Edgar Filing: TFS Financial CORP

For the Three Months Ended December 31,

Options to purchase shares

Restricted stock units

10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

________________________

FORM 10-Q

________________________



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended December 31, 2015



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For transition period from to

Commission File Number 001-33390

__________________________

TFS FINANCIAL CORPORATION

(Exact Name of Registrant as Specified in its Charter)

__________________________



United States of America		52-2054948
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

7007 Broadway Avenue Cleveland, Ohio		44105
(Address of Principal Executive Offices)		(Zip Code)

(216) 441-6000

Registrant’s telephone number, including area code:

Not Applicable

(Former name or former address, if changed since last report)

__________________________

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 filing requirements for the past 90 days. Yes x 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	ý		Accelerated filer	¨

Non-accelerated filer	¨	(do not check if a smaller reporting company)	Smaller Reporting Company	¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý.

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of the latest practicable date.

As of February 4, 2016, there were 288,557,381 shares of the Registrant’s common stock, par value $0.01 per share, outstanding, of which 227,119,132 shares, or 78.7% of the Registrant’s common stock, were held by Third Federal Savings and Loan Association of Cleveland, MHC, the Registrant’s mutual holding company.

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TFS Financial Corporation

INDEX



		Page

	Glossary of Terms	3

PART l – FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited)

	Consolidated Statements of Condition December 31, 2015 and September 30, 2015	4

	Consolidated Statements of Income Three months ended December 31, 2015 and 2014	5

	Consolidated Statements of Comprehensive Income Three months ended December 31, 2015 and 2014	6

	Consolidated Statements of Shareholders’ Equity Three months ended December 31, 2015 and 2014	7

	Consolidated Statements of Cash Flows Three months ended December 31, 2015 and 2014	8

	Notes to Unaudited Interim Consolidated Financial Statements	9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	57

Item 4.	Controls and Procedures	61

Part II — OTHER INFORMATION

Item 1.	Legal Proceedings	61

Item 1A.	Risk Factors	61

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	61

Item 3.	Defaults Upon Senior Securities	62

Item 4.	Mine Safety Disclosures	62

Item 5.	Other Information	62

Item 6.	Exhibits	62

SIGNATURES		63

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GLOSSARY OF TERMS

TFS Financial Corporation provides the following list of acronyms and defined terms as a tool for the reader. The acronyms and defined terms identified below are used throughout the document.



AOCI: Accumulated Other Comprehensive Income	FRS: Board of Governors of the Federal Reserve System
ARM: Adjustable Rate Mortgage	GAAP: Generally Accepted Accounting Principles
ASC: Accounting Standards Codification	GVA: General Valuation Allowances
ASU: Accounting Standards Update	HARP: Home Affordable Refinance Program
Association: Third Federal Savings and Loan	HPI: Home Price Index
Association of Cleveland	IRR: Interest Rate Risk
BAAS: OCC Bank Accounting Advisory Series	IRS: Internal Revenue Service
BOLI: Bank Owned Life Insurance	IVA: Individual Valuation Allowance
CDs: Certificates of Deposit	LIHTC: Low Income Housing Tax Credit
CFPB: Consumer Financial Protection Bureau	LIP: Loans-in-Process
CLTV: Combined Loan-to-Value	LTV: Loan-to-Value
Company: TFS Financial Corporation and its	MGIC: Mortgage Guaranty Insurance Corporation
subsidiaries	NOW: Negotiable Order of Withdrawal
DFA: Dodd-Frank Wall Street Reform and Consumer	OCC: Office of the Comptroller of the Currency
Protection Act	OCI: Other Comprehensive Income
DIF: Depository Insurance Fund	PMI: Private Mortgage Insurance
EaR: Earnings at Risk	PMIC: PMI Mortgage Insurance Co.
EPS: Earnings per Share	QTL: Qualified Thrift Lender
ESOP: Third Federal Employee (Associate) Stock	REMICs: Real Estate Mortgage Investment Conduits
Ownership Plan	REIT: Real Estate Investment Trust
EVE: Economic Value of Equity	SVA: Specific Valuation Allowance
FASB: Financial Accounting Standards Board	SEC: United States Securities and Exchange
FDIC: Federal Deposit Insurance Corporation	Commission
FHFA: Federal Housing Finance Agency	TDR: Troubled Debt Restructuring
FHLB: Federal Home Loan Bank	Third Federal Savings, MHC: Third Federal Savings
Fannie Mae: Federal National Mortgage Association	and Loan Association of Cleveland, MHC
FRB-Cleveland: Federal Reserve Bank of Cleveland

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Item 1. Financial Statements

TFS FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION (unaudited)

(In thousands, except share data)



