September 30, 2009.  Since the underlying GAAP guidance for nongovernmental entities will not change as a result of the issuance of SFAS No. 168, the Company’s adoption of the SFAS is not expected to have an impact on its financial condition or results of operations.  References to codification guidance will be updated in the Annual Report on Form 10-K for the fiscal year ending September 30, 2009.

 

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4.   Fair Value of Financial Instruments

Fair Value Measurements

Effective October 1, 2008, the Company adopted 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 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 June 30, 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, LHFS, 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:

•		Level 1 — Valuation is based upon quoted prices for identical instruments traded in active markets.
•		Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
•		Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models, and similar techniques. The results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability.

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.

AFS Securities

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.  In the table below, in accordance with FSP FAS 157-4, the Company has disclosed its major security types based on the nature and risks of the securities.  Substantially all of the securities within the AFS portfolio are 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 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.

 

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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 June 30, 2009:

						Quoted Prices				Significant				Significant
						in Active Markets				Other				Unobservable
		Carrying				for Identical Assets				Observable Inputs				Inputs
		Value				(Level 1)				(Level 2)				(Level 3) (1)
		(Dollars in thousands)
AFS securities:
U.S. government-sponsored agencies		$	254,745			$	--			$	254,745			$	--
Municipal bonds			2,738				--				2,738				--
Trust preferred securities			1,826				--				--				1,826
MBS			1,472,547				--				1,472,547				--
		$	1,731,856			$	--			$	1,730,030			$	1,826

(1) The Company’s Level 3 AFS securities were immaterial as of June 30, 2009 and had no material activity during the nine months ended June 30, 2009.

The following is a description of valuation methodologies used for significant assets measured at fair value on a non-recurring basis.

Loans Receivable

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 June 30, 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 June 30, 2009 were $29.4 million. Based on this evaluation, the Company maintains an allowance for loan losses of $4.4 million at June 30, 2009 for such impaired loans.

REO, net

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 June 30, 2009 was $5.1 million. During the three and nine months ended June 30, 2009, charge-offs to the allowance for loan losses related to loans that were transferred to REO were $328 thousand and $1.0 million, respectively. Write downs related to REO that were charged to other expense were $ 245 thousand and $885 thousand for the three and nine months ended June 30, 2009.

 

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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 June 30, 2009:

						Quoted Prices				Significant				Significant
						in Active Markets				Other				Unobservable
		Carrying				for Identical Assets				Observable Inputs				Inputs
		Value				(Level 1)				(Level 2)				(Level 3)
		(Dollars in thousands)
Impaired loans		$	29,399			$	--			$	--			$	29,399
REO, net			5,077				--				--				5,077
		$	34,476			$	--			$	--			$	34,476

Fair Value Disclosures

Effective June 30, 2009, the Company adopted FSP FAS 107-1 and ABP Opinion No. 28-1, “Interim Disclosures about Fair Value of Financial Instruments.”  The FSP requires interim and annual disclosures of the fair value of financial instruments, the methods and significant assumptions used to determine the estimated fair values and significant changes in the methods or assumptions used to calculate the estimated fair values.  The Company determined estimated fair value amounts using available market information and a selection from a variety of valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amount the Company could realize in a current market exchange. The use of different market assumptions and estimation methodologies may have a material effect on the estimated fair value amounts.  The fair value estimates presented herein are based on pertinent information available to management as of June 30, 2009 and September 30, 2008. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date.

