Edgar Filing: TFS Financial CORP

Document

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, 2016



¨	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 x 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	x		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 x.

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 6, 2017, there were 283,468,300 shares of the Registrant’s common stock, par value $0.01 per share, outstanding, of which 227,119,132 shares, or 80.1% 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, 2016 and September 30, 2016	4

	Consolidated Statements of Income
	Three Months Ended December 31, 2016 and 2015	5

	Consolidated Statements of Comprehensive Income
	Three Months Ended December 31, 2016 and 2015	6

	Consolidated Statements of Shareholders’ Equity
	Three Months Ended December 31, 2016 and 2015	7

	Consolidated Statements of Cash Flows
	Three Months Ended December 31, 2016 and 2015	8

	Notes to Unaudited Interim Consolidated Financial Statements	9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	60

Item 4.	Controls and Procedures	64

Part II — OTHER INFORMATION

Item 1.	Legal Proceedings	64

Item 1A.	Risk Factors	64

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	64

Item 3.	Defaults Upon Senior Securities	65

Item 4.	Mine Safety Disclosures	65

Item 5.	Other Information	65

Item 6.	Exhibits	65

SIGNATURES		66

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

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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, 2016			September 30, 2016
ASSETS
Cash and due from banks	$	39,521		$	27,914
Interest-earning cash equivalents	286,890			203,325
Cash and cash equivalents	326,411			231,239
Investment securities available for sale (amortized cost $532,809 and $517,228, respectively)	524,175			517,866
Mortgage loans held for sale, at lower of cost or market ($8,205 and $0 measured at fair value, respectively)	8,205			4,686
Loans held for investment, net:
Mortgage loans	11,921,485			11,748,099
Other consumer loans	3,173			3,116
Deferred loan expenses, net	22,318			19,384
Allowance for loan losses	(60,447		)	(61,795		)
Loans, net	11,886,529			11,708,804
Mortgage loan servicing rights, net	8,645			8,852
Federal Home Loan Bank stock, at cost	75,809			69,853
Real estate owned	5,661			6,803
Premises, equipment, and software, net	59,952			61,003
Accrued interest receivable	33,082			32,818
Bank owned life insurance contracts	201,724			200,144
Other assets	59,682			63,994
TOTAL ASSETS	$	13,189,875		$	12,906,062
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits	$	8,235,989		$	8,331,368
Borrowed funds	3,049,367			2,718,795
Borrowers’ advances for insurance and taxes	86,668			92,313
Principal, interest, and related escrow owed on loans serviced	45,961			49,401
Accrued expenses and other liabilities	106,557			53,727
Total liabilities	11,524,542			11,245,604
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; 283,511,967 and 284,219,019 outstanding at December 31, 2016 and September 30, 2016, respectively	3,323			3,323
Paid-in capital	1,718,085			1,716,818
Treasury stock, at cost; 48,806,783 and 48,099,731 shares at December 31, 2016 and September 30, 2016, respectively	(699,132		)	(681,569		)
Unallocated ESOP shares	(56,334		)	(57,418		)
Retained earnings—substantially restricted	712,079			698,930
Accumulated other comprehensive loss	(12,688		)	(19,626		)
Total shareholders’ equity	1,665,333			1,660,458
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	13,189,875		$	12,906,062

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,
	2016		2015
INTEREST AND DIVIDEND INCOME:
Loans, including fees	$	95,380	$	93,174
Investment securities available for sale	1,853		2,471
Other interest and dividend earning assets	981		786
Total interest and dividend income	98,214		96,431
INTEREST EXPENSE:
Deposits	22,057		22,439
Borrowed funds	7,927		6,351
Total interest expense	29,984		28,790
NET INTEREST INCOME	68,230		67,641
PROVISION FOR LOAN LOSSES	—		(1,000		)
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES	68,230		68,641
NON-INTEREST INCOME:
Fees and service charges, net of amortization	1,776		1,969
Net gain on the sale of loans	883		825
Increase in and death benefits from bank owned life insurance contracts	1,604		2,343
Other	1,105		980
Total non-interest income	5,368		6,117
NON-INTEREST EXPENSE:
Salaries and employee benefits	24,020		24,948
Marketing services	4,535		4,321
Office property, equipment and software	5,873		5,763
Federal insurance premium and assessments	2,272		2,829
State franchise tax	1,354		1,448
Real estate owned expense, net	1,051		2,161
Other operating expenses	6,157		6,163
Total non-interest expense	45,262		47,633
INCOME BEFORE INCOME TAXES	28,336		27,125
INCOME TAX EXPENSE	8,726		9,274
NET INCOME	$	19,610	$	17,851
Earnings per share—basic and diluted	$	0.07	$	0.06
Weighted average shares outstanding
Basic	277,925,724		283,834,670
Diluted	280,272,455		286,340,053

