UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2020
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __ to __
Commission file number: 001-34814
Capitol Federal Financial, Inc.
(Exact name of registrant as specified in its charter)
|(State or other jurisdiction of incorporation or organization)||(I.R.S. Employer Identification No.)|
|700 South Kansas Avenue,||Topeka,||Kansas||66603|
|(Address of principal executive offices)||(Zip Code)|
Registrant's telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
|Title of each class||Trading Symbol(s)||Name of each exchange on which registered|
par value $0.01 per share
|CFFN||The NASDAQ Stock Market LLC|
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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.
Large accelerated filer ☒ Accelerated filer ☐ Non-accelerated filer ☐
Smaller reporting company ☐ Emerging growth company ☐
If an emerging growth 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. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant, computed by reference to the average of the closing bid and asked price of such stock on the NASDAQ Stock Market as of March 31, 2020, was $1.61 billion.
As of November 19, 2020, there were issued and outstanding 138,792,496 shares of the Registrant's common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of Form 10-K - Portions of the proxy statement for the Annual Meeting of Stockholders for the year ended September 30, 2020.
|PART I||Item 1.|
|PART II||Item 5.|
|PART III||Item 10.|
|PART IV||Item 15.|
Private Securities Litigation Reform Act-Safe Harbor Statement
Capitol Federal Financial, Inc. (the "Company"), and Capitol Federal Savings Bank ("Capitol Federal Savings" or the "Bank"), may from time to time make written or oral "forward-looking statements," including statements contained in documents filed or furnished by the Company with the Securities and Exchange Commission ("SEC"). These forward-looking statements may be included in this Annual Report on Form 10-K and the exhibits attached to it, in the Company's reports to stockholders, in the Company's press releases, and in other communications by the Company, which are made in good faith pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include statements about our beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, which are subject to significant risks and uncertainties, and are subject to change based on various factors, some of which are beyond our control. The words "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan" and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause our future results to differ materially from the beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions expressed in the forward-looking statements:
•our ability to maintain overhead costs at reasonable levels;
•our ability to originate and purchase a sufficient volume of one- to four-family loans in order to maintain the balance of that portfolio at a level desired by management;
•our ability to invest funds in wholesale or secondary markets at favorable yields compared to the related funding source;
•our ability to access cost-effective funding;
•the expected synergies and other benefits from our acquisition activities, including our acquisition of Capital City Bancshares, Inc. ("CCB"), might not be realized within the anticipated time frames or at all;
•our ability to extend the commercial banking and trust asset management expertise acquired from CCB through our existing branch footprint;
•fluctuations in deposit flows;
•the future earnings and capital levels of the Bank and the continued non-objection by our primary federal banking regulators, to the extent required, to distribute capital from the Bank to the Company, which could affect the ability of the Company to pay dividends in accordance with its dividend policy;
•the strength of the U.S. economy in general and the strength of the local economies in which we conduct operations, including areas where we have purchased large amounts of correspondent loans;
•changes in real estate values, unemployment levels, and the level and direction of loan delinquencies and charge-offs may require changes in the estimates of the adequacy of the allowance for credit losses ("ACL"), which may adversely affect our business;
•potential adverse impacts of the ongoing Coronavirus Disease 2019 ("COVID-19") pandemic and any governmental or societal responses thereto on the economic conditions in the Company's local market areas and other market areas where the Bank has lending relationships, on other aspects of the Company's business operations and on financial markets;
•increases in classified and/or non-performing assets, which may require the Bank to increase the ACL, charge-off loans and incur elevated collection and carrying costs related to such non-performing assets;
•results of examinations of the Bank and the Company by their respective primary federal banking regulators, including the possibility that the regulators may, among other things, require us to increase our ACL;
•changes in accounting principles, policies, or guidelines;
•the effects of, and changes in, monetary and interest rate policies of the Board of Governors of the Federal Reserve System ("FRB");
•the effects of, and changes in, trade and fiscal policies and laws of the United States government;
•the effects of, and changes in, foreign and military policies of the United States government;
•inflation, interest rate, market, monetary, and currency fluctuations;
•the timely development and acceptance of new products and services and the perceived overall value of these products and services by users, including the features, pricing, and quality compared to competitors' products and services;
•the willingness of users to substitute competitors' products and services for our products and services;
•our success in gaining regulatory approval of our products and services and branching locations, when required;
•the impact of interpretations of, and changes in, financial services laws and regulations, including laws concerning taxes, banking, securities, consumer protection, trust and insurance and the impact of other governmental initiatives affecting the financial services industry;
•implementing business initiatives may be more difficult or expensive than anticipated;
•our ability to maintain the security of our financial, accounting, technology, and other operating systems and facilities, including the ability to withstand cyber-attacks;
•acquisitions and dispositions;
•changes in consumer spending, borrowing and saving habits; and
•our success at managing the risks involved in our business.
This list of important factors is not all inclusive. See "Part I, Item 1A. Risk Factors" for a discussion of risks and uncertainties related to our business that could adversely impact our operations and/or financial results. We do not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company or the Bank.
As used in this Form 10-K, unless we specify or the context indicates otherwise, "the Company," "we," "us," and "our" refer to Capitol Federal Financial, Inc. a Maryland corporation, and its subsidiaries. "Capitol Federal Savings," and "the Bank," refer to Capitol Federal Savings Bank, a federal savings bank and the wholly-owned subsidiary of Capitol Federal Financial, Inc.
Item 1. Business
The Company is a Maryland corporation that was incorporated in 2010 to be the successor corporation upon completion of the second step mutual-to-stock conversion of Capitol Federal Savings Bank MHC in December 2010. The Company's common stock is traded on the Global Select tier of the NASDAQ Stock Market under the symbol "CFFN."