The estimated fair values of the Company’s financial instruments as of June 30, 2009 and September 30, 2008 are as follows:

		At								At
		June 30, 2009								September 30, 2008
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
		(Dollars in thousands)
Assets:
Cash and cash equivalents		$	74,101			$	74,101			$	87,138			$	87,138
Investment securities:
AFS			259,309				259,309				49,586				49,586
HTM			62,857				63,757				92,773				92,211
MBS:
AFS			1,472,547				1,472,547				1,484,055				1,484,055
HTM			628,451				643,110				750,284				743,764
Loans receivable			5,541,731				5,693,858				5,320,780				5,301,179
Capital stock of FHLB			132,071				132,071				124,406				124,406
Liabilities:
Deposits			4,175,251				4,238,765				3,923,883				3,934,188
Advances from FHLB			2,410,949				2,543,948				2,447,129				2,485,545
Other borrowings			713,609				737,770				713,581				716,951

The following methods and assumptions were used to estimate the fair value of the financial instruments:

Cash and Cash Equivalents - The carrying amounts of cash and cash equivalents are considered to approximate their fair value due to the nature of the financial asset.

 

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Investment Securities and MBS - Estimated fair values of securities are based on one of three methods:  1) quoted market prices where available, 2) quoted market prices for similar instruments if quoted market prices are not available, 3) unobservable data that represents the Bank’s assumptions about items that market participants would consider in determining fair value where no market data is available.  AFS securities are carried at estimated fair value.  HTM securities are carried at amortized cost.

Loans Receivable - Fair values are estimated for portfolios with similar financial characteristics.  Loans are segregated by type, such as one- to four-family residential mortgages, multi-family residential mortgages, nonresidential and installment loans.  Each loan category is further segmented into fixed and adjustable interest rate categories.  Market pricing sources are used to approximate the estimated fair value of fixed and adjustable-rate one- to four-family residential mortgages.  For all other loan categories, future cash flows are discounted using the LIBOR curve at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturity.

Capital Stock of FHLB – The carrying value of FHLB stock equals cost.  The fair value is based on redemption at par value.

Deposits - The estimated fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date. The estimated fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered by the Bank for certificates of similar remaining maturities.

Advances from FHLB - The estimated fair value of advances from FHLB are determined by discounting the future cash flows of each advance using the LIBOR curve.

Other Borrowings – Other borrowings consists of repurchase agreements and Junior Subordinated Deferrable Interest Debentures (“the debentures”).   The estimated fair value of the repurchase agreements is determined by discounting the future cash flows of each agreement using the LIBOR curve.  The debentures have a variable rate structure.  The Company was able to prepay the debentures at a premium until April 2009, at which point the borrowings became redeemable at par.  The carrying value of the debentures approximates their estimated fair value.

 

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5.   Securities

The following tables reflect the amortized cost, estimated fair value, and gross unrealized gains and losses of AFS and HTM securities at June 30, 2009 and September 30, 2008.  The majority of the security portfolio is composed of securities issued by U.S. government-sponsored enterprises.

 

		June 30, 2009
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
		(Dollars in thousands)
AFS:
U.S. government-sponsored agencies		$	254,424			$	549			$	228			$	254,745
Municipal bonds			2,673				99				34				2,738
Trust preferred securities			3,789				--				1,963				1,826
MBS			1,433,171				40,819				1,443				1,472,547
			1,694,057				41,467				3,668				1,731,856
HTM:
Municipal bonds			62,857				1,171				271				63,757
MBS			628,451				15,100				441				643,110
			691,308				16,271				712				706,867
		$	2,385,365			$	57,738			$	4,380			$	2,438,723
		September 30, 2008
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
		(Dollars in thousands)
AFS:
U.S. government-sponsored agencies		$	45,155			$	--			$	967			$	44,188
Municipal bonds			2,686				61				4				2,743
Trust preferred securities			3,859				--				1,204				2,655
MBS			1,491,536				3,940				11,421				1,484,055
			1,543,236				4,001				13,596				1,533,641
HTM:
U.S. government-sponsored agencies			37,397				19				647				36,769
Municipal bonds			55,376				408				342				55,442
MBS			750,284				2,105				8,625				743,764
			843,057				2,532				9,614				835,975
		$	2,386,293			$	6,533			$	23,210			$	2,369,616

 

 

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The following tables summarize the estimated fair value and gross unrealized losses of those securities on which an unrealized loss at June 30, 2009 and September 30, 2008 was reported and the continuous unrealized loss position for the twelve months prior to June 30, 2009 and September 30, 2008 or for a shorter period of time, as applicable. At June 30, 2009 and September 30, 2008, there were 84 and 92 securities, respectively, in a continuous unrealized loss position for more than 12 months.