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,
	2016			2015
Net income	$	19,610		$	17,851
Other comprehensive income (loss), net of tax:
Net change in unrealized loss on securities available for sale	(6,027		)	(5,252		)
Net change in cash flow hedges	12,620			55
Change in pension obligation	345			250
Total other comprehensive income (loss)	6,938			(4,947		)
Total comprehensive income	$	26,548		$	12,904

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, 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

Balance at September 30, 2016	$	3,323	$	1,716,818		$	(681,569	)	$	(57,418	)	$	698,930		$	(19,626	)	$	1,660,458
Net income	—		—			—			—			19,610			—			19,610
Other comprehensive income, net of tax	—		—			—			—			—			6,938			6,938
ESOP shares allocated or committed to be released	—		913			—			1,084			—			—			1,997
Compensation costs for stock-based plans	—		1,103			—			—			(29		)	—			1,074
Purchase of treasury stock (896,000 shares)	—		—			(16,119		)	—			—			—			(16,119		)
Treasury stock allocated to restricted stock plan	—		(749		)	(1,444		)	—			—			—			(2,193		)
Dividends paid to common shareholders ($0.125 per common share)	—		—			—			—			(6,432		)	—			(6,432		)
Balance at December 31, 2016	$	3,323	$	1,718,085		$	(699,132	)	$	(56,334	)	$	712,079		$	(12,688	)	$	1,665,333

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,
	2016			2015
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	19,610		$	17,851
Adjustments to reconcile net income to net cash provided by operating activities:
ESOP and stock-based compensation expense	3,071			3,695
Depreciation and amortization	5,787			4,222
Deferred income tax expense	13			10
Provision for loan losses	—			(1,000		)
Net gain on the sale of loans	(883		)	(825		)
Other net losses	224			586
Principal repayments on and proceeds from sales of loans held for sale	4,805			3,480
Loans originated for sale	(8,438		)	(3,673		)
Increase in bank owned life insurance contracts	(1,607		)	(43		)
Cash collateral received from derivative counterparties	17,702			—
Net decrease in interest receivable and other assets	6,302			2,299
Net increase in accrued expenses and other liabilities	50,570			42,739
Other	—			(12		)
Net cash provided by operating activities	97,156			69,329
CASH FLOWS FROM INVESTING ACTIVITIES:
Loans originated	(866,302		)	(548,729		)
Principal repayments on loans	618,202			505,786
Proceeds from principal repayments and maturities of:
Securities available for sale	46,226			37,825
Proceeds from sale of:
Loans	67,467			24,571
Real estate owned	2,376			6,027
Purchases of:
FHLB stock	(5,956		)	—
Securities available for sale	(63,472		)	(50,681		)
Premises and equipment	(365		)	(2,783		)
Other	27			24
Net cash used in investing activities	(201,797		)	(27,960		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in deposits	(95,379		)	19,504
Net decrease in borrowers' advances for insurance and taxes	(5,645		)	(4,871		)
Net decrease in principal and interest owed on loans serviced	(3,440		)	(3,998		)
Net increase (decrease) in short-term borrowed funds	249,175			(29,829		)
Proceeds from long-term borrowed funds	100,000			30,000
Repayment of long-term borrowed funds	(18,603		)	(4,573		)
Purchase of treasury shares	(17,670		)	(35,054		)
Excess tax benefit related to stock-based compensation	—			1,678
Acquisition of treasury shares through net settlement of stock benefit plans compensation	(2,193		)	(4,222		)
Dividends paid to common shareholders	(6,432		)	(5,751		)
Net cash provided by (used in) financing activities	199,813			(37,116		)
NET INCREASE IN CASH AND CASH EQUIVALENTS	95,172			4,253
CASH AND CASH EQUIVALENTS—Beginning of period	231,239			155,369
CASH AND CASH EQUIVALENTS—End of period	$	326,411		$	159,622
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest on deposits	$	22,078		$	22,380
Cash paid for interest on borrowed funds	6,499			6,179
Cash paid for income taxes	218			9,711
SUPPLEMENTAL SCHEDULES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Transfer of loans to real estate owned	1,403			3,420
Transfer of loans from held for investment to held for sale	66,968			24,196
Treasury stock issued for stock benefit plans	749			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. As of December 31, 2016, approximately 80% 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 U.S. GAAP 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 deferred tax assets, and the determination of pension obligations 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, 2016, 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 SEC 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, 2016 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, 2017 or for any other period.


