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 March 31, 2018



¨	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, former address and former fiscal year, 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, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” “smaller reporting company,” and "emerging growth 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	¨

Emerging Growth Company	o

If an emerging company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

As of May 4, 2018, there were 280,545,644 shares of the Registrant’s common stock, par value $0.01 per share, outstanding, of which 227,119,132 shares, or 81.0% of the Registrant’s common stock, were held by Third Federal Savings and Loan Association of Cleveland, MHC, the Registrant’s mutual holding company.

Table of Contents

TFS Financial Corporation

INDEX



		Page

	Glossary of Terms	3

PART l – FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited)

	Consolidated Statements of Condition
	March 31, 2018 and September 30, 2017	4

	Consolidated Statements of Income
	Three and Six Months Ended March 31, 2018 and 2017	5

	Consolidated Statements of Comprehensive Income
	Three and Six Months Ended March 31, 2018 and 2017	6

	Consolidated Statements of Shareholders’ Equity
	Six Months Ended March 31, 2018 and 2017	7

	Consolidated Statements of Cash Flows
	Six Months Ended March 31, 2018 and 2017	8

	Notes to Unaudited Interim Consolidated Financial Statements	9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	36

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	67

Item 4.	Controls and Procedures	70

Part II — OTHER INFORMATION

Item 1.	Legal Proceedings	71

Item 1A.	Risk Factors	71

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	71

Item 3.	Defaults Upon Senior Securities	72

Item 4.	Mine Safety Disclosures	72

Item 5.	Other Information	72

Item 6.	Exhibits	72

SIGNATURES		73

Table of Contents

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.



ACT: Tax Cuts and Jobs Act	FRB-Cleveland: Federal Reserve Bank of Cleveland
AOCI: Accumulated Other Comprehensive Income	Freddie Mac: Federal Home Loan Mortgage Association
ARM: Adjustable Rate Mortgage	FRS: Board of Governors of the Federal Reserve System
ASC: Accounting Standards Codification	GAAP: Generally Accepted Accounting Principles
ASU: Accounting Standards Update	Ginnie Mae: Government National Mortgage Association
Association: Third Federal Savings and Loan	GVA: General Valuation Allowances
Association of Cleveland	HARP: Home Affordable Refinance Program
BOLI: Bank Owned Life Insurance	HPI: Home Price Index
CDs: Certificates of Deposit	IRR: Interest Rate Risk
CFPB: Consumer Financial Protection Bureau	IRS: Internal Revenue Service
CLTV: Combined Loan-to-Value	IVA: Individual Valuation Allowance
Company: TFS Financial Corporation and its	LIHTC: Low Income Housing Tax Credit
subsidiaries	LIP: Loans-in-Process
DFA: Dodd-Frank Wall Street Reform and Consumer	LTV: Loan-to-Value
Protection Act	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	PMI: Private Mortgage Insurance
EVE: Economic Value of Equity	PMIC: PMI Mortgage Insurance Co.
Fannie Mae: Federal National Mortgage Association	QTL: Qualified Thrift Lender
FASB: Financial Accounting Standards Board	REMICs: Real Estate Mortgage Investment Conduits
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

Table of Contents

Item 1. Financial Statements

TFS FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION (unaudited)

(In thousands, except share data)