		June 30, 2009
		Less Than												Equal to or Greater
		12 Months												Than 12 Months
		Count				Estimated Fair Value				Unrealized				Count				Estimated Fair Value				Unrealized
										Losses												Losses
AFS:		(Dollars in thousands)
U.S. government-sponsored agencies			5			$	102,600			$	228				--			$	--			$	--
Municipal bonds			5				1,293				34				--				--				--
Trust preferred securities			1				1,826				1,963				--				--				--
MBS			12				77,288				1,106				73				37,919				337
			23			$	183,007			$	3,331				73			$	37,919			$	337
HTM:
Municipal bonds			22			$	11,649			$	234				1			$	463			$	37
MBS			6				16,374				83				10				44,352				358
			28			$	28,023			$	317				11			$	44,815			$	395
		September 30, 2008
		Less Than												Equal to or Greater
		12 Months												Than 12 Months
		Count				Estimated Fair Value				Unrealized				Count				Estimated Fair Value				Unrealized
										Losses												Losses
AFS:		(Dollars in thousands)
U.S. government-sponsored agencies			2			$	44,189			$	967				--			$	--			$	--
Municipal bonds			2				491				4				--				--				--
Trust preferred securities			1				2,655				1,204				--				--				--
MBS			150				956,968				10,191				62				51,515				1,230
			155			$	1,004,303			$	12,366				62			$	51,515			$	1,230
HTM:
U.S. government-sponsored agencies			1			$	24,353			$	647				--			$	--			$	--
Municipal bonds			47				24,522				342				--				--				--
MBS			42				417,400				5,004				30				166,807				3,621
			90			$	466,275			$	5,993				30			$	166,807			$	3,621

On a quarterly basis, management conducts a formal review of securities for the presence of OTTI.  Management assesses whether an OTTI is present when the fair value of a security is less than its amortized cost basis at the balance sheet date.  For such securities, OTTI is considered to have occurred if the Company intends to sell the security, if it is more likely than not the Company will be required to sell the security before recovery of its amortized cost basis or if the present values of expected cash flows is not sufficient to recover the entire amortized cost.

 

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The unrealized losses are primarily a result of increases in market yields from the time of purchase.  In general, as market yields rise, the fair value of securities will decrease; as market yields fall, the fair value of securities will increase. Management generally views changes in fair value caused by changes in interest rates as temporary; therefore, these securities have not been classified as other-than-temporarily impaired.  Additionally, the impairment is also considered temporary because scheduled coupon payments have been made, it is anticipated that the entire principal balance will be collected as scheduled, and management neither intends to sell the securities and it is not more likely than not that the Company will be required to sell the securities before the recovery of the remaining amortized cost amount.

The amortized cost and estimated fair value of securities by remaining contractual maturity without consideration for call features or pre-refunding dates as of June 30, 2009 are shown below.  Actual maturities of MBS may differ from contractual maturities because borrowers have the right to call or prepay obligations, sometimes without penalties.  Maturities of MBS depend on the repayment characteristics and experience of the underlying financial instruments.

 

		June 30, 2009
		Available-For-Sale								Held-To-Maturity
						Estimated								Estimated
		Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value
		(Dollars in thousands)
One year or less		$	--			$	--			$	194			$	194
One year through five years			254,801				255,123				12,545				12,810
Five years through ten years			70,939				74,015				371,814				381,521
Ten years and thereafter			1,368,317				1,402,718				306,755				312,342
		$	1,694,057			$	1,731,856			$	691,308			$	706,867

 

 

Issuers of certain securities have the right to call and prepay obligations with or without prepayment penalties.  As of June 30, 2009, the amortized cost of the securities in our portfolio which are callable or have pre-refunding dates within one year totaled $206.2 million.  All dispositions of securities for the nine months ended June 30, 2009 and twelve months ended September 30, 2008 were the result of principal repayments, maturities, or calls.