2.	EARNINGS PER SHARE

Basic earnings per share is the amount of earnings attributable to each share of common stock outstanding during the reporting period. Diluted earnings per share is the amount of earnings attributable 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, 2016 and 2015, respectively, the ESOP held 5,633,416 and 6,066,756 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,
	2016					2015
	Income		Shares	Per share amount		Income		Shares	Per share amount
	(Dollars in thousands, except per share data)
Net income	$	19,610				$	17,851
Less: income allocated to restricted stock units	204					179
Basic earnings per share:
Income available to common shareholders	$	19,406	277,925,724	$	0.07	$	17,672	283,834,670	$	0.06
Diluted earnings per share:
Effect of dilutive potential common shares			2,346,731					2,505,383
Income available to common shareholders	$	19,406	280,272,455	$	0.07	$	17,672	286,340,053	$	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.



	For the Three Months Ended December 31,
	2016	2015
Options to purchase shares	686,700	393,500
Restricted stock units	67,000	51,200


3.	INVESTMENT SECURITIES

Investments available for sale are summarized as follows:



	December 31, 2016
	Amortized Cost		Gross Unrealized					Fair Value
	Amortized Cost		Gains		Losses			Fair Value
REMICs	$	523,772	$	70	$	(9,139	)	$	514,703
Fannie Mae certificates	9,037		484		(49		)	9,472
Total	$	532,809	$	554	$	(9,188	)	$	524,175



	September 30, 2016
	Amortized Cost		Gross Unrealized					Fair Value
	Amortized Cost		Gains		Losses			Fair Value
REMICs	$	508,044	$	1,447	$	(1,494	)	$	507,997
Fannie Mae certificates	9,184		685		—			9,869
Total	$	517,228	$	2,132	$	(1,494	)	$	517,866

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Gross unrealized losses on available for sale securities and the estimated fair value of the related securities, aggregated by the length of time the securities have been in a continuous loss position, at December 31, 2016 and September 30, 2016, were as follows:



	December 31, 2016
	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	$	405,423	$	7,087	$	90,545	$	2,052	$	495,968	$	9,139
Fannie Mae certificates	4,662		49		—		—		4,662		49
Total	$	410,085	$	7,136	$	90,545	$	2,052	$	500,630	$	9,188



	September 30, 2016
	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	$	210,735	$	797	$	73,361	$	697	$	284,096	$	1,494

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.


4.	LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans held for investment consist of the following:



	December 31, 2016			September 30, 2016
Real estate loans:
Residential Core	$	10,257,449		$	10,069,652
Residential Home Today	118,601			121,938
Home equity loans and lines of credit	1,519,100			1,531,282
Construction	62,788			61,382
Real estate loans	11,957,938			11,784,254
Other consumer loans	3,173			3,116
Add (deduct):
Deferred loan expenses, net	22,318			19,384
Loans in process	(36,453		)	(36,155		)
Allowance for loan losses	(60,447		)	(61,795		)
Loans held for investment, net	$	11,886,529		$	11,708,804

At December 31, 2016 and September 30, 2016, respectively, $8,205 and $4,686 of loans were classified as mortgage loans held for sale.

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A large concentration of the Company’s lending is in Ohio and Florida. As of December 31, 2016 and September 30, 2016, the percentage of aggregate Residential Core, Home Today and Construction loans held in Ohio were 59% and 60%, respectively, and the percentages held in Florida was 16% as of both dates. As of December 31, 2016 and September 30, 2016, home equity loans and lines of credit were concentrated in Ohio (39% as of both dates), Florida (24% as of both dates), and California (13% and 14%, respectively).