The Bank is a wholly-owned subsidiary of the Company and is a federally chartered and insured savings bank headquartered in Topeka, Kansas. The Bank is examined and regulated by the Office of the Comptroller of the Currency (the "OCC"), its primary regulator, and its deposits are insured up to applicable limits by the Deposit Insurance Fund ("DIF"), which is administered by the Federal Deposit Insurance Corporation ("FDIC"). The Company, as a savings and loan holding company, is examined and regulated by the FRB.
In August 2018, the Company completed the acquisition of CCB and its wholly-owned subsidiary Capital City Bank, a commercial bank with $450 million in assets that was headquartered in Topeka, Kansas. During April 2019, the Bank completed the integration of the operations of Capital City Bank into the Bank's operations. The acquisition of Capital City Bank has allowed us to advance our commercial banking strategy while staying under $10 billion in assets, and allowed us to offer trust and brokerage services. The Bank competes for commercial banking business through a wide variety of commercial deposit and expanded lending products.
We have been, and intend to continue to be, a community-oriented financial institution offering a variety of financial services to meet the needs of the communities we serve. We attract deposits primarily from the general public and from businesses, and invest those funds primarily in permanent loans secured by first mortgages on owner-occupied, one- to four-family residences. We also originate and participate with other lenders in commercial loans, originate consumer loans primarily secured by mortgages on one- to four-family residences, and invest in certain investment securities and mortgage-backed securities ("MBS") using funding from deposits, repurchase agreements, and Federal Home Loan Bank Topeka ("FHLB") borrowings. We offer a variety of deposit accounts having a wide range of interest rates and terms, which generally include savings accounts, money market accounts, interest-bearing and non-interest-bearing checking accounts, and certificates of deposit with terms ranging from 91 days to 120 months.
The Company's results of operations are primarily dependent on net interest income, which is the difference between the interest earned on loans, securities, and cash, and the interest paid on deposits and borrowings. On a weekly basis, management reviews deposit flows, loan demand, cash levels, and changes in several market rates to assess all pricing
strategies. The Bank's pricing strategy for first mortgage loan products includes setting interest rates based on secondary market prices and competitor pricing for our local lending markets, and secondary market prices and competitor pricing for our correspondent lending markets. Pricing for commercial loans is generally based on competitor pricing and the credit risk of the borrower with consideration given to the overall relationship of the borrower. Generally, deposit pricing is based upon a survey of competitors in the Bank's market areas, and the need to attract funding and retain maturing deposits. The majority of our loans are fixed-rate products with maturities up to 30 years, while the majority of our retail deposits are either non-maturity deposits or have stated maturities of less than two years.
The Company is significantly affected by prevailing economic conditions, including federal monetary and fiscal policies and federal regulation of financial institutions. Deposit balances are influenced by a number of factors, including interest rates paid on competing investment products, the level of personal income, and the personal rate of savings within our market areas. Lending activities are influenced by the demand for housing and business activity levels, our loan underwriting guidelines compared to those of our competitors, as well as interest rate pricing competition from other lending institutions.
Local economic conditions have a significant impact on the ability of borrowers to repay loans and the value of the collateral securing these loans. The industries in the Bank's local market areas, which are listed below under "Market Area and Competition" and where the properties securing approximately 69% of the Bank's one- to four-family loans are located, are diversified. This is especially true in the Kansas City metropolitan statistical area, which comprises the largest segment of our one- to four-family loan portfolio and deposit base. Management also monitors broad industry and economic indicators and trends in the states and/or metropolitan statistical areas with the highest concentrations of correspondent one- to four-family purchased loans and commercial loans. The Kansas City market area has an average household income of approximately $97 thousand per annum, based on 2020 estimates from Claritas Pop-Facts Premier. The average household income in our combined local market areas is approximately $95 thousand per annum, with 93% of the population at or above the poverty level, based on 2020 estimates from Claritas Pop-Facts Premier.
In addition to our local market areas, the properties securing approximately 33% of the Bank's correspondent purchased one- to four-family loans are located in the state of Texas. The average household income in the Texas region where the majority of our correspondent one- to four-family loans are located is approximately $104 thousand per annum, with 90% of the population at or above the poverty level, based on 2020 estimates from Claritas Pop-Facts Premier. As of October 2020, the unemployment rate was 5.3% for Kansas, 4.6% for Missouri, and 6.9% for Texas, compared to the national average of 6.9%, based on information from the Bureau of Labor Statistics.
Our executive offices are located at 700 South Kansas Avenue, Topeka, Kansas 66603, and our telephone number at that address is (785) 235-1341.
Our website address is www.capfed.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports can be obtained free of charge from our website. These reports are available on our website as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. These reports are also available on the SEC's website at http://www.sec.gov.
Market Area and Competition
Our corporate office is located in Topeka, Kansas. We currently have a network of 54 branches (45 traditional branches and 9 in-store branches) located in nine counties throughout Kansas and three counties in Missouri. We primarily serve the metropolitan areas of Topeka, Wichita, Lawrence, Manhattan, Emporia, and Salina, Kansas and a portion of the metropolitan area of greater Kansas City. In addition to our full service banking offices, we provide services through our call center, which operates on extended hours, mobile banking, telephone banking, and online banking and bill payment services.
The Bank ranked first in deposit market share, at 6.90%, in the state of Kansas as reported in the June 30, 2020 FDIC "Summary of Deposits - Market Share Report." Management considers our well-established banking network together with our reputation for financial strength and customer service to be major factors in our success at attracting and retaining customers in our market areas.
The Bank consistently has been one of the top one- to four-family lenders with regard to mortgage loan origination volume in the state of Kansas. Through our strong relationships with real estate agents and marketing efforts, which reflect our reputation, and pricing, we attract mortgage loan business from walk-in customers, customers that apply online, and existing customers. Competition in originating one- to four-family loans primarily comes from other savings institutions, commercial banks, credit unions, and mortgage bankers.