	March 31, 2018			September 30, 2017
ASSETS
Cash and due from banks	$	33,822		$	35,243
Interest-earning cash equivalents	237,267			232,975
Cash and cash equivalents	271,089			268,218
Investment securities available for sale (amortized cost $558,224 and $541,964, respectively)	545,001			537,479
Mortgage loans held for sale, at lower of cost or market ($469 and $0 measured at fair value, respectively)	469			351
Loans held for investment, net:
Mortgage loans	12,688,172			12,434,339
Other consumer loans	2,812			3,050
Deferred loan expenses, net	35,023			30,865
Allowance for loan losses	(43,106		)	(48,948		)
Loans, net	12,682,901			12,419,306
Mortgage loan servicing rights, net	8,034			8,375
Federal Home Loan Bank stock, at cost	93,544			89,990
Real estate owned	3,668			5,521
Premises, equipment, and software, net	63,651			60,875
Accrued interest receivable	36,439			35,479
Bank owned life insurance contracts	208,935			205,883
Other assets	42,297			61,086
TOTAL ASSETS	$	13,956,028		$	13,692,563
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits	$	8,350,422		$	8,151,625
Borrowed funds	3,717,064			3,671,377
Borrowers’ advances for insurance and taxes	88,158			100,446
Principal, interest, and related escrow owed on loans serviced	31,922			35,766
Accrued expenses and other liabilities	38,667			43,390
Total liabilities	12,226,233			12,002,604
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; 280,644,630 and 281,291,750 outstanding at March 31, 2018 and September 30, 2017, respectively	3,323			3,323
Paid-in capital	1,723,254			1,722,672
Treasury stock, at cost; 51,674,120 and 51,027,000 shares at March 31, 2018 and September 30, 2017, respectively	(746,645		)	(735,530		)
Unallocated ESOP shares	(50,917		)	(53,084		)
Retained earnings—substantially restricted	786,167			760,070
Accumulated other comprehensive income (loss)	14,613			(7,492		)
Total shareholders’ equity	1,729,795			1,689,959
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	13,956,028		$	13,692,563

See accompanying notes to unaudited interim consolidated financial statements.

Table of Contents

TFS FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (unaudited)

(In thousands, except share and per share data)



	For the Three Months Ended						For the Six Months Ended
	March 31,						March 31,
	2018			2017			2018			2017
INTEREST AND DIVIDEND INCOME:
Loans, including fees	$	105,239		$	97,676		$	207,865		$	193,056
Investment securities available for sale	2,759			2,198			5,348			4,051
Other interest and dividend earning assets	2,182			1,209			4,196			2,190
Total interest and dividend income	110,180			101,083			217,409			199,297
INTEREST EXPENSE:
Deposits	23,630			21,320			46,624			43,377
Borrowed funds	14,852			9,477			29,099			17,404
Total interest expense	38,482			30,797			75,723			60,781
NET INTEREST INCOME	71,698			70,286			141,686			138,516
PROVISION (CREDIT) FOR LOAN LOSSES	(4,000		)	(6,000		)	(7,000		)	(6,000		)
NET INTEREST INCOME AFTER PROVISION (CREDIT) FOR LOAN LOSSES	75,698			76,286			148,686			144,516
NON-INTEREST INCOME:
Fees and service charges, net of amortization	1,799			1,673			3,559			3,449
Net gain on the sale of loans	65			330			543			1,213
Increase in and death benefits from bank owned life insurance contracts	1,509			1,559			3,063			3,163
Other	1,243			990			2,295			2,095
Total non-interest income	4,616			4,552			9,460			9,920
NON-INTEREST EXPENSE:
Salaries and employee benefits	26,057			23,945			49,310			47,700
Marketing services	6,016			4,791			11,054			9,326
Office property, equipment and software	6,728			6,111			13,379			11,984
Federal insurance premium and assessments	3,008			2,664			5,726			4,936
State franchise tax	1,284			1,317			2,410			2,671
Real estate owned expense, net	536			829			1,119			1,880
Other expenses	6,059			5,637			12,466			12,059
Total non-interest expense	49,688			45,294			95,464			90,556
INCOME BEFORE INCOME TAXES	30,626			35,544			62,682			63,880
INCOME TAX EXPENSE	7,312			12,083			19,755			20,809
NET INCOME	$	23,314		$	23,461		$	42,927		$	43,071
Earnings per share—basic and diluted	$	0.08		$	0.08		$	0.15		$	0.15
Weighted average shares outstanding
Basic	275,656,445			277,787,284			275,737,265			277,857,265
Diluted	277,256,178			279,911,556			277,434,648			280,091,879

See accompanying notes to unaudited interim consolidated financial statements.