	December 31, 2015			September 30, 2015
ASSETS
Cash and due from banks	$	30,787		$	22,428
Interest-earning cash equivalents	128,835			132,941
Cash and cash equivalents	159,622			155,369
Investment securities available for sale (amortized cost $593,523 and $582,091, respectively)	588,406			585,053
Mortgage loans held for sale, at lower of cost or market (none measured at fair value)	374			116
Loans held for investment, net:
Mortgage loans	11,256,718			11,245,557
Other consumer loans	3,273			3,468
Deferred loan expenses, net	12,020			10,112
Allowance for loan losses	(69,241		)	(71,554		)
Loans, net	11,202,770			11,187,583
Mortgage loan servicing rights, net	9,621			9,988
Federal Home Loan Bank stock, at cost	69,470			69,470
Real estate owned	14,299			17,492
Premises, equipment, and software, net	59,059			57,187
Accrued interest receivable	32,271			32,490
Bank owned life insurance contracts	195,890			195,861
Other assets	58,857			58,277
TOTAL ASSETS	$	12,390,639		$	12,368,886
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits	$	8,305,362		$	8,285,858
Borrowed funds	2,164,225			2,168,627
Borrowers’ advances for insurance and taxes	81,421			86,292
Principal, interest, and related escrow owed on loans serviced	45,495			49,493
Accrued expenses and other liabilities	91,691			49,246
Total liabilities	10,688,194			10,639,516
Commitments and contingent liabilities
Preferred stock, $0.01 par value, 100,000,000 shares authorized, none issued and outstanding	—			—
Common stock, $0.01 par value, 700,000,000 shares authorized; 332,318,750 shares issued; 289,243,649 and 290,882,379 outstanding at December 31, 2015 and September 30, 2015, respectively	3,323			3,323
Paid-in capital	1,709,868			1,707,629
Treasury stock, at cost; 43,075,101 and 41,436,371 shares at December 31, 2015 and September 30, 2015, respectively	(585,958		)	(548,557		)
Unallocated ESOP shares	(60,667		)	(61,751		)
Retained earnings—substantially restricted	653,891			641,791
Accumulated other comprehensive loss	(18,012		)	(13,065		)
Total shareholders’ equity	1,702,445			1,729,370
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	12,390,639		$	12,368,886

See accompanying notes to unaudited interim consolidated financial statements.

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TFS FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

(In thousands, except share and per share data)



	For the Three Months Ended
	December 31,
	2015			2014
INTEREST AND DIVIDEND INCOME:
Loans, including fees	$	93,174		$	91,835
Investment securities available for sale	2,471			2,555
Other interest and dividend earning assets	786			1,346
Total interest and dividend income	96,431			95,736
INTEREST EXPENSE:
Deposits	22,439			24,476
Borrowed funds	6,351			4,124
Total interest expense	28,790			28,600
NET INTEREST INCOME	67,641			67,136
PROVISION FOR LOAN LOSSES	(1,000		)	2,000
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES	68,641			65,136
NON-INTEREST INCOME:
Fees and service charges, net of amortization	1,969			2,158
Net gain on the sale of loans	825			698
Increase in and death benefits from bank owned life insurance contracts	2,343			1,901
Other	980			1,196
Total non-interest income	6,117			5,953
NON-INTEREST EXPENSE:
Salaries and employee benefits	24,948			23,565
Marketing services	4,321			4,500
Office property, equipment and software	5,763			5,393
Federal insurance premium and assessments	2,829			2,461
State franchise tax	1,448			1,403
Real estate owned expense, net	2,161			2,700
Other operating expenses	6,163			5,951
Total non-interest expense	47,633			45,973
INCOME BEFORE INCOME TAXES	27,125			25,116
INCOME TAX EXPENSE	9,274			8,472
NET INCOME	$	17,851		$	16,644
Earnings per share—basic and diluted	$	0.06		$	0.06
Weighted average shares outstanding
Basic	283,834,670			293,797,138
Diluted	286,340,053			296,128,813

See accompanying notes to unaudited interim consolidated financial statements.

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TFS FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

(In thousands)



	For the Three Months Ended
	December 31,
	2015			2014
Net income	$	17,851		$	16,644
Other comprehensive income (loss), net of tax:
Net change in unrealized (loss) gain on securities available for sale	(5,252		)	433
Net change in cash flow hedges	55			—
Change in pension obligation	250			124
Total other comprehensive (loss) income	(4,947		)	557
Total comprehensive income	$	12,904		$	17,201

See accompanying notes to unaudited interim consolidated financial statements.

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TFS FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (unaudited)

(In thousands, except share and per share data)



	Common stock		Paid-in capital			Treasury stock			Unallocated common stock held by ESOP			Retained earnings			Accumulated other comprehensive income (loss)			Total shareholders’ equity
Balance at September 30, 2014	$	3,323	$	1,702,441		$	(379,109	)	$	(66,084	)	$	589,678		$	(10,792	)	$	1,839,457
Net income	—		—			—			—			16,644			—			16,644
Other comprehensive income, net of tax	—		—			—			—			—			557			557
ESOP shares allocated or committed to be released	—		520			—			1,083			—			—			1,603
Compensation costs for stock-based plans	—		2,099			—			—			—			—			2,099
Excess tax effect from stock-based compensation	—		945			—			—			—			—			945
Purchase of treasury stock (2,802,800 shares)	—		—			(41,555		)	—			—			—			(41,555		)
Treasury stock allocated to restricted stock plan	—		(4,023		)	3,086			—			(1,409		)	—			(2,346		)
Dividends paid to common shareholders ($0.07 per common share)	—		—			—			—			(4,711		)	—			(4,711		)
Balance at December 31, 2014	$	3,323	$	1,701,982		$	(417,578	)	$	(65,001	)	$	600,202		$	(10,235	)	$	1,812,693

Balance at September 30, 2015	$	3,323	$	1,707,629		$	(548,557	)	$	(61,751	)	$	641,791		$	(13,065	)	$	1,729,370
Net income	—		—			—			—			17,851			—			17,851
Other comprehensive loss, net of tax	—		—			—			—			—			(4,947		)	(4,947		)
ESOP shares allocated or committed to be released	—		903			—			1,084			—			—			1,987
Compensation costs for stock-based plans	—		1,708			—			—			—			—			1,708
Excess tax effect from stock-based compensation	—		1,678			—			—			—			—			1,678
Purchase of treasury stock (1,920,000 shares)	—		—			(35,229		)	—			—			—			(35,229		)
Treasury stock allocated to restricted stock plan	—		(2,050		)	(2,172		)	—			—			—			(4,222		)
Dividends paid to common shareholders ($0.10 per common share)	—		—			—			—			(5,751		)	—			(5,751		)
Balance at December 31, 2015	$	3,323	$	1,709,868		$	(585,958	)	$	(60,667	)	$	653,891		$	(18,012	)	$	1,702,445

See accompanying notes to unaudited interim consolidated financial statements.