Lending Practices and Underwriting Standards
General. Originating and purchasing loans secured by one- to four-family residential properties is the Bank's primary lending business, resulting in a loan concentration in residential first mortgage loans secured by properties located in Kansas and Missouri. The Bank also originates and participates in commercial loans, and originates consumer loans and construction loans.
One- to Four-Family Residential Real Estate Lending. The Bank originates and services one- to four-family loans that are not guaranteed or insured by the federal government, and purchases one- to four-family loans, on a loan-by-loan basis, from a select group of correspondent lenders.
While the Bank originates both fixed- and adjustable-rate loans, our origination volume is dependent upon customer demand for loans in our market areas. Demand is affected by the local housing market, competition, and the interest rate environment. During fiscal years 2020 and 2019, the Bank originated and refinanced $931.3 million and $581.1 million of one- to four-family loans, respectively.
Correspondent Purchased Loans
The Bank purchases one- to four-family loans, on a loan-by-loan basis, from a select group of correspondent lenders. Loan purchases enable the Bank to attain geographic diversification in the loan portfolio. At September 30, 2020, the Bank had correspondent lending relationships in 28 states and the District of Columbia. During fiscal years 2020 and 2019, the Bank purchased $448.0 million and $166.4 million, respectively, of one- to four-family loans from correspondent lenders. We generally pay a premium of 0.50% to 1.0% of the loan balance to purchase these loans, and we pay 1.0% of the loan balance to purchase the servicing of these loans. The premium paid is amortized against the interest earned over the life of the loan, which reduces the loan yield. If a loan pays off before the scheduled maturity date, the remaining premium is recognized as reduction in interest income.
The Bank has an agreement with a third-party mortgage sub-servicer to service loans originated by the Bank's correspondent lenders in certain states. The sub-servicer has experience servicing loans in the market areas in which the Bank purchases loans and services the loans according to the Bank's servicing standards, which is intended to allow the Bank greater control over servicing and reporting and help maintain a standard of loan performance.
Bulk Purchased Loans
In the past, the Bank has also purchased one- to four-family loans from correspondent and nationwide lenders in bulk loan packages. See "Part I, Item 1A. Risk Factors" for additional information regarding why the Bank no longer purchases bulk loan packages. At September 30, 2020, $158.2 million, or 76% of the Bank's bulk purchased loan portfolio, are loans guaranteed by one seller. Based on the historical performance of these loans and the seller, the Bank believes the seller has the financial ability to repurchase or replace loans if any were to become delinquent. The Bank has not experienced any losses with this group of loans since the loan package was purchased in August 2012.
The servicing rights associated with bulk purchased loans were generally retained by the lender/seller for the loans purchased from nationwide lenders. The servicing by nationwide lenders is governed by a servicing agreement, which outlines collection policies and procedures, as well as oversight requirements, such as servicer certifications attesting to and providing proof of compliance with the servicing agreement.
Full documentation to support an applicant's credit and income, and sufficient funds to cover all applicable fees and reserves at closing, are required on all loans. Generally, loans are underwritten according to the "ability to repay" and "qualified mortgage" standards, as issued by the Consumer Financial Protection Bureau ("CFPB"). Information pertaining to the creditworthiness of the borrower generally consists of a summary of the borrower's credit history, employment stability, sources of income, assets, net worth, and debt ratios. The value of the subject property must be supported by an appraisal
report prepared in accordance with our appraisal policy by either a staff appraiser or a fee appraiser, both of which are independent of the loan origination function.
The underwriting standards for loans purchased from correspondent and nationwide lenders are generally similar to the Bank's internal underwriting standards. The underwriting of correspondent loans is performed by the Bank's underwriters. Our standard contractual agreement with the lender/seller includes recourse options for any breach of representation or warranty with respect to the loans purchased. The Bank requested the repurchase of one loan from a lender for breach of representation during fiscal year 2020.
Adjustable-rate Mortgage ("ARM") Loans
ARM loans are offered with a three-year, five-year, or seven-year term to the initial repricing date. After the initial period, the interest rate for each ARM loan adjusts annually for the remainder of the term of the loan. Currently, the repricing index for loan originations and correspondent purchases is tied to the one-year Constant Maturity Treasury ("CMT") index; however, other indices have been used in the past, including LIBOR. See "Part I, Item 1A. Risk Factors - Risks Related to Lending Activities" for information regarding the upcoming discontinuation of LIBOR. Current adjustable-rate one- to four-family loans originated by the Bank generally provide for a specified rate limit or cap on the periodic adjustment to the interest rate, as well as a specified maximum lifetime cap and minimum rate, or floor. As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as our cost of funds. Negative amortization of principal is not allowed. For three- and five-year ARM loans, borrowers are qualified based on the principal, interest, tax, and insurance payments at the initial interest rate plus the life of loan cap and the initial interest rate plus the first period cap, respectively. For seven-year ARM loans, borrowers are qualified based on the principal, interest, tax, and insurance payments at the initial rate. After the initial three-, five-, or seven-year period, the interest rate resets annually and the new principal and interest payment is based on the new interest rate, remaining unpaid principal balance, and remaining term of the ARM loan. Our ARM loans are not automatically convertible into fixed-rate loans; however, we do allow borrowers to pay an endorsement fee to convert an ARM loan into a fixed-rate loan. ARM loans can pose greater credit risks than fixed-rate loans, primarily because if interest rates rise, the borrower's payment also rises, increasing the potential for default. This specific type of risk is known as repricing risk.
Our pricing strategy for one- to four-family loan products includes setting interest rates based on secondary market prices and local competitor pricing for our local lending markets, and secondary market prices and national competitor pricing for our correspondent markets.
For a one- to four-family loan with a loan-to-value ("LTV") ratio in excess of 80% at the time of origination, private mortgage insurance ("PMI") is required in order to reduce the Bank's loss exposure. The Bank will lend up to 97% of the lesser of the appraised value or purchase price for one- to four-family loans, provided PMI is obtained. Management continuously monitors the claim-paying ability of our PMI counterparties. We believe our PMI counterparties have the ability to meet potential claim obligations we may file in the foreseeable future.