Table of Contents

TFS FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (unaudited)

(In thousands)



	For the Three Months Ended					For the Six Months Ended
	March 31,					March 31,
	2018			2017		2018			2017
Net income	$	23,314		$	23,461	$	42,927		$	43,071
Other comprehensive income (loss), net of tax:
Net change in unrealized loss on securities available for sale	(3,262		)	692		(6,259		)	(5,335		)
Net change in cash flow hedges	19,552			257		27,812			12,877
Change in pension obligation	317			346		594			691
Total other comprehensive income	16,607			1,295		22,147			8,233
Total comprehensive income	$	39,921		$	24,756	$	65,074		$	51,304

See accompanying notes to unaudited interim consolidated financial statements.

Table of Contents

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, 2016	$	3,323	$	1,716,818		$	(681,569	)	$	(57,418	)	$	698,930		$	(19,626	)	$	1,660,458
Net income	—		—			—			—			43,071			—			43,071
Other comprehensive income, net of tax	—		—			—			—			—			8,233			8,233
ESOP shares allocated or committed to be released	—		1,729			—			2,167			—			—			3,896
Compensation costs for stock-based plans	—		2,048			—			—			(29		)	—			2,019
Purchase of treasury stock (1,357,210 shares)	—		—			(23,954		)	—			—			—			(23,954		)
Treasury stock allocated to restricted stock plan	—		(877		)	(1,547		)	—			—			—			(2,424		)
Dividends paid to common shareholders ($0.25 per common share)	—		—			—			—			(12,909		)	—			(12,909		)
Balance at March 31, 2017	$	3,323	$	1,719,718		$	(707,070	)	$	(55,251	)	$	729,063		$	(11,393	)	$	1,678,390

Balance at September 30, 2017	$	3,323	$	1,722,672		$	(735,530	)	$	(53,084	)	$	760,070		$	(7,492	)	$	1,689,959
Net income	—		—			—			—			42,927			—			42,927
Other comprehensive income, net of tax	—		—			—			—			42			22,105			22,147
ESOP shares allocated or committed to be released	—		1,106			—			2,167			—			—			3,273
Compensation costs for stock-based plans	—		2,525			—			—			—			—			2,525
Purchase of treasury stock (858,000 shares)	—		—			(13,034		)	—			—			—			(13,034		)
Treasury stock allocated to restricted stock plan	—		(3,049		)	1,919			—			—			—			(1,130		)
Dividends paid to common shareholders ($0.34 per common share)	—		—			—			—			(16,872		)	—			(16,872		)
Balance at March 31, 2018	$	3,323	$	1,723,254		$	(746,645	)	$	(50,917	)	$	786,167		$	14,613		$	1,729,795

See accompanying notes to unaudited interim consolidated financial statements.