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TFS FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (in thousands)



	For the Three Months Ended
	December 31,
	2015			2014
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	17,851		$	16,644
Adjustments to reconcile net income to net cash provided by operating activities:
ESOP and stock-based compensation expense	3,695			3,702
Depreciation and amortization	4,222			3,865
Deferred income tax expense	10			—
Provision for loan losses	(1,000		)	2,000
Net gain on the sale of loans	(825		)	(698		)
Other net losses	586			890
Principal repayments on and proceeds from sales of loans held for sale	3,480			3,842
Loans originated for sale	(3,673		)	(4,748		)
Increase in bank owned life insurance contracts	(43		)	(1,628		)
Net decrease in interest receivable and other assets	2,299			2,179
Net increase in accrued expenses and other liabilities	42,739			45,418
Other	(12		)	118
Net cash provided by operating activities	69,329			71,584
CASH FLOWS FROM INVESTING ACTIVITIES:
Loans originated	(548,729		)	(611,208		)
Principal repayments on loans	505,786			446,149
Proceeds from principal repayments and maturities of:
Securities available for sale	37,825			33,679
Proceeds from sale of:
Loans	24,571			20,385
Real estate owned	6,027			5,691
Purchases of:
FHLB stock	—			(23,675		)
Securities available for sale	(50,681		)	(45,853		)
Premises and equipment	(2,783		)	(1,160		)
Other	24			295
Net cash used in investing activities	(27,960		)	(175,697		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in deposits	19,504			(114,664		)
Net decrease in borrowers' advances for insurance and taxes	(4,871		)	(1,912		)
Net decrease in principal and interest owed on loans serviced	(3,998		)	(5,093		)
Net (decrease) increase in short term borrowed funds	(29,829		)	224,284
Proceeds from long term borrowed funds	30,000			150,294
Repayment of long term borrowed funds	(4,573		)	(8,512		)
Purchase of treasury shares	(35,054		)	(39,755		)
Excess tax benefit related to stock-based compensation	1,678			945
Acquisition of treasury shares through net settlement of stock benefit plans compensation	(4,222		)	(2,346		)
Dividends paid to common shareholders	(5,751		)	(4,711		)
Net cash (used in) provided by financing activities	(37,116		)	198,530
NET INCREASE IN CASH AND CASH EQUIVALENTS	4,253			94,417
CASH AND CASH EQUIVALENTS—Beginning of period	155,369			181,403
CASH AND CASH EQUIVALENTS—End of period	$	159,622		$	275,820
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest on deposits	$	22,380		$	24,543
Cash paid for interest on borrowed funds	6,179			3,839
Cash paid for income taxes	9,711			80
SUPPLEMENTAL SCHEDULES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Transfer of loans to real estate owned	3,420			6,807
Transfer of loans from held for investment to held for sale	24,196			15,545
Treasury stock issued for stock benefit plans	2,050			—

See accompanying notes to unaudited interim consolidated financial statements.

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TFS FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands unless otherwise indicated)


1.	BASIS OF PRESENTATION

TFS Financial Corporation, a federally chartered stock holding company, conducts its principal activities through its wholly owned subsidiaries. The principal line of business of the Company is retail consumer banking, including mortgage lending, deposit gathering, and, to a much lesser extent, other financial services. On December 31, 2015, approximately 79% of the Company’s outstanding shares were owned by a federally chartered mutual holding company, Third Federal Savings and Loan Association of Cleveland, MHC. The thrift subsidiary of TFS Financial Corporation is Third Federal Savings and Loan Association of Cleveland.

The accounting and reporting policies followed by the Company conform in all material respects to accounting principles generally accepted in the United States of America and to general practices in the financial services industry. The preparation of financial statements in conformity with U.S. GAAP requires management 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. Actual results could differ from those estimates. The allowance for loan losses, the valuation of mortgage loan servicing rights, the valuation of deferred tax assets, and the determination of pension obligations and stock-based compensation are particularly subject to change.

The unaudited interim consolidated financial statements were prepared without an audit and reflect all adjustments of a normal recurring nature which, in the opinion of management, are necessary to present fairly the consolidated financial condition of the Company at December 31, 2015, and its results of operations and cash flows for the periods presented. Such adjustments are the only adjustments reflected in the unaudited interim financial statements. In accordance with Regulation S-X for interim financial information, these statements do not include certain information and footnote disclosures required for complete audited financial statements. The Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2015 contains consolidated financial statements and related notes, which should be read in conjunction with the accompanying interim consolidated financial statements. The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2016 or for any other period.