The Bank's one- to four-family loans are primarily fully amortizing fixed-rate or ARM loans. The contractual maturities for fixed-rate loans and ARM loans can be up to 30 years; however, there are certain bulk purchased ARM loans that had original contractual maturities of 40 years. Our one- to four-family loans are generally not assumable and do not contain prepayment penalties. A "due on sale" clause, allowing the Bank to declare the unpaid principal balance due and payable upon the sale of the secured property, is generally included in the security instrument.
The Bank originates owner-occupied construction-to-permanent loans secured by one- to four-family residential real estate. The majority of these loans are secured by property located within the Bank's Kansas City market area. At September 30, 2020, we had $34.6 million in one- to four-family construction loans outstanding, representing 0.5% of our total loan portfolio.
The application process for a construction loan includes submission of complete plans, specifications, and costs of the project to be constructed. Construction draw requests and the supporting documentation are reviewed and approved by authorized management or experienced construction loan personnel. The Bank also performs regular documented inspections of the construction project to ensure the funds are being used for the intended purpose. Interest is not capitalized during the construction period; it is billed and collected monthly based on the amount of funds disbursed.
The Bank's owner-occupied construction-to-permanent loan program combines the construction loan and the permanent loan into one loan, allowing the borrower to secure the same interest rate structure throughout the construction period and the permanent loan term. Once the construction period is complete, the payment method is changed from interest-only to an amortized principal and interest payment for the remaining term of the loan.
Loan Endorsement Program
In an effort to offset the impact of repayments and to retain our customers, existing loan customers, including customers whose loans were purchased from a correspondent lender, have the opportunity, for a fee, to endorse their original loan terms to current loan terms being offered. Customers whose loans have been sold to third parties, have been delinquent on their contractual loan payments during the previous 12 months, have an active charge-off, or are currently in bankruptcy, are not eligible to participate in this program. The Bank does not solicit customers for this program, but considers it a valuable opportunity to retain customers who, based on our initial underwriting criteria, could likely obtain similar financing elsewhere. During fiscal years 2020 and 2019, the Bank endorsed $695.4 million and $121.5 million of one- to four-family loans, respectively.
One- to four-family loans may be sold on a bulk basis or on a flow basis as loans are originated. Loans originated by the Bank and purchased from correspondent lenders are generally eligible for sale in the secondary market. Loans are generally sold for portfolio restructuring purposes, to reduce interest rate risk and/or to maintain a certain liquidity position. The Bank generally retains the servicing on these loans. The Bank's Asset and Liability Management Committee ("ALCO") determines the criteria upon which one- to four-family loans are to be classified as held-for-sale or held-for-investment. One- to four-family loans classified as held-for-sale are to be sold in accordance with policies set forth by ALCO. During fiscal years 2020 and 2019, the Bank did not sell any loans.
Consumer Lending. The Bank offers a variety of secured consumer loans, including home equity loans and lines of credit, home improvement loans, vehicle loans, and loans secured by savings deposits. The Bank also originates a very limited amount of unsecured loans. Generally, consumer loans are originated in the Bank's market areas. The majority of our consumer loan portfolio is comprised of home equity lines of credit which have adjustable interest rates. For a majority of the home equity lines of credit, the Bank has the first mortgage or the Bank is in the first lien position. At September 30, 2020, our consumer loan portfolio totaled $113.9 million, or approximately 2% of our total loan portfolio.
The underwriting standards for consumer loans include a determination of the applicant's payment history on other debts and an assessment of the applicant's ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is a primary consideration, the underwriting process also includes a comparison of the value of the security in relation to the proposed loan amount. For consumer loans secured by one- to four-family property, an appraisal is required if the loan is over a certain dollar threshold; otherwise, a property inspection along with county tax assessment valuations and other supporting documentation is required.
Consumer loans generally have shorter terms-to-maturity or reprice more frequently, usually without periodic caps, which reduces our exposure to credit risk and changes in interest rates, and usually carry higher rates of interest than do one- to four-family loans. Management believes that offering consumer loan products helps to expand and create stronger ties to our existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities.
Commercial Lending. At September 30, 2020, the Bank's commercial loans totaled $829.7 million, or approximately 12% of our total loan portfolio. Of this amount, $372.5 million were participation loans. Total undisbursed loan amounts related to commercial loans were $154.2 million, resulting in a total commercial loan concentration of $983.9 million at September 30, 2020.
At September 30, 2020, the Bank's commercial real estate loan portfolio totaled $732.0 million or approximately 88% of our commercial loan portfolio. Our commercial real estate loans include a variety of property types, including hotels, office and retail buildings, senior housing facilities, and multi-family dwellings located in Kansas, Missouri, and 13 other states. Our largest commercial lending relationship was $68.0 million at September 30, 2020, all of which was disbursed, including $64.9 million in commercial real estate loans and $3.1 million in commercial and industrial loans. These loans were current according to their terms at September 30, 2020.
At September 30, 2020, the Bank's commercial and industrial loan portfolio totaled $97.6 million, or approximately 12% of our commercial loan portfolio. Included in this amount was $43.9 million of Small Business Administration ("SBA") Paycheck Protection Program ("PPP") loans. Excluding PPP loans, the Bank's commercial and industrial loan portfolio consists largely of loans secured by accounts receivable, inventory and equipment.
The Bank performs more extensive due diligence in underwriting commercial loans than loans secured by one- to four-family residential properties due to the larger loan amounts, the more complex sources of repayment and the riskier nature of such loans. When participating in a commercial loan, the Bank performs the same underwriting procedures as if the loan was being originated by the Bank.