Table of Contents

TFS FINANCIAL CORPORATION AND SUBSIDIARIES

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



	For the Six Months Ended
	March 31,
	2018			2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	42,927		$	43,071
Adjustments to reconcile net income to net cash provided by operating activities:
ESOP and stock-based compensation expense	5,798			5,915
Depreciation and amortization	12,661			11,093
Deferred income taxes	4,604			(10		)
Provision (credit) for loan losses	(7,000		)	(6,000		)
Net gain on the sale of loans	(543		)	(1,213		)
Other net losses	409			425
Principal repayments on and proceeds from sales of loans held for sale	7,919			14,824
Loans originated for sale	(7,884		)	(14,623		)
Increase in bank owned life insurance contracts	(3,052		)	(3,166		)
Cash collateral received from derivative counterparties	41,280			17,844
Net decrease in interest receivable and other assets	698			691
Net decrease in accrued expenses and other liabilities	(2,699		)	(4,630		)
Net cash provided by operating activities	95,118			64,221
CASH FLOWS FROM INVESTING ACTIVITIES:
Loans originated	(1,504,338		)	(1,813,251		)
Principal repayments on loans	1,177,999			1,223,532
Proceeds from principal repayments and maturities of:
Securities available for sale	67,588			82,458
Proceeds from sale of:
Loans	60,101			130,176
Real estate owned	4,520			4,722
Purchases of:
FHLB stock	(3,554		)	(13,024		)
Securities available for sale	(86,184		)	(112,084		)
Premises and equipment	(5,744		)	(663		)
Other	—			(24		)
Net cash used in investing activities	(289,612		)	(498,158		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in deposits	198,797			(143,363		)
Net decrease in borrowers' advances for insurance and taxes	(12,288		)	(7,581		)
Net decrease in principal and interest owed on loans serviced	(3,844		)	(12,842		)
Net increase in short-term borrowed funds	159,833			697,482
Proceeds from long-term borrowed funds	88			—
Repayment of long-term borrowed funds	(114,234		)	(50,088		)
Purchase of treasury shares	(12,985		)	(24,813		)
Acquisition of treasury shares through net settlement of stock benefit plans compensation	(1,130		)	(2,424		)
Dividends paid to common shareholders	(16,872		)	(12,909		)
Net cash provided by financing activities	197,365			443,462
NET INCREASE IN CASH AND CASH EQUIVALENTS	2,871			9,525
CASH AND CASH EQUIVALENTS—Beginning of period	268,218			231,239
CASH AND CASH EQUIVALENTS—End of period	$	271,089		$	240,764
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest on deposits	$	45,786		$	43,504
Cash paid for interest on borrowed funds	27,060			14,746
Cash paid for income taxes	14,827			19,982
SUPPLEMENTAL SCHEDULES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Transfer of loans to real estate owned	2,900			3,901
Transfer of loans from held for sale to held for investment	149			—
Transfer of loans from held for investment to held for sale	60,274			130,368
Treasury stock issued for stock benefit plans	3,049			877

See accompanying notes to unaudited interim consolidated financial statements.

Table of Contents

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 March 31, 2018, approximately 81% 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 March 31, 2018, 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, 2017 contains audited 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, 2018 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 March 31, 2018 and 2017, respectively, the ESOP held 5,091,741 and 5,525,081 shares, respectively, that were neither allocated to participants nor committed to be released to participants.

Table of Contents

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



	For the Three Months Ended March 31,
	2018					2017
	Income		Shares	Per share amount		Income		Shares	Per share amount
	(Dollars in thousands, except per share data)
Net income	$	23,314				$	23,461
Less: income allocated to restricted stock units	300					221
Basic earnings per share:
Income available to common shareholders	$	23,014	275,656,445	$	0.08	$	23,240	277,787,284	$	0.08
Diluted earnings per share:
Effect of dilutive potential common shares			1,599,733					2,124,272
Income available to common shareholders	$	23,014	277,256,178	$	0.08	$	23,240	279,911,556	$	0.08



	For the Six Months Ended March 31,
	2018					2017
	Income		Shares	Per share amount		Income		Shares	Per share amount
	(Dollars in thousands, except per share data)
Net income	$	42,927				$	43,071
Less: income allocated to restricted stock units	543					425
Basic earnings per share:
Income available to common shareholders	$	42,384	275,737,265	$	0.15	$	42,646	277,857,265	$	0.15
Diluted earnings per share:
Effect of dilutive potential common shares			1,697,383					2,234,614
Income available to common shareholders	$	42,384	277,434,648	$	0.15	$	42,646	280,091,879	$	0.15

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 March 31,		For the Six Months Ended March 31,
	2018	2017	2018	2017
Options to purchase shares	2,571,240	693,900	2,149,740	693,900
Restricted stock units	15,501	16,500	11,001	16,500


3.	INVESTMENT SECURITIES

Investments available for sale are summarized as follows:



	March 31, 2018
	Amortized Cost		Gross Unrealized					Fair Value
	Amortized Cost		Gains		Losses			Fair Value
REMICs	$	549,984	$	2	$	(13,442	)	$	536,544
Fannie Mae certificates	8,240		324		(107		)	8,457
Total	$	558,224	$	326	$	(13,549	)	$	545,001

Table of Contents



	September 30, 2017
	Amortized Cost		Gross Unrealized					Fair Value
	Amortized Cost		Gains		Losses			Fair Value
REMICs	$	533,427	$	52	$	(4,943	)	$	528,536
Fannie Mae certificates	8,537		419		(13		)	8,943
Total	$	541,964	$	471	$	(4,956	)	$	537,479

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 March 31, 2018 and September 30, 2017, were as follows:



	March 31, 2018
	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	$	246,728	$	4,941	$	288,785	$	8,501	$	535,513	$	13,442
Fannie Mae certificates	4,441		107		—		—		4,441		107
Total	$	251,169	$	5,048	$	288,785	$	8,501	$	539,954	$	13,549



	September 30, 2017
	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	$	246,113	$	1,508	$	260,837	$	3,435	$	506,950	$	4,943
Fannie Mae certificates	4,601		13		—		—		4,601		13
Total	$	250,714	$	1,521	$	260,837	$	3,435	$	511,551	$	4,956

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.

Table of Contents


4.	LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans held for investment consist of the following:



	March 31, 2018			September 30, 2017
Real estate loans:
Residential Core	$	10,873,401		$	10,746,204
Residential Home Today	101,361			108,964
Home equity loans and lines of credit	1,690,708			1,552,315
Construction	54,524			60,956
Real estate loans	12,719,994			12,468,439
Other consumer loans	2,812			3,050
Add (deduct):
Deferred loan expenses, net	35,023			30,865
Loans in process ("LIP")	(31,822		)	(34,100		)
Allowance for loan losses	(43,106		)	(48,948		)
Loans held for investment, net	$	12,682,901		$	12,419,306

At March 31, 2018 and September 30, 2017, respectively, $469 and $351 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 March 31, 2018 and September 30, 2017, the percentage of aggregate Residential Core, Home Today and Construction loans held in Ohio was 57% as of both dates and the percentage held in Florida was 16% as of both dates. As of March 31, 2018 and September 30, 2017, home equity loans and lines of credit were concentrated in Ohio (37% and 39%), Florida (21% and 22% ), and California (14% and 13%).

Home Today was an affordable housing program targeted to benefit low- and moderate-income home buyers and most loans under the program were originated prior to 2009. No new loans were originated under the Home Today program after September 30, 2016. 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 contained the same features as loans offered to our Residential Core borrowers. Borrowers with a Home Today loan completed 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. As of March 31, 2018 and September 30, 2017, the principal balance of Home Today loans originated prior to March 27, 2009 was $97,974 and $105,485, respectively. Since loans are no longer originated under the Home Today program, the Home Today portfolio will continue to decline in balance due to contractual amortization. To supplant the Home Today product and to continue to meet the credit needs of customers and the communities served, during fiscal 2016 the Association began to offer Fannie Mae eligible, Home Ready loans. These loans are originated in accordance with Fannie Mae's underwriting standards. While the Association retains the servicing to these loans, the loans, along with the credit risk associated therewith, are securitized/sold to Fannie Mae. 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.

Table of Contents

An age analysis of the recorded investment in loan receivables that are past due at March 31, 2018 and September 30, 2017 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
March 31, 2018
Real estate loans:
Residential Core	$	7,863	$	2,948	$	11,050	$	21,861	$	10,866,832	$	10,888,693
Residential Home Today	2,485		894		5,913		9,292		91,977		101,269
Home equity loans and lines of credit	3,986		1,427		5,883		11,296		1,699,534		1,710,830
Construction	—		—		—		—		22,403		22,403
Total real estate loans	14,334		5,269		22,846		42,449		12,680,746		12,723,195
Other consumer loans	—		—		—		—		2,812		2,812
Total	$	14,334	$	5,269	$	22,846	$	42,449	$	12,683,558	$	12,726,007