2.	EARNINGS PER SHARE

Basic earnings per share is the amount of earnings available to each share of common stock outstanding during the reporting period. Diluted earnings per share is the amount of earnings available to each share of common stock outstanding during the reporting period adjusted to include the effect of potentially dilutive common shares. For purposes of computing earnings per share amounts, outstanding shares include shares held by the public, shares held by the ESOP that have been allocated to participants or committed to be released for allocation to participants, the 227,119,132 shares held by Third Federal Savings, MHC, and, for purposes of computing dilutive earnings per share, stock options and restricted stock units with a dilutive impact. Unvested shares awarded pursuant to the Company's restricted stock plans are treated as participating securities in the computation of EPS pursuant to the two-class method as they contain nonforfeitable rights to dividends. The two-class method is an earnings allocation that determines EPS for each class of common stock and participating security. At December 31, 2015 and 2014, respectively, the ESOP held 6,066,756 and 6,500,096 shares that were neither allocated to participants nor committed to be released to participants.

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The following is a summary of the Company's earnings per share calculations.



	For the Three Months Ended December 31,
	2015					2014
	Income		Shares	Per share amount		Income		Shares	Per share amount
	(Dollars in thousands, except per share data)
Net income	$	17,851				$	16,644
Less: income allocated to restricted stock units	179					147
Basic earnings per share:
Income available to common shareholders	$	17,672	283,834,670	$	0.06	$	16,497	293,797,138	$	0.06
Diluted earnings per share:
Effect of dilutive potential common shares			2,505,383					2,331,675
Income available to common shareholders	$	17,672	286,340,053	$	0.06	$	16,497	296,128,813	$	0.06

The following is a summary of outstanding stock options and restricted stock units that are excluded from the computation of diluted earnings per share because their inclusion would be anti-dilutive.


3.	INVESTMENT SECURITIES

Investments available for sale are summarized as follows:



	December 31, 2015
	Amortized Cost		Gross Unrealized					Fair Value
	Amortized Cost		Gains		Losses			Fair Value
REMICs	$	583,788	$	314	$	(5,955	)	$	578,147
Fannie Mae certificates	9,735		597		(73		)	10,259
Total	$	593,523	$	911	$	(6,028	)	$	588,406



	September 30, 2015
	Amortized Cost		Gross Unrealized					Fair Value
	Amortized Cost		Gains		Losses			Fair Value
U.S. government and agency obligations	$	2,000	$	2	$	—		$	2,002
REMICs	570,194		3,135		(878		)	572,451
Fannie Mae certificates	9,897		703		—			10,600
Total	$	582,091	$	3,840	$	(878	)	$	585,053

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Gross unrealized losses and the estimated fair value of REMICs, aggregated by the length of time the securities have been in a continuous loss position, at December 31, 2015 and September 30, 2015, were as follows:



	December 31, 2015
	Less Than 12 Months				12 Months or More				Total
	Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss
Available for sale—
REMICs	$	443,025	$	4,161	$	85,794	$	1,794	$	528,819	$	5,955
Fannie Mae certificates	4,764		73		—		—		4,764		73
Total	$	447,789	$	4,234	$	85,794	$	1,794	$	533,583	$	6,028



	September 30, 2015
	Less Than 12 Months				12 Months or More				Total
	Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss		Estimated Fair Value		Unrealized Loss
Available for sale—
REMICs	$	86,754	$	299	$	80,639	$	579	$	167,393	$	878
Fannie Mae certificates	—		—		—		—		—		—
Total	$	86,754	$	299	$	80,639	$	579	$	167,393	$	878

The unrealized losses on investment securities were attributable to interest rate increases. The contractual terms of U.S. government and agency obligations do not permit the issuer to settle the security at a price less than the par value of the investment. The contractual cash flows of mortgage-backed securities are guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. REMICs are issued by or backed by securities issued by these governmental agencies. It is expected that the securities would not be settled at a price substantially less than the amortized cost of the investment. The U.S. Treasury Department established financing agreements in 2008 to ensure Fannie Mae and Freddie Mac meet their obligations to holders of mortgage-backed securities that they have issued or guaranteed.

Since the decline in value is attributable to changes in interest rates and not credit quality and because the Association has neither the intent to sell the securities nor is it more likely than not the Association will be required to sell the securities for the time periods necessary to recover the amortized cost, these investments are not considered other-than-temporarily impaired. At December 31, 2015, the Association did not have U.S. government and agency obligations available for sale. At September 30, 2015, the amortized cost and fair value of U.S. government and agency obligations, then categorized as due within one year, were $2,000 and $2,002, respectively.


4.	LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans held for investment consist of the following:



	December 31, 2015			September 30, 2015
Real estate loans:
Residential Core	$	9,504,202		$	9,462,939
Residential Home Today	131,657			135,746
Home equity loans and lines of credit	1,597,289			1,625,239
Construction	55,723			55,421
Real estate loans	11,288,871			11,279,345
Other consumer loans	3,273			3,468
Add (deduct):
Deferred loan expenses, net	12,020			10,112
Loans in process	(32,153		)	(33,788		)
Allowance for loan losses	(69,241		)	(71,554		)
Loans held for investment, net	$	11,202,770		$	11,187,583

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At December 31, 2015 and September 30, 2015, respectively, $374 and $116 of loans were classified as mortgage loans held for sale.

A large concentration of the Company’s lending is in Ohio and Florida. As of December 31, 2015 and September 30, 2015, the percentages of residential real estate loans held in Ohio and Florida were 63% and 17%, respectively, at each date. As of December 31, 2015 and September 30, 2015, home equity loans and lines of credit were concentrated in Ohio (39%), Florida (26%), and California (13%) at each date. Although somewhat dissipating during the last two years, the lingering effects of the adverse economic conditions and market for real estate in Ohio and Florida that arose in connection with the financial crisis of 2008, continue to unfavorably impact the ability of borrowers in those areas to repay their loans.