When underwriting a commercial real estate loan, several factors are considered, such as the income producing potential of the property to support the debt service, cash equity provided by the borrower, the financial strength of the borrower, tenant and/or guarantor(s), managerial expertise of the borrower or tenant, feasibility studies from the borrower or an independent third party, the marketability of the property and our lending experience with the borrower. For non-owner occupied properties, the Bank has a pre-lease requirement, depending on the property type, and overall strength of the credit.
For non-construction properties, the historical net operating income, which is the income derived from the operation of the property less all operating expenses, generally must be at least 1.15 times the required payments related to the outstanding debt (debt service coverage ratio) at the time of origination. For construction projects, the minimum debt service coverage ratio of 1.15 applies to the projected cash flows, and the borrower must have successful experience with the construction and operation of properties similar to the subject property. As part of the underwriting process, the historical or projected cash flows are stressed under various scenarios to measure the viability of the project under adverse conditions.
Generally, our maximum LTV ratios conform to supervisory limits, including 65% for raw land, 75% for land development and 85% for commercial real estate loans. The Bank requires full independent appraisals for commercial real estate properties. The Bank generally requires at least 15% cash equity from the borrower for land acquisition, land development and commercial real estate construction loans. For non-acquisition, development or construction loans, the equity may be from a combination of cash and the appraised value of the secured property.
Our commercial and industrial loans are primarily made in the Bank's market areas and are underwritten on the basis of the borrower's ability to service the debt from income. Other sources of repayment include the collateral underlying the loans and guarantees from business owners. Working capital loans are primarily collateralized by short-term assets whereas term loans are primarily collateralized by long-term assets.
In general, commercial and industrial loans involve more credit risk than commercial real estate loans. The increased risk in commercial and industrial loans is due to the type of collateral securing these loans as well as the expectation that commercial and industrial loans generally will be serviced principally from the operations of the business, and those operations may not be successful. Significant adverse changes in borrowers' industries and businesses could cause a rapid decline in the values of, and collectability associated with, business assets securing the loans, which could result in inadequate collateral coverage of our commercial and industrial loans. Additionally, commercial and industrial loans secured by accounts receivable may be substantially dependent on the ability of the borrower to collect amounts due from clients and loans secured by inventory and equipment are subject to depreciation over time and may be difficult to appraise. As a result of these additional complexities, variables and risks, commercial and industrial loans require more thorough underwriting and servicing than other types of commercial loans.
Commercial loans generally have amortization terms of 15 to 30 years and maturities ranging from 90 days to 20 years, which generally requires balloon payments of the remaining principal balance.
Commercial loans have either fixed or adjustable interest rates based on prevailing market rates. The interest rate on adjustable-rate loans is based on a variety of indices, but is generally determined through negotiation with the borrower or determined by the lead bank in the case of a loan participation.
For a construction loan, generally, the Bank allows interest-only payments during the construction phase of a project and for a stabilization period of 6 to 24 months after occupancy. The Bank requires amortizing payments at the conclusion of the stabilization period.
Additionally, the Bank may include covenants in the loan agreement that allow the Bank to take action when deterioration in the financial strength of the project is detected to potentially prevent the credit from becoming impaired. The covenants are specific to each loan agreement, based on factors such as the purpose of funds, the collateral type, and the financial strength of the project, the borrower and the guarantor, among other factors.
Monitoring of Risk
For the Bank's commercial real estate loan portfolio, borrowers are generally required to provide financial information annually, including borrower financial statements, subject property rental rates and income, maintenance costs, an update of real estate property tax and insurance payments, and personal financial information for the guarantor(s). The annual review process for loans with a principal balance of $1.5 million or more or borrowing relationships with a total exposure of $5 million or more allows the Bank to monitor compliance with loan covenants and review the borrower's performance, including cash flows from operations, debt service coverage, and comparison of performance to projections and year-over-year performance trending. Additionally, the Bank monitors and performs site visits, or in the case of participation loans, obtains updates from the lead bank as needed to determine the condition of the collateral securing the loan. Depending on the financial strength of the project and/or the complexity of the borrower's financials, the Bank may also perform a global analysis of cash flows to account for all other properties owned by the borrower or guarantor. If signs of weakness are identified, the Bank may begin performing more frequent financial and/or collateral reviews or will initiate contact with the borrower, or the lead bank will contact the borrower if the loan is a participation loan, to ensure cash flows from operations are maintained at a satisfactory level to meet the debt requirements. Both macro-level and loan-level stress-test scenarios based on existing and forecasted market conditions are part of the on-going portfolio management process for the commercial real estate portfolio.
Commercial real estate construction lending generally involves a greater degree of risk than commercial real estate lending. Repayment of a construction loan is, to a great degree, dependent upon the successful and timely completion of the construction of the subject property. Construction delays, slower than anticipated stabilization or the financial impairment of the builder may negatively affect the borrower's ability to repay the loan. The Bank takes these risks into consideration during the underwriting process including the requirement of personal guarantees. The Bank mitigates the risk of commercial real estate construction lending during the construction period by monitoring inspection reports from an independent third-party, project budget, percentage of completion, on-site inspections and percentage of advanced funds.
Commercial and industrial loans are monitored through a review of borrower performance as indicated by borrower financial statements, borrowing base reports, accounts receivable aging reports, and inventory aging reports. These reports are required to be provided by the borrowers monthly, quarterly, or annually depending on the nature of the borrowing relationship.
Our commercial loans are generally large dollar loans and involve a greater degree of credit risk than one- to four-family loans. Because payments on these loans are often dependent on the successful operation or management of the properties and/or businesses, repayment of such loans may be subject to adverse conditions in the economy, the borrower's line of business, and/or the real estate market. If the cash flows from the project or business operation are reduced, or if leases are not obtained or renewed, the borrower's ability to repay the loan may become impaired. The Bank regularly monitors the level of risk in the portfolio, including concentrations in such factors as geographic locations, collateral types, tenant brand name, borrowing relationships, and lending relationships in the case of participation loans, among other factors.