	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total
September 30, 2017
Real estate loans:
Residential Core	$	6,077	$	2,593	$	11,975	$	20,645	$	10,740,398	$	10,761,043
Residential Home Today	4,067		1,496		6,851		12,414		95,269		107,683
Home equity loans and lines of credit	4,418		1,952		5,408		11,778		1,558,273		1,570,051
Construction	—		—		—		—		26,427		26,427
Total real estate loans	14,562		6,041		24,234		44,837		12,420,367		12,465,204
Other consumer loans	—		—		—		—		3,050		3,050
Total	$	14,562	$	6,041	$	24,234	$	44,837	$	12,423,417	$	12,468,254

At March 31, 2018 and September 30, 2017, real estate loans include $12,380 and $14,736, 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. Loans where the borrowers' sustained ability to repay is not reasonably assured at the time of modification are placed in non-accrual status for a minimum of twelve months. 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 loans in non-accrual status is summarized in the following table. Balances are adjusted for deferred loan fees or expenses.



	March 31, 2018		September 30, 2017
Real estate loans:
Residential Core	$	41,223	$	43,797
Residential Home Today	16,248		18,109
Home equity loans and lines of credit	20,777		17,185
Total non-accrual loans	$	78,248	$	79,091

Table of Contents

At March 31, 2018 and September 30, 2017, respectively, the recorded investment in non-accrual loans includes $55,402 and $54,858, which are performing according to the terms of their agreement, of which $31,971 and $34,142 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 first applied to the oldest scheduled, unpaid payment. 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, except cash payments may be applied to interest capitalized in a restructuring when collection of remaining amounts due is considered probable. 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 March 31, 2018 and September 30, 2017 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.



	March 31, 2018						September 30, 2017
	Individually		Collectively		Total		Individually		Collectively		Total
Real estate loans:
Residential Core	$	92,297	$	10,796,396	$	10,888,693	$	94,747	$	10,666,296	$	10,761,043
Residential Home Today	44,373		56,896		101,269		46,641		61,042		107,683
Home equity loans and lines of credit	43,603		1,667,227		1,710,830		39,172		1,530,879		1,570,051
Construction	—		22,403		22,403		—		26,427		26,427
Total real estate loans	180,273		12,542,922		12,723,195		180,560		12,284,644		12,465,204
Other consumer loans	—		2,812		2,812		—		3,050		3,050
Total	$	180,273	$	12,545,734	$	12,726,007	$	180,560	$	12,287,694	$	12,468,254

An analysis of the allowance for loan losses at March 31, 2018 and September 30, 2017 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.



	March 31, 2018						September 30, 2017
	Individually		Collectively		Total		Individually		Collectively		Total
Real estate loans:
Residential Core	$	7,140	$	6,940	$	14,080	$	7,336	$	6,850	$	14,186
Residential Home Today	2,116		1,624		3,740		2,250		2,258		4,508
Home equity loans and lines of credit	2,046		23,236		25,282		1,475		28,774		30,249
Construction	—		4		4		—		5		5
Total	$	11,302	$	31,804	$	43,106	$	11,061	$	37,887	$	48,948

At March 31, 2018 and September 30, 2017, 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.

Table of Contents

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 March 31, 2018 and September 30, 2017, respectively, allowances on individually reviewed loans evaluated for impairment based on the present value of cash flows, such as performing TDRs, were $11,249 and $11,061; and allowances on loans with further deteriorations in the fair value of collateral not yet identified as uncollectible were $53 and $0.

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 March 31, 2018 and September 30, 2017, respectively, approximately 20% and 22% 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 in 2011 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 owned residential portfolio covered by mortgage insurance provided by PMIC as of March 31, 2018 and September 30, 2017, respectively, was $48,444 and $61,470, of which $44,694 and $56,511 was current. The amount of loans in the Association's total owned residential portfolio covered by mortgage insurance provided by Mortgage Guaranty Insurance Corporation as of March 31, 2018 and September 30, 2017, respectively, was $24,906 and $28,946 of which $24,787 and $28,870 was current. As of March 31, 2018, 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, which are comprised primarily of home equity lines of credit, represent a significant portion of the residential real estate portfolio. 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 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 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.