Home Today began as an affordable housing program targeted to benefit low- and moderate-income home buyers. Through this program the Association provided the majority of loans to borrowers who would not otherwise qualify for the Association’s loan products, generally because of low credit scores. Although the credit profiles of borrowers in the Home Today program might be described as sub-prime, Home Today loans generally contain the same features as loans offered to our Core borrowers. Borrowers with a Home Today loan complete financial management education and counseling and were referred to the Association by a sponsoring organization with which the Association partnered as part of the program. Because the Association applied less stringent underwriting and credit standards to the majority of Home Today loans, loans originated under the program have greater credit risk than its traditional residential real estate mortgage loans. While effective March 27, 2009, the Home Today underwriting guidelines were changed to be substantially the same as the Association’s traditional first mortgage product and the program focused on financial education and down payment assistance. The majority of loans in this program were originated prior to that date. As of December 31, 2015 and September 30, 2015, the principal balance of Home Today loans originated prior to March 27, 2009 was $128,617 and $132,762, respectively. The Association does not offer, and has not offered, loan products frequently considered to be designed to target sub-prime borrowers containing features such as higher fees or higher rates, negative amortization, a loan-to-value ratio greater than 100%, or pay option adjustable-rate mortgages.

An age analysis of the recorded investment in loan receivables that are past due at December 31, 2015 and September 30, 2015 is summarized in the following tables. When a loan is more than one month past due on its scheduled payments, the loan is considered 30 days or more past due. Balances are adjusted for deferred loan fees or expenses and any applicable loans-in-process.



	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total
December 31, 2015
Real estate loans:
Residential Core	$	6,998	$	3,206	$	21,903	$	32,107	$	9,476,307	$	9,508,414
Residential Home Today	5,121		2,798		9,063		16,982		112,997		129,979
Home equity loans and lines of credit	4,337		2,193		6,046		12,576		1,594,133		1,606,709
Construction	—		—		—		—		23,636		23,636
Total real estate loans	16,456		8,197		37,012		61,665		11,207,073		11,268,738
Other consumer loans	—		—		—		—		3,273		3,273
Total	$	16,456	$	8,197	$	37,012	$	61,665	$	11,210,346	$	11,272,011

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	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total
September 30, 2015
Real estate loans:
Residential Core	8,242		$	4,323	$	23,306	$	35,871	$	9,430,189	$	9,466,060
Residential Home Today	5,866		2,507		9,068		17,441		116,535		133,976
Home equity loans and lines of credit	5,012		1,162		5,575		11,749		1,622,683		1,634,432
Construction	—		—		427		427		20,774		21,201
Total real estate loans	19,120		7,992		38,376		65,488		11,190,181		11,255,669
Other consumer loans	—		—		—		—		3,468		3,468
Total	$	19,120	$	7,992	$	38,376	$	65,488	$	11,193,649	$	11,259,137

At December 31, 2015 and September 30, 2015, real estate loans include $26,345 and $28,864, respectively, of loans that were in the process of foreclosure.

The recorded investment of loan receivables in non-accrual status is summarized in the following table. Balances are adjusted for deferred loan fees or expenses.



	December 31, 2015		September 30, 2015
Real estate loans:
Residential Core	$	59,947	$	62,293
Residential Home Today	22,000		22,556
Home equity loans and lines of credit	21,016		21,514
Construction	—		427
Total non-accrual loans	$	102,963	$	106,790

Loans are placed in non-accrual status when they are contractually 90 days or more past due. Loans restructured in TDRs that were in non-accrual status prior to the restructurings remain in non-accrual status for a minimum of six months after restructuring. Additionally, home equity loans and lines of credit where the customer has a severely delinquent first mortgage loan and loans in Chapter 7 bankruptcy status where all borrowers have filed, and not reaffirmed or been dismissed, are placed in non-accrual status. At December 31, 2015 and September 30, 2015, respectively, the recorded investment in non-accrual loans includes $65,951 and $68,415 which are performing according to the terms of their agreement, of which $43,623 and $45,575 are loans in Chapter 7 bankruptcy status primarily where all borrowers have filed, and have not reaffirmed or been dismissed.

Interest on loans in accrual status, including certain loans individually reviewed for impairment, is recognized in interest income as it accrues, on a daily basis. Accrued interest on loans in non-accrual status is reversed by a charge to interest income and income is subsequently recognized only to the extent cash payments are received. Cash payments on loans in non-accrual status are applied to the oldest scheduled, unpaid payment first. Cash payments on loans with a partial charge-off are applied fully to principal, then to recovery of the charged off amount prior to interest income being recognized. A non-accrual loan is generally returned to accrual status when contractual payments are less than 90 days past due. However, a loan may remain in non-accrual status when collectability is uncertain, such as a TDR that has not met minimum payment requirements, a loan with a partial charge-off, an equity loan or line of credit with a delinquent first mortgage greater than 90 days, or a loan in Chapter 7 bankruptcy status where all borrowers have filed, and have not reaffirmed or been dismissed. The number of days past due is determined by the number of scheduled payments that remain unpaid, assuming a period of 30 days between each scheduled payment.

The recorded investment in loan receivables at December 31, 2015 and September 30, 2015 is summarized in the following table. The table provides details of the recorded balances according to the method of evaluation used for determining the allowance for loan losses, distinguishing between determinations made by evaluating individual loans and determinations made by evaluating groups of loans not individually evaluated. Balances of recorded investments are adjusted for deferred loan

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fees or expenses and any applicable loans-in-process.