As of June 30, 2009, the Bank had pledged AFS and HTM MBS as collateral with an amortized cost of $933.3 million and an estimated fair value of $960.0 million to the public unit depositors, repurchase agreement counterparties, and the Federal Reserve Bank.

6.   FHLB Advances

During the nine months ended June 30, 2009, the Bank prepaid $875.0 million of fixed-rate FHLB advances with a weighted average interest rate of 5.65% and a weighted average remaining term to maturity of 11 months.  The prepaid FHLB advances were replaced with $875.0 million of fixed-rate FHLB advances, with a weighted average contractual interest rate of 3.41% and an average term of 69 months.  The Bank paid a $38.4 million penalty to the FHLB as a result of prepaying the FHLB advances.  The prepayment penalty will be deferred and recognized in interest expense over the life of the new FHLB advances.  As a result, the prepayment penalty will effectively increase the interest rate on the new advances 96 basis points at the time of the transaction.  The benefit of the refinance will be recognized in the form of an immediate decrease in interest expense, and a decrease in interest rate sensitivity, as the maturities of the refinanced advances were extended at a lower rate.  In accordance with 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 following table presents the face value of FHLB advances and the maturities and rates for all FHLB advances outstanding at June 30, 2009.

 

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						Weighted				Weighted
		FHLB				Average				Average
		Advances				Contractual				Effective
Maturity by fiscal year		Amount				Rate				Rate (1)
(Dollars in thousands)
2009		$	20,000				5.09	%			5.09	%
2010			350,000				4.49				4.49
2011			276,000				4.87				4.87
2012			350,000				3.35				3.35
2013			525,000				3.72				4.06
2014			450,000				3.14				3.90
Thereafter			475,000				3.67				4.28
		$	2,446,000				3.80	%			4.13	%

(1) The effective rate includes the net impact of the amortization of deferred prepayment penalties related to the prepayment of certain FHLB advances and deferred gains related to the termination of interest rate swaps during fiscal year 2008.

7.   Subsequent Events

 

Management has evaluated events and transactions that occurred after the balance sheet date of June 30, 2009 through August 4, 2009, the date the financial statements were available to be issued.  No material events or transactions which would require adjustments to or disclosures in the consolidated financial statements occurred during this period.

 

Item 2.   Management’s Discussion and Analysis of Financial Condition and 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:

·	our ability to continue to maintain overhead costs at reasonable levels;

·	our ability to continue to originate a significant volume of one- to four-family mortgage loans in our market area;

·	our ability to acquire funds from or invest funds in wholesale or secondary markets;

·	the future earnings and capital levels of the Bank, which could affect the ability of the Company to pay dividends in accordance with its dividend policies;

·	fluctuations in deposit flows, loan demand, and/or real estate values, which may adversely affect our business;

·	the credit risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses;

·	the strength of the U.S. economy in general and the strength of the local economies in which we conduct operations;

·	the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;

·	the effects of, and changes in, foreign and military policies of the United States Government;

 

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·	inflation, interest rate, market and monetary fluctuations;

·	our ability to access cost-effective funding;

·	the timely development of and acceptance of our new products and services and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors’ products and services;

·	the willingness of users to substitute competitors’ products and services for our products and services;

·	our success in gaining regulatory approval of our products and services and branching locations, when required;

·	the impact of changes in financial services laws and regulations, including laws concerning taxes, banking securities and insurance and the impact of other governmental initiatives affecting the financial services industry;

·	implementing business initiatives may be more difficult or expensive than anticipated;

·	technological changes;

·	acquisitions and dispositions;

·	changes in consumer spending and saving habits; and

·	our success at managing the risks involved in our business

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.