Table of Contents

The recorded investment and the unpaid principal balance of impaired loans, including those reported as TDRs, as of March 31, 2018 and September 30, 2017 are summarized as follows. Balances of recorded investments are adjusted for deferred loan fees or expenses.



	March 31, 2018						September 30, 2017
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related IVA recorded:
Residential Core	$	53,929	$	70,129	$	—	$	47,507	$	65,132	$	—
Residential Home Today	17,467		37,076		—		18,780		41,064		—
Home equity loans and lines of credit	21,324		27,759		—		18,793		25,991		—
Total	$	92,720	$	134,964	$	—	$	85,080	$	132,187	$	—
With an IVA recorded:
Residential Core	$	38,368	$	38,446	$	7,140	$	47,240	$	47,747	$	7,336
Residential Home Today	26,906		26,891		2,116		27,861		28,210		2,250
Home equity loans and lines of credit	22,279		22,317		2,046		20,379		20,389		1,475
Total	$	87,553	$	87,654	$	11,302	$	95,480	$	96,346	$	11,061
Total impaired loans:
Residential Core	$	92,297	$	108,575	$	7,140	$	94,747	$	112,879	$	7,336
Residential Home Today	44,373		63,967		2,116		46,641		69,274		2,250
Home equity loans and lines of credit	43,603		50,076		2,046		39,172		46,380		1,475
Total	$	180,273	$	222,618	$	11,302	$	180,560	$	228,533	$	11,061

At March 31, 2018 and September 30, 2017, respectively, the recorded investment in impaired loans includes $161,676 and $162,020 of loans restructured in TDRs of which $10,408 and $11,884 were 90 days or more past due.

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 March 31,
	2018				2017
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related IVA recorded:
Residential Core	$	50,403	$	1,374	$	51,256	$	431
Residential Home Today	17,454		856		19,601		42
Home equity loans and lines of credit	20,071		99		19,622		82
Total	$	87,928	$	2,329	$	90,479	$	555
With an IVA recorded:
Residential Core	$	42,180	$	535	$	51,075	$	468
Residential Home Today	27,211		620		29,785		361
Home equity loans and lines of credit	21,633		144		18,095		120
Total	$	91,024	$	1,299	$	98,955	$	949
Total impaired loans:
Residential Core	$	92,583	$	1,909	$	102,331	$	899
Residential Home Today	44,665		1,476		49,386		403
Home equity loans and lines of credit	41,704		243		37,717		202
Total	$	178,952	$	3,628	$	189,434	$	1,504

Table of Contents



	For the Six Months Ended March 31,
	2018				2017
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related IVA recorded:
Residential Core	$	50,718	$	1,760	$	52,216	$	742
Residential Home Today	18,124		972		19,782		149
Home equity loans and lines of credit	20,059		173		19,957		149
Total	$	88,901	$	2,905	$	91,955	$	1,040
With an IVA recorded:
Residential Core	$	42,804	$	955	$	51,912	$	978
Residential Home Today	27,384		956		30,282		738
Home equity loans and lines of credit	21,329		275		17,354		598
Total	$	91,517	$	2,186	$	99,548	$	2,314
Total impaired loans:
Residential Core	$	93,522	$	2,715	$	104,128	$	1,720
Residential Home Today	45,508		1,928		50,064		887
Home equity loans and lines of credit	41,388		448		37,311		747
Total	$	180,418	$	5,091	$	191,503	$	3,354

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 $795 and $1,208 for the three and six months ended March 31, 2018 and $414 and $770 for the three and six months ended March 31, 2017. 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, except cash payments may be applied to interest capitalized in a restructuring when collection of remaining amounts due is considered probable. 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.