	December 31, 2015						September 30, 2015
	Individually		Collectively		Total		Individually		Collectively		Total
Real estate loans:
Residential Core	$	115,666	$	9,392,748	$	9,508,414	$	119,588	$	9,346,472	$	9,466,060
Residential Home Today	55,903		74,076		129,979		58,046		75,930		133,976
Home equity loans and lines of credit	32,473		1,574,236		1,606,709		34,112		1,600,320		1,634,432
Construction	—		23,636		23,636		426		20,775		21,201
Total real estate loans	204,042		11,064,696		11,268,738		212,172		11,043,497		11,255,669
Other consumer loans	—		3,273		3,273		—		3,468		3,468
Total	$	204,042	$	11,067,969	$	11,272,011	$	212,172	$	11,046,965	$	11,259,137

An analysis of the allowance for loan losses at December 31, 2015 and September 30, 2015 is summarized in the following table. The analysis provides details of the allowance for loan losses according to the method of evaluation, distinguishing between allowances for loan losses determined by evaluating individual loans and allowances for loan losses determined by evaluating groups of loans collectively.



	December 31, 2015						September 30, 2015
	Individually		Collectively		Total		Individually		Collectively		Total
Real estate loans:
Residential Core	$	9,527	$	10,941	$	20,468	$	9,354	$	13,242	$	22,596
Residential Home Today	4,345		5,507		9,852		4,166		5,831		9,997
Home equity loans and lines of credit	603		38,304		38,907		772		38,154		38,926
Construction	—		14		14		26		9		35
Total	$	14,475	$	54,766	$	69,241	$	14,318	$	57,236	$	71,554

At December 31, 2015 and September 30, 2015, individually evaluated loans that required an allowance were comprised only of loans evaluated for impairment based on the present value of cash flows, such as performing TDRs, and loans with a further deterioration in the fair value of collateral not yet identified as uncollectible. All other individually evaluated loans received a charge-off, if applicable.

Because many variables are considered in determining the appropriate level of general valuation allowances, directional changes in individual considerations do not always align with the directional change in the balance of a particular component of the general valuation allowance. At December 31, 2015 and September 30, 2015, respectively, allowances on individually reviewed loans evaluated for impairment based on the present value of cash flows, such as performing TDRs, were $14,424 and $14,117.

Residential Core mortgage loans represent the largest portion of the residential real estate portfolio. The Company believes overall credit risk is low based on the nature, composition, collateral, products, lien position and performance of the portfolio. The portfolio does not include loan types or structures that have historically experienced severe performance problems at other financial institutions (sub-prime, no documentation or pay option adjustable rate mortgages).

As described earlier in this footnote, Home Today loans have greater credit risk than traditional residential real estate mortgage loans. At December 31, 2015 and September 30, 2015, respectively, approximately 32% and 34% of Home Today loans include private mortgage insurance coverage. The majority of the coverage on these loans was provided by PMI Mortgage Insurance Co., which was seized by the Arizona Department of Insurance and through March 31, 2015 paid all claim payments at 67%. In April 2015, the Association was notified that, in addition to a catch-up adjustment for prior claims, all future claims will be paid at 70%. Appropriate adjustments have been made to the Association’s affected valuation allowances and charge-offs, and estimated loss severity factors were adjusted accordingly for loans evaluated collectively. The amount of loans in our owned portfolio covered by mortgage insurance provided by PMIC as of December 31, 2015 and September 30, 2015, respectively, was $121,160 and $132,857 of which $111,066 and $122,025 was current. The amount of loans in our owned portfolio covered by mortgage insurance provided by Mortgage Guaranty Insurance Corporation as of December 31, 2015 and September 30, 2015, respectively, was $53,056 and $56,898 of which $52,631 and $56,295 was current. As of

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December 31, 2015, MGIC's long-term debt rating, as published by the major credit rating agencies, did not meet the requirements to qualify as "high credit quality"; however, MGIC continues to make claims payments in accordance with its contractual obligations and the Association has not increased its estimated loss severity factors related to MGIC's claim paying ability. No other loans were covered by mortgage insurers that were deferring claim payments or which were assessed as being non-investment grade.

Home equity loans and lines of credit represent a significant portion of the residential real estate portfolio, primarily comprised of home equity lines of credit. The state of the economy and low housing prices continue to have an adverse impact on a portion of this portfolio since the home equity lines generally are in a second lien position. Post-origination deterioration in economic and housing market conditions may also impact a borrower's ability to afford the higher payments required during the end of draw repayment period that follows the period of interest only payments on home equity lines of credit originated prior to 2012 or the ability to secure alternative financing. Beginning in February 2013, the terms on new home equity lines of credit included monthly principal and interest payments throughout the entire term to minimize the potential payment differential between the during draw and after draw periods.

The Association originates construction loans to individuals for the construction of their personal single-family residence by a qualified builder (construction/permanent loans). The Association’s construction/permanent loans generally provide for disbursements to the builder or sub-contractors during the construction phase as work progresses. During the construction phase, the borrower only pays interest on the drawn balance. Upon completion of construction, the loan converts to a permanent amortizing loan without the expense of a second closing. The Association offers construction/permanent loans with fixed or adjustable rates, and a current maximum loan-to-completed-appraised value ratio of 80%.

Other consumer loans are comprised of loans secured by certificate of deposit accounts, which are fully recoverable in the event of non-payment.

The recorded investment and the unpaid principal balance of impaired loans, including those reported as TDRs, as of December 31, 2015 and September 30, 2015 are summarized as follows. Balances of recorded investments are adjusted for deferred loan fees or expenses.