Executive Summary

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, 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

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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 the third quarter of fiscal year 2009, the national economy continued to contract due to an increase in unemployment and a general decline in household wealth.  The financial services industry as a whole continued to experience 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 economic recession and sharp downturn in the housing and real estate markets nationally.  We recorded a $3.1 million provision for loan losses during the current quarter.  The additional provision reflects an increase in our purchased loan loss factors in the formula analysis and purchased loan specific valuation allowances and accounts for charge-offs during the quarter, primarily related to purchased loans..  We have experienced an increase in the overall 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.

The Company recognized net income of $15.5 million for the quarter ended June 30, 2009, compared to net income of $18.1 million for the quarter ended March 31, 2009.  The decrease in net income between the periods was primarily due to the $3.8 million ($2.4 million on an after-tax basis) Federal Deposit Insurance Corporation (“FDIC”) special assessment at June 30, 2009 and a $1.3 million increase in the regular quarterly deposit insurance premiums.   Recent bank failures have depleted the Deposit Insurance Fund (the “DIF”) below the required reserve ratio which resulted in the FDIC increasing deposit insurance premiums and charging a five basis point special assessment at June 30, 2009 based upon total assets less Tier 1 capital.  The authority for the FDIC to impose any additional special assessments terminates January 1, 2010.  See additional discussion regarding the FDIC assessments in the section entitled “Liquidity and Capital Resources.”

Since December 2008, mortgage rates have, at various points in time, declined to record lows in response to the Federal Reserve’s purchase of U.S. agency debt and MBS, which has spurred an increased demand for our loan modification program and mortgage refinances.  Additionally, originations during fiscal year 2009 have generally been at rates lower than the overall loan portfolio rate.  As a result of modifications and refinances, approximately 20% of our mortgage loan portfolio has repriced to lower market rates during fiscal year 2009.  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.   During fiscal year 2009, we have modified $1.07 billion and refinanced $207.3 million of our originated loans.  The weighted average interest rate reduction for the modified loans is approximately 88 basis points.  In an effort to mitigate the net interest income impact of the loan modifications, refinances and loan originations at rates lower than the overall portfolio, the Bank refinanced $875.0 million of FHLB advances during fiscal year 2009.  As a result of refinancing the FHLB advances, the Bank was able to lower its contractual interest rate on the refinanced advances by 224 basis points, from 5.65% to 3.41%.  See additional discussion regarding the FHLB advance refinance in “Notes to Financial Statements - Note 6 - FHLB Advances.”  Due to the positive gap position of the Bank, our interest-earning assets are repricing faster than our interest-bearing liabilities.  If interest rates were to increase, this would likely result in net interest income expansion in future periods as our interest-earning assets will reprice upward faster than our interest-bearing liabilities.

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, like the Bank, desirable for many customers.  In response to the economic recession, households have increased their personal savings rate which we believe has contributed to our growth in deposits during fiscal year 2009.  We believe that our strong capital position (the Bank’s tangible equity ratio at June 30, 2009 was 9.8% - see tangible equity to GAAP equity reconciliation in “Liquidity and Capital Resources – Regulatory Capital”), lending policies, and underwriting standards have helped position us to better withstand these adverse economic conditions.  In addition, the investments of the Bank are primarily 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 three branches in our market areas in Kansas City and Wichita, and has preliminary plans to open three additional branches in those same market areas during fiscal year 2010.

 

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Available Information

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 SFAS 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.

 

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 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.

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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.  During the quarter ended March 31, 2009, management noted measurable 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, loss factors on 30-89 day delinquent loans were modified based on whether the loan is an originated or purchased loan.  The loss factors for purchased loans were modified higher than the loss factors associated with originated loans to account for the performance difference between the two portfolios.  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, during the quarter ended March 31, 2009, the real estate market factors used to calculate estimated current loan-to-value (“LTV”) ratios in the formula analysis were modified as a result of management’s quarterly analysis.  The real estate market factors used in the formula analysis are based on 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. The factors are updated in the formula analysis each quarter to reflect current market activity.