Loan Portfolio. The following table presents the composition of our loan portfolio as of the dates indicated.
|(Dollars in thousands)|
|One- to four-family:|
|Commercial real estate||626,588||8.7||583,617||7.9||426,243||5.7||183,030||2.6||110,768||1.6|
|Commercial and industrial||97,614||1.4||61,094||0.8||62,869||0.9||—||—||—||—|
|Total loans receivable||7,224,996||100.0||%||7,412,473||100.0||%||7,507,645||100.0||%||7,182,751||100.0||%||6,949,522||100.0||%|
|Discounts/unearned loan fees||29,190||31,058||33,933||24,962||24,933|
|Total loans receivable, net||$||7,202,851||$||7,416,747||$||7,514,485||$||7,195,071||$||6,958,024|
The following table presents the contractual maturity of our loan portfolio, along with associated weighted average yields, at September 30, 2020. Loans which have adjustable interest rates are shown as maturing in the period during which the contract is due. The table does not reflect the effects of possible prepayments or enforcement of due on sale clauses.
|One- to Four-Family||Commercial|
|(Dollars in thousands)|
Within one year(1)
|After one year:|
|Over one to two||2,855||4.23||106,369||3.05||384||3.75||412||5.08||971||5.50||110,991||3.11|
|Over two to three||10,262||3.85||49,650||4.56||—||—||402||5.37||2,220||4.92||62,534||4.46|
|Over three to five||46,938||3.89||75,892||4.82||—||—||1,346||5.43||3,912||3.99||128,088||4.46|
|Over five to ten||497,411||3.18||267,221||4.57||—||—||11,201||5.52||1,383||5.81||777,216||3.70|
|Over ten to fifteen||1,316,691||3.12||64,802||4.66||—||—||42,602||4.41||355||6.06||1,424,450||3.23|
|After fifteen years||4,371,425||3.57||42,858||4.76||—||—||45,745||4.59||84||5.67||4,460,112||3.59|
|Total due after one year||6,245,582||3.44||606,792||4.36||384||3.75||101,708||4.64||8,925||4.76||6,963,391||3.54|
|Discounts/unearned loan fees||29,190|
|Total loans receivable, net||$||7,202,851|
(1)Includes demand loans, loans having no stated maturity, and overdraft loans.
(2)Construction loans are presented based upon the estimated term to complete construction. See "One- to Four-Family Residential Real Estate Lending - Construction Lending" above for more information regarding our construction-to-permanent loan program.
(3)For home equity loans, including those that do not have a stated maturity date, the maturity date calculated assumes the borrower always makes the required minimum payment. The majority of home equity loans assume a maximum term of 240 months.
The following table presents, as of September 30, 2020, the amount of loans due after September 30, 2021, and whether these loans have fixed or adjustable interest rates.
|(Dollars in thousands)|
|One- to four-family||$||5,416,534||$||829,048||$||6,245,582|
The Bank's traditional one- to four-family underwriting guidelines have provided the Bank with generally low delinquencies and low levels of non-performing assets within this loan category compared to national levels. Of particular importance is the complete and full documentation required for each loan the Bank originates, participates in or purchases. This allows the Bank to make an informed credit decision based upon a thorough assessment of the borrower's ability to repay the loan.
For one- to four-family loans and consumer loans, when a borrower fails to make a loan payment within 15 days after the due date, a late charge is assessed and a notice is mailed. Collection personnel review all delinquent loan accounts more than 16 days past due. Attempts to contact the borrower occur, with the purpose of establishing repayment arrangements. For residential mortgage loans serviced by the Bank, beginning at approximately the 31st day of delinquency, and again at approximately the 50th day of delinquency, information notices are mailed to borrowers to inform them of the availability of payment assistance programs. Once a loan becomes 90 days delinquent, assuming a loss mitigation solution is not actively in process, a demand letter is issued requiring the loan be brought current or foreclosure procedures will be implemented. Generally, when a loan becomes 120 days delinquent, and an acceptable repayment plan or loss mitigation solution has neither been established nor is in the process of being negotiated, the loan is forwarded to legal counsel to initiate foreclosure. We also monitor whether borrowers who have filed for bankruptcy are meeting their obligation to pay the mortgage debt in accordance with the terms of the bankruptcy petition.
For purchased one- to four-family loans serviced by a third party, we monitor delinquencies using data received from the servicers. The reports generally provide total principal and interest due and length of delinquency, and are used to prepare monthly management reports and perform delinquent loan trend analysis. The information from the sub-servicer of our correspondent one- to four-family loans is generally received during the first week of the month while the information from the servicers of our one- to-four family bulk loans is received later in the month. Management also utilizes information from the servicers to monitor property valuations and identify the need to charge-off loan balances.
For commercial loans originated by the Bank, when a loan becomes past due, the Bank begins collection efforts, initially by notifying the borrower of the past due payment and attempting to determine if there have been changes in the borrower's financial condition that may affect future loan performance. If it is determined that future loan performance may be adversely affected, the Bank initiates discussions with the borrower regarding plans to ensure cash flow from operations is sufficient to satisfy the debt requirements and meet the loan covenants. Generally, once a loan becomes 90 days delinquent, foreclosure or collection procedures are initiated. For participation loans, the lead bank is responsible for all collection efforts and contact with the borrower. However, if the Bank does not receive an expected payment on a participation loan, the Bank contacts the lead bank to determine the cause of the late payment and to initiate discussions with the lead bank of collection efforts, as necessary. See "Lending Practices and Underwriting Standards – Commercial Lending – Monitoring of Risk" for additional information.
In late March 2020, the Bank suspended the initiation of foreclosure proceedings for one- to four-family loans through the end of calendar year 2020. Additionally, the Bank announced loan modification programs to support and provide relief for its borrowers during the COVID-19 pandemic. Generally, loan modifications under these programs ("COVID-19 loan modifications") for one- to four-family loans and consumer loans consist of a three-month payment forbearance of principal, interest and, in some cases, escrow. COVID-19 loan modifications of commercial loans mainly consist of a six-month interest-only payment period. See "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Loans Receivable" for additional discussion regarding COVID-19 loan modifications.