	December 31, 2015						September 30, 2015
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related IVA recorded:
Residential Core	$	59,685	$	78,396	$	—	$	62,177	$	80,622	$	—
Residential Home Today	22,007		48,830		—		23,038		50,256		—
Home equity loans and lines of credit	20,834		29,918		—		23,046		32,312		—
Construction	—		—		—		—		—		—
Total	$	102,526	$	157,144	$	—	$	108,261	$	163,190	$	—
With an IVA recorded:
Residential Core	$	55,981	$	56,775	$	9,527	$	57,411	$	58,224	$	9,354
Residential Home Today	33,896		34,325		4,345		35,008		35,479		4,166
Home equity loans and lines of credit	11,639		11,699		603		11,066		11,034		772
Construction	—		—		—		426		572		26
Total	$	101,516	$	102,799	$	14,475	$	103,911	$	105,309	$	14,318
Total impaired loans:
Residential Core	$	115,666	$	135,171	$	9,527	$	119,588	$	138,846	$	9,354
Residential Home Today	55,903		83,155		4,345		58,046		85,735		4,166
Home equity loans and lines of credit	32,473		41,617		603		34,112		43,346		772
Construction	—		—		—		426		572		26
Total	$	204,042	$	259,943	$	14,475	$	212,172	$	268,499	$	14,318

At December 31, 2015 and September 30, 2015, respectively, the recorded investment in impaired loans includes $175,609 and $178,259 of loans restructured in TDRs of which $15,222 and $14,971 were 90 days or more past due.

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For all classes of loans, a loan is considered impaired when, based on current information and events, it is probable that the Association will be unable to collect the scheduled payments of principal and interest according to the contractual terms of the loan agreement. Factors considered in determining that a loan is impaired may include the deteriorating financial condition of the borrower indicated by missed or delinquent payments, a pending legal action, such as bankruptcy or foreclosure, or the absence of adequate security for the loan.

Charge-offs on residential mortgage loans, home equity loans and lines of credit, and construction loans are recognized when triggering events, such as foreclosure actions, short sales, or deeds accepted in lieu of repayment, result in less than full repayment of the recorded investment in the loans.

Partial or full charge-offs are also recognized for the amount of impairment on loans considered collateral dependent that meet the conditions described below.


•	For residential mortgage loans, payments are greater than 180 days delinquent;


•	For home equity lines of credit, equity loans, and residential loans restructured in a TDR, payments are greater than 90 days delinquent;


•	For all classes of loans, a sheriff sale is scheduled within 60 days to sell the collateral securing the loan;


•	For all classes of loans, all borrowers have been discharged of their obligation through a Chapter 7 bankruptcy;


•	For all classes of loans, within 60 days of notification, all borrowers obligated on the loan have filed Chapter 7 bankruptcy and have not reaffirmed or been dismissed;


•	For all classes of loans, a borrower obligated on a loan has filed bankruptcy and the loan is greater than 30 days delinquent, and


•	For all classes of loans, it becomes evident that a loss is probable.

Collateral dependent residential mortgage loans and construction loans are charged off to the extent the recorded investment in a loan, net of anticipated mortgage insurance claims, exceeds the fair value less costs to dispose of the underlying property. Management can determine the loan is uncollectible for reasons such as foreclosures exceeding a reasonable time frame and recommend a full charge-off. Home equity loans or lines of credit are charged off to the extent the recorded investment in the loan plus the balance of any senior liens exceeds the fair value less costs to dispose of the underlying property or management determines the collateral is not sufficient to satisfy the loan. A loan in any portfolio that is identified as collateral dependent will continue to be reported as impaired until it is no longer considered collateral dependent, is less than 30 days past due and does not have a prior charge-off. A loan in any portfolio that has a partial charge-off consequent to impairment evaluation will continue to be individually evaluated for impairment until, at a minimum, the impairment has been recovered.

The following summarizes the effective dates of charge-off policies that changed or were first implemented during the current and previous four fiscal years and the portfolios to which those policies apply.



Effective Date	Policy	Portfolio(s) Affected
6/30/2014	A loan is considered collateral dependent and any collateral shortfall is charged off when, within 60 days of notification, all borrowers obligated on a loan filed Chapter 7 bankruptcy and have not reaffirmed or been dismissed (1)	All
9/30/2012	Pursuant to an OCC directive, a loan is considered collateral dependent and any collateral shortfall is charged off when all borrowers obligated on a loan are discharged through Chapter 7 bankruptcy	All
6/30/2012	Loans in any form of bankruptcy greater than 30 days past due are considered collateral dependent and any collateral shortfall is charged off	All
12/31/2011	Pursuant to an OCC directive, impairment on collateral dependent loans previously reserved for in the allowance were charged off. Charge-offs are recorded to recognize confirmed collateral shortfalls on impaired loans (2)	All

____________________________


(1)	Prior to 6/30/2014, collateral shortfalls on loans in Chapter 7 bankruptcy were charged off when all borrowers were discharged of the obligation or when the loan was 30 days or more past due.


(2)	Prior to 12/31/2011, partial charge-offs were not used, but a reserve in the allowance was established when the recorded investment in the loan exceeded the fair value of the collateral less costs to dispose. Individual loans were only charged off when a triggering event occurred, such as a foreclosure action was culminated, a short sale was approved, or a deed was accepted in lieu of repayment.