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 Residential 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 in the Residential Core portfolio. 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 and loans are no longer originated under the Home Today program. As of December 31, 2016 and September 30, 2016, the principal balance of Home Today loans originated prior to March 27, 2009 was $114,946 and $118,255, 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, 2016 and September 30, 2016 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, 2016
Real estate loans:
Residential Core	$	7,325	$	2,803	$	14,133	$	24,261	$	10,244,116	$	10,268,377
Residential Home Today	5,663		1,762		8,251		15,676		101,502		117,178
Home equity loans and lines of credit	4,123		1,772		5,462		11,357		1,520,441		1,531,798
Construction	—		—		—		—		26,450		26,450
Total real estate loans	17,111		6,337		27,846		51,294		11,892,509		11,943,803
Other consumer loans	—		—		—		—		3,173		3,173
Total	$	17,111	$	6,337	$	27,846	$	51,294	$	11,895,682	$	11,946,976



	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total
September 30, 2016
Real estate loans:
Residential Core	$	6,653	$	3,157	$	15,593	$	25,403	$	10,054,211	$	10,079,614
Residential Home Today	5,271		2,583		7,356		15,210		105,225		120,435
Home equity loans and lines of credit	4,605		1,811		4,932		11,348		1,531,242		1,542,590
Construction	—		—		—		—		24,844		24,844
Total real estate loans	16,529		7,551		27,881		51,961		11,715,522		11,767,483
Other consumer loans	—		—		—		—		3,116		3,116
Total	$	16,529	$	7,551	$	27,881	$	51,961	$	11,718,638	$	11,770,599

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At December 31, 2016 and September 30, 2016, real estate loans include $18,487 and $20,047, respectively, of loans that were in the process of foreclosure.

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.

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, 2016		September 30, 2016
Real estate loans:
Residential Core	$	49,047	$	51,304
Residential Home Today	20,011		19,451
Home equity loans and lines of credit	18,309		19,206
Total non-accrual loans	$	87,367	$	89,961

At December 31, 2016 and September 30, 2016, respectively, the recorded investment in non-accrual loans includes $59,522 and $62,081, which are performing according to the terms of their agreement, of which $38,899 and $40,546 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 past due, 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, 2016 and September 30, 2016 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 fees or expenses and any applicable loans-in-process.



	December 31, 2016						September 30, 2016
	Individually		Collectively		Total		Individually		Collectively		Total
Real estate loans:
Residential Core	$	103,948	$	10,164,429	$	10,268,377	$	107,541	$	9,972,073	$	10,079,614
Residential Home Today	50,059		67,119		117,178		51,415		69,020		120,435
Home equity loans and lines of credit	36,707		1,495,091		1,531,798		35,894		1,506,696		1,542,590
Construction	—		26,450		26,450		—		24,844		24,844
Total real estate loans	190,714		11,753,089		11,943,803		194,850		11,572,633		11,767,483
Other consumer loans	—		3,173		3,173		—		3,116		3,116
Total	$	190,714	$	11,756,262	$	11,946,976	$	194,850	$	11,575,749	$	11,770,599

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An analysis of the allowance for loan losses at December 31, 2016 and September 30, 2016 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, 2016						September 30, 2016
	Individually		Collectively		Total		Individually		Collectively		Total
Real estate loans:
Residential Core	$	8,222	$	6,585	$	14,807	$	8,927	$	6,141	$	15,068
Residential Home Today	2,732		3,223		5,955		2,979		4,437		7,416
Home equity loans and lines of credit	972		38,708		39,680		722		38,582		39,304
Construction	—		5		5		—		7		7
Total	$	11,926	$	48,521	$	60,447	$	12,628	$	49,167	$	61,795

At December 31, 2016 and September 30, 2016, 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, 2016 and September 30, 2016, respectively, allowances on individually reviewed loans evaluated for impairment based on the present value of cash flows, such as performing TDRs, were $11,891 and $12,432.

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, 2016 and September 30, 2016, respectively, approximately 25% and 27% 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 currently pays all claim payments at 71.5%. 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 the Association's total residential portfolio covered by mortgage insurance provided by PMIC as of December 31, 2016 and September 30, 2016, respectively, was $81,957 and $91,784, of which $75,006 and $84,007 was current. The amount of loans in the Association's owned portfolio covered by mortgage insurance provided by Mortgage Guaranty Insurance Corporation as of December 31, 2016 and September 30, 2016, respectively, was $37,569 and $40,578 of which $37,511 and $40,190 was current. As of December 31, 2016, 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. Post-origination deterioration in economic and housing market conditions may 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

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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 85%.

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

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.

The recorded investment and the unpaid principal balance of impaired loans, including those reported as TDRs, as of December 31, 2016 and September 30, 2016 are summarized as follows. Balances of recorded investments are adjusted for deferred loan fees or expenses.