Delinquent and non-performing loans and other real estate owned ("OREO")
The following table presents the Company's 30 to 89 day delinquent loans at the dates indicated. Loans subject to payment forbearance under the Bank's COVID-19 loan modification program are not reported as delinquent during the forbearance time period. The amounts in the table represent the unpaid principal balance of the loans less related charge-offs. Of the loans 30 to 89 days delinquent at September 30, 2020, 2019, and 2018, approximately 70%, 67%, and 74%, respectively, were 59 days or less delinquent.
|Loans Delinquent for 30 to 89 Days at September 30,|
|(Dollars in thousands)|
|One- to four-family:|
|Loans 30 to 89 days delinquent|
|to total loans receivable, net||0.13||%||0.20||%||0.25||%|
The table below presents the Company's non-performing loans and OREO at the dates indicated. The amounts in the table represent the unpaid principal balance of the loans less related charge-offs. Non-performing loans are loans that are 90 or more days delinquent or in foreclosure and other loans required to be reported as nonaccrual pursuant to accounting and/or regulatory reporting requirements and/or internal policies, even if the loans are current. At all dates presented, there were no loans 90 or more days delinquent that were still accruing interest. Non-performing assets include non-performing loans and OREO. OREO primarily includes assets acquired in settlement of loans. Over the past 12 months, one- to four-family OREO properties acquired in settlement of one- to four-family loans were owned by the Bank, on average, for approximately four months before the properties were sold.
|(Dollars in thousands)|
|Loans 90 or More Days Delinquent or in Foreclosure:|
|One- to four-family:|
|Loans 90 or more days delinquent or in foreclosure|
|as a percentage of total loans||0.16||%||0.08||%||0.12||%||0.13||%||0.24||%|
Nonaccrual loans less than 90 Days Delinquent:(1)
|One- to four-family:|
|Total non-performing loans||101||12,490||103||7,563||132||10,990||172||16,603||227||29,128|
|Non-performing loans as a percentage of total loans||0.17||%||0.10||%||0.15||%||0.23||%||0.42||%|
|(Dollars in thousands)|
|One- to four-family:|
|Total non-performing assets||105||$||12,673||112||$||8,908||142||$||12,887||182||$||18,007||245||$||32,862|
|Non-performing assets as a percentage of total assets||0.13||%||0.10||%||0.14||%||0.20||%||0.35||%|
(1)Includes loans required to be reported as nonaccrual pursuant to accounting and/or regulatory reporting requirements and/or internal policies, even if the loans are current. The decrease in the balance of these loans at September 30, 2017 compared to September 30, 2016 was due to fewer loans being classified as troubled debt restructurings ("TDRs") as a result of management refining its methodology for assessing whether a loan modification qualifies as a TDR.
(2)Real estate-related consumer loans where we also hold the first mortgage are included in the one- to four-family category as the underlying collateral is one- to four-family property.
The amount of interest income on nonaccrual loans and TDRs as of September 30, 2020 included in interest income was $1.0 million for the year ended September 30, 2020. The amount of additional interest income that would have been recorded on nonaccrual loans and TDRs as of September 30, 2020, if they had performed in accordance with their original terms, was $123 thousand for the year ended September 30, 2020.
The following table presents the states where the properties securing five percent or more of the total amount of our one- to four-family loans are located and the corresponding balance of loans 30 to 89 days delinquent, 90 or more days delinquent or in foreclosure, and weighted average LTV ratios for loans 90 or more days delinquent or in foreclosure at September 30, 2020. The LTV ratios were based on the current loan balance and either the lesser of the purchase price or original appraisal, or the most recent Bank appraisal, if available. At September 30, 2020, potential losses, after taking into consideration anticipated PMI proceeds and estimated selling costs, have been charged-off.
|Loans 30 to 89||Loans 90 or More Days Delinquent|
|One- to Four-Family||Days Delinquent||or in Foreclosure|
|State||Amount||% of Total||Amount||% of Total||Amount||% of Total||LTV|
|(Dollars in thousands)|
Classified Assets. In accordance with the Bank's asset classification policy, management regularly reviews the problem assets in the Bank's portfolio to determine whether any assets require classification. See "Part II, Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 5. Loans Receivable and Allowance for Credit Losses" for asset classification definitions.
The following table sets forth the recorded investment in assets, classified as either special mention or substandard, as of September 30, 2020. At September 30, 2020, there were no loans classified as doubtful, and all loans classified as loss were fully charged-off.
|(Dollars in thousands)|
|One- to four-family:|
|Commercial real estate||5||50,957||9||3,541|
|Commercial and industrial||7||1,040||3||1,368|
|One- to four-family:|
|Total classified assets||114||$||63,653||289||$||31,241|
Troubled Debt Restructurings. For borrowers experiencing financial difficulties, the Bank may grant a concession to the borrower, resulting in a TDR. Such concessions generally involve extensions of loan maturity dates, the granting of periods during which reduced payment amounts are required, reductions in interest rates, and/or loans that have been discharged under Chapter 7 bankruptcy proceedings where the borrower has not reaffirmed the debt. The Bank does not forgive principal or interest, nor does it commit to lend additional funds, except for situations generally involving the capitalization of delinquent interest and/or escrow on one- to four-family and consumer loans, not to exceed the original loan balance, to these borrowers. For commercial loans, the Bank does not forgive principal or interest or commit to lend additional funds unless the borrower provides additional collateral or other enhancements to improve credit quality. See "Part II, Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 1. Summary of Significant Accounting Policies and Note 5. Loans Receivable and Allowance for Credit Losses" for additional information related to TDRs.