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Loans restructured in TDRs that are not evaluated based on collateral are separately evaluated for impairment on a loan by loan basis at the time of restructuring and at each subsequent reporting date for as long as they are reported as TDRs. The impairment evaluation is based on the present value of expected future cash flows discounted at the effective interest rate of the original loan. Expected future cash flows include a discount factor representing a potential for default. Valuation allowances are recorded for the excess of the recorded investments over the result of the cash flow analysis. Loans discharged in Chapter 7 bankruptcy are reported as TDRs and also evaluated based on the present value of expected future cash flows unless evaluated based on collateral. We evaluate these loans using the expected future cash flows because we expect the borrower, not liquidation of the collateral, to be the source of repayment for the loan. Other consumer loans are not considered for restructuring. A loan restructured in a TDR is classified as an impaired loan for a minimum of one year. After one year, that loan may be reclassified out of the balance of impaired loans if the loan was restructured to yield a market rate for loans of similar credit risk at the time of restructuring and the loan is not impaired based on the terms of the restructuring agreement. No loans whose terms were restructured in TDRs were reclassified from impaired loans during the three months ended December 31, 2015 and December 31, 2014.

The average recorded investment in impaired loans and the amount of interest income recognized during the period that the loans were impaired are summarized below.



	For the Three Months Ended December 31,
	2015				2014
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related IVA recorded:
Residential Core	$	60,931	$	369	$	72,542	$	287
Residential Home Today	22,523		150		27,677		58
Home equity loans and lines of credit	21,940		64		25,498		72
Construction	—		—		—		—
Total	$	105,394	$	583	$	125,717	$	417
With an IVA recorded:
Residential Core	$	56,696	$	590	$	58,785	$	664
Residential Home Today	34,452		432		38,363		487
Home equity loans and lines of credit	11,353		77		8,145		67
Construction	213		—		—		—
Total	$	102,714	$	1,099	$	105,293	$	1,218
Total impaired loans:
Residential Core	$	117,627	$	959	$	131,327	$	951
Residential Home Today	56,975		582		66,040		545
Home equity loans and lines of credit	33,293		141		33,643		139
Construction	213		—		—		—
Total	$	208,108	$	1,682	$	231,010	$	1,635

Interest on loans in non-accrual status is recognized on a cash-basis. The amount of interest income on impaired loans recognized using a cash-basis method was $449 for the quarter ended December 31, 2015 and $277 for the quarter ended December 31, 2014. Cash payments on loans with a partial charge-off are applied fully to principal, then to recovery of the charged off amount prior to interest income being recognized. Interest income on the remaining impaired loans is recognized on an accrual basis.

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The recorded investment in TDRs by type of concession as of December 31, 2015 and September 30, 2015 is shown in the tables below.



December 31, 2015	Reduction in Interest Rates		Payment Extensions		Forbearance or Other Actions		Multiple Concessions		Multiple Restructurings		Bankruptcy		Total
Residential Core	$	14,978	$	881	$	9,085	$	22,072	$	22,352	$	30,916	$	100,284
Residential Home Today	6,956		7		5,361		12,168		21,598		6,076		52,166
Home equity loans and lines of credit	153		3,246		502		4,972		1,040		13,246		23,159
Total	$	22,087	$	4,134	$	14,948	$	39,212	$	44,990	$	50,238	$	175,609



September 30, 2015	Reduction in Interest Rates		Payment Extensions		Forbearance or Other Actions		Multiple Concessions		Multiple Restructurings		Bankruptcy		Total
Residential Core	$	15,743	$	934	$	8,252	$	22,211	$	22,594	$	32,215	$	101,949
Residential Home Today	7,734		12		5,643		12,302		21,928		6,272		53,891
Home equity loans and lines of credit	96		3,253		509		4,214		909		13,438		22,419
Total	$	23,573	$	4,199	$	14,404	$	38,727	$	45,431	$	51,925	$	178,259

TDRs may be restructured more than once. Among other requirements, a subsequent restructuring may be available for a borrower upon the expiration of temporary restructuring terms if the borrower cannot return to regular loan payments. If the borrower is experiencing an income curtailment that temporarily has reduced his/her capacity to repay, such as loss of employment, reduction of hours, non-paid leave or short term disability, a temporary restructuring is considered. If the borrower lacks the capacity to repay the loan at the current terms due to a permanent condition, a permanent restructuring is considered. In evaluating the need for a subsequent restructuring, the borrower’s ability to repay is generally assessed utilizing a debt to income and cash flow analysis. As the economy slowly improves, the need for multiple restructurings continues to linger. Loans discharged in Chapter 7 bankruptcy are classified as multiple restructurings if the loan's original terms had also been restructured by the Association.

For all loans restructured during the three months ended December 31, 2015 and December 31, 2014 (set forth in the table below), the pre-restructured outstanding recorded investment was not materially different from the post-restructured outstanding recorded investment.

The following tables set forth the recorded investment in TDRs restructured during the periods presented, according to the types of concessions granted.



	For the Three Months Ended December 31, 2015
	Reduction in Interest Rates		Payment Extensions		Forbearance or Other Actions		Multiple Concessions		Multiple Restructurings		Bankruptcy		Total
Residential Core	$	112	$	—	$	900	$	1,188	$	558	$	1,374	$	4,132
Residential Home Today	—		—		23		295		821		179		1,318
Home equity loans and lines of credit	61		225		8		1,056		121		515		1,986
Total	$	173	$	225	$	931	$	2,539	$	1,500	$	2,068	$	7,436

For the Three Months Ended December 31, 2014

Reduction in

Interest Rates

Payment

Extensions

Forbearance
or Other Actions

Multiple

Concessions

Multiple
Restructurings

Bankruptcy

Total