	December 31, 2016						September 30, 2016
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related IVA recorded:
Residential Core	$	51,640	$	70,009	$	—	$	53,560	$	72,693	$	—
Residential Home Today	19,746		43,729		—		20,108		44,914		—
Home equity loans and lines of credit	19,879		28,882		—		20,549		30,216		—
Construction	—		—		—		—		—		—
Total	$	91,265	$	142,620	$	—	$	94,217	$	147,823	$	—
With an IVA recorded:
Residential Core	$	52,308	$	53,007	$	8,222	$	53,981	$	54,717	$	8,927
Residential Home Today	30,313		30,694		2,732		31,307		31,725		2,979
Home equity loans and lines of credit	16,828		16,838		972		15,345		15,357		722
Construction	—		—		—		—		—		—
Total	$	99,449	$	100,539	$	11,926	$	100,633	$	101,799	$	12,628
Total impaired loans:
Residential Core	$	103,948	$	123,016	$	8,222	$	107,541	$	127,410	$	8,927
Residential Home Today	50,059		74,423		2,732		51,415		76,639		2,979
Home equity loans and lines of credit	36,707		45,720		972		35,894		45,573		722
Construction	—		—		—		—		—		—
Total	$	190,714	$	243,159	$	11,926	$	194,850	$	249,622	$	12,628

At December 31, 2016 and September 30, 2016, respectively, the recorded investment in impaired loans includes $167,999 and $170,602 of loans restructured in TDRs of which $12,913 and $12,368 were 90 days or more past due.

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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,
	2016				2015
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related IVA recorded:
Residential Core	$	52,600	$	311	$	60,931	$	369
Residential Home Today	19,927		107		22,523		150
Home equity loans and lines of credit	20,214		67		21,940		64
Construction	—		—		—		—
Total	$	92,741	$	485	$	105,394	$	583
With an IVA recorded:
Residential Core	$	53,145	$	510	$	56,696	$	590
Residential Home Today	30,810		377		34,452		432
Home equity loans and lines of credit	16,087		478		11,353		77
Construction	—		—		213		—
Total	$	100,042	$	1,365	$	102,714	$	1,099
Total impaired loans:
Residential Core	$	105,745	$	821	$	117,627	$	959
Residential Home Today	50,737		484		56,975		582
Home equity loans and lines of credit	36,301		545		33,293		141
Construction	—		—		213		—
Total	$	192,783	$	1,850	$	208,108	$	1,682

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 $356 for the three months ended December 31, 2016 and $449 for the three months ended December 31, 2015. 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.

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 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

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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

____________________________

(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.

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, 2016 and December 31, 2015.

The recorded investment in TDRs by type of concession as of December 31, 2016 and September 30, 2016 is shown in the tables below.



December 31, 2016	Reduction in Interest Rates		Payment Extensions		Forbearance or Other Actions		Multiple Concessions		Multiple Restructurings		Bankruptcy		Total
Residential Core	$	12,894	$	735	$	8,525	$	22,638	$	21,582	$	26,028	$	92,402
Residential Home Today	6,121		—		5,108		11,294		19,930		5,050		47,503
Home equity loans and lines of credit	117		4,146		367		11,206		1,164		11,094		28,094
Total	$	19,132	$	4,881	$	14,000	$	45,138	$	42,676	$	42,172	$	167,999



September 30, 2016	Reduction in Interest Rates		Payment Extensions		Forbearance or Other Actions		Multiple Concessions		Multiple Restructurings		Bankruptcy		Total
Residential Core	$	13,456	$	748	$	8,595	$	22,641	$	21,517	$	28,263	$	95,220
Residential Home Today	6,338		—		5,198		11,330		20,497		5,241		48,604
Home equity loans and lines of credit	120		4,135		401		9,354		1,166		11,602		26,778
Total	$	19,914	$	4,883	$	14,194	$	43,325	$	43,180	$	45,106	$	170,602

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

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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 has begun to abate. 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, 2016 and December 31, 2015 (set forth in the tables 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, 2016
	Reduction in Interest Rates		Payment Extensions		Forbearance or Other Actions		Multiple Concessions		Multiple Restructurings		Bankruptcy		Total
Residential Core	$	—	$	—	$	218	$	479	$	835	$	347	$	1,879
Residential Home Today	69		—		73		236		431		262		1,071
Home equity loans and lines of credit	—		135		—		2,180		190		330		2,835
Total	$	69	$	135	$	291	$	2,895	$	1,456	$	939	$	5,785



	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	$