 

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 the quarter ended March 31, 2009, management noted 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 began applying market value adjustments to non-performing purchased loans as of March 31, 2009 to more accurately estimate the fair values of the underlying collateral based upon recent trends.  The adjustments are determined based on the location of the underlying collateral, recent 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.

 

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 monitors the securities portfolio for OTTI on an ongoing basis and performs a formal review quarterly.  Management’s OTTI evaluation process conforms to the guidance contained in EITF 99-20 “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets”, FSP EITF 99-20-1 “Amendments to the Impairment Guidance of EITF Issue No. 99-20”, SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities”, FSP FAS 115-2 and FSP FAS 124-2 “Recognition and Presentation of Other-Than Temporary Impairments”.  The process involves monitoring market events and other items that could impact issuers.  The evaluation includes, but is not limited to such factors as:  the nature of the investment, the length of time the security has had a fair value less than the cost basis, the cause(s) and severity of the loss, expectation of an anticipated recovery period, recent events specific to the issuer or industry including the issuer’s financial condition and the current ability to make future payments in a timely manner, external credit ratings and recent downgrades in such ratings, the Company’s intent to sell and whether it is more likely than not the Company would be required to sell prior to recovery for debt securities and changes in estimated cash flows of MBS.

 

Management determines whether OTTI losses should be recognized for securities by assessing all known facts and circumstances surrounding the securities.  If the Company intends to sell a security or if it is more likely than not that the Company will be required to sell a security before recovery of its amortized cost basis, OTTI has occurred and the difference between amortized cost and fair value will be recognized as a loss in earnings.

 

 

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If the Company does not intend to sell the security but also does not expect to recover the entire amortized cost basis of the security, an impairment loss would be recognized in earnings in the amount of the expected amortized cost basis that would not be collected (credit loss).  The remaining amount of OTTI would be recognized in other comprehensive income (loss).

Financial Condition

Total assets increased from $8.06 billion at September 30, 2008 to $8.32 billion at June 30, 2009.  The $264.0 million increase in assets was primarily attributed to a $221.0 million increase in loans receivable substantially due to loan purchases.  The growth in assets during fiscal year 2009 was primarily funded by growth in deposits.  Deposits increased from $3.92 billion at September 30, 2008 to $4.18 billion at June 30, 2009.  The $251.4 million increase was primarily in the certificate of deposit and money market portfolios.  Stockholders’ equity increased from $871.2 million at September 30, 2008 to $922.6 million at June 30, 2009.  The $51.4 million increase was due to net income of $49.5 million during fiscal year 2009 and an increase in accumulated other comprehensive gain (loss) of $29.5 million, partially offset by $33.6 million of dividend payments during fiscal year 2009.

The following table presents selected balance sheet data for the Company at the dates indicated.

		Balance at
		June 30,				March 31,				December 31,				September 30,				June 30,
		2009				2009				2008				2008				2008
		(Dollars in thousands, except per share amounts)
Total assets		$	8,319,292			$	8,269,881			$	8,157,324			$	8,055,249			$	7,892,137
Cash and cash equivalents			74,101				52,025				143,134				87,138				86,437
Investment securities			322,166				214,410				105,965				142,359				144,346
MBS			2,100,998				2,204,369				2,176,302				2,234,339				2,066,685
Loans receivable, net			5,541,731				5,377,699				5,456,569				5,320,780				5,326,061
Capital stock of FHLB			132,071				131,278				131,230				124,406				129,172
Deposits			4,175,251				4,116,514				3,867,304				3,923,883				3,961,543
Advances from FHLB			2,410,949				2,411,560				2,596,964				2,447,129				2,547,294
Other borrowings			713,609				713,609				713,595				713,581				453,566
Stockholders' equity			922,634				916,391				897,435				871,216				863,906
A