As previously noted, in late March 2020, the Bank announced COVID-19 loan modification programs to support and provide relief for its borrowers during the COVID-19 pandemic. The Company has followed the Coronavirus Aid, Relief, and Economic Security ("CARES") Act and interagency guidance from the federal banking agencies when determining if a borrower's modification is subject to TDR classification.
The following table presents the Company's TDRs, based on accrual status, at the dates indicated.
|(Dollars in thousands)|
(1)Nonaccrual TDRs are included in the non-performing loan table above and are classified as substandard.
Impaired Loans. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due, including principal and interest, according to the original contractual terms of the loan agreement. Interest income on impaired loans is recognized in the period collected unless the ultimate collection of principal is considered doubtful. The unpaid principal balance of loans reported as impaired at September 30, 2020, 2019, and 2018 was $23.1 million, $23.4 million, and $29.9 million, respectively. Included in the impaired loan balance at September 30, 2020 were $22.9 million of loans classified as either special mention or substandard.
See "Part II, Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 1. Summary of Significant Accounting Policies and Note 5. Loans Receivable and Allowance for Credit Losses" for additional information related to impaired loans.
Allowance for credit losses and provision for credit losses. Management maintains an ACL to absorb inherent losses in the loan portfolio based on quarterly assessments of the loan portfolio. The ACL is maintained through provisions for credit losses which are either charged to or credited to income. See "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies – Allowance for Credit Losses" and "Part II, Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 1. Summary of Significant Accounting Policies" for a full discussion of our ACL methodology. See "Part II, Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 5. Loans Receivable and Allowance for Credit Losses" for additional information on the ACL.
Each quarter a formula analysis model is prepared which segregates the loan portfolio into categories based on certain risk characteristics. Historical loss and qualitative factors are applied to each loan category in the formula analysis model. The factors are reviewed by management quarterly to assess whether they adequately cover probable and estimable losses inherent in the loan portfolio.
During the current fiscal year, management increased the historical loss and qualitative factors applied in the formula analysis model for all loan categories and added a COVID-19 qualitative factor to the Bank's commercial loan portfolio. The increase in the factors and addition of the new qualitative factor was in response to the deterioration of economic conditions due to the COVID-19 pandemic. When determining the appropriate historical loss and qualitative factors to apply in the formula analysis model, management considered such items as: national and state unemployment and unemployment benefit claim information, amount and timing of governmental financial assistance, the Bank's COVID-19 loan modification programs, consumer spending information, industries most impacted by the COVID-19 pandemic, and a loan analysis completed by the commercial lending team.
As of September 30, 2020, unemployment benefit claims continued to be at high levels, but not as high as the late March 2020/early April 2020 timeframe. Individuals that were unemployed benefited from the Federal Pandemic Unemployment Compensation Program ("FPUC") which the CARES Act created. FPUC provided an additional $600 per week to individuals collecting regular unemployment compensation. The FPUC expired in late July 2020. There were other unemployment compensation benefits created under the CARES Act which benefited individuals that exhausted their regular unemployment insurance benefits and that are generally not eligible for regular unemployment compensation, like self-employed individuals. In early August 2020, President Trump signed an executive memorandum authorizing the Federal Emergency Management Agency to provide $300 per week in extra unemployment benefits for six weeks, which started on August 1, 2020. The majority of the financial assistance provided by the federal government, which may be masking the Bank's actual credit exposure, tapered off significantly by September 30, 2020. In late March 2020, the Bank began offering
a COVID-19 loan modification program for one- to four-family and consumer loans. While the intention of the COVID-19 loan modification program was to keep customers current on their payments and therefore in their homes during the worst of the economic downturn, the program could also be masking the Bank's actual credit exposure on these loans. See "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition" for additional information regarding COVID-19 loan modifications.
Many of the stay-at-home orders issued in March and April 2020 were lifted by September 30, 2020, resulting in some people returning to work, but not at the same level as prior to March 2020. Several companies are still requiring their employees to work from home and limit business travel and several colleges and schools are electing remote and/or hybrid learning. The residents of senior housing facilities continue to be generally disproportionately impacted by the COVID-19 pandemic. Consumer spending has continued to gradually rebound, but generally not in the travel, lodging, and entertainment industries. The Bank's commercial lending team analyzed the Bank's largest commercial lending relationships through September 30, 2020. Approximately 91% of all commercial loans, excluding PPP loans, were evaluated. The commercial lending team primarily focused on the lending relationships considered most at risk of short-term operational cash flow issues and/or collateral concerns, which had an aggregate unpaid principal balance of $201.2 million at September 30, 2020, and was primarily in the following categories: senior housing facilities, hotels, retail buildings, office buildings and single use buildings. These loan categories were among the categories with the highest usage of the Bank's COVID-19 loan modification program. We believe the Bank's COVID-19 loan modification program has been very beneficial to the majority of the Bank's commercial borrowers that took advantage of the program; however, as is the case with one- to four-family loans, the modifications may be masking the Bank's actual credit exposure. The commercial lending team also considered the largest credits in the industries most impacted by the COVID-19 pandemic: senior housing, hotel, retail building, office building and single use buildings. The weighted average LTV ratios based on the aggregate unpaid principal balances of senior housing, hotel, retail building, office building, and single use building loans were 69%, 58%, 67%, 75%, and 69%, respectively, at September 30, 2020. In most cases, the most recent appraisal was obtained at the time of origination.
There was no significant deterioration in credit quality indicators, such as loan delinquencies, asset classification and credit scores, during the current fiscal year; however, as noted above, the financial assistance provided by the federal government and our COVID-19 loan modifications may be masking our actual credit exposure which could result in worsening credit quality indicators in the coming months. Loans 30 to 89 days delinquent were 0.13% of total loans at September 30, 2020 and 0.20% of total loans at September 30, 2019. Loans 90 days or more delinquent or in foreclosure were 0.16% of total loans at September 30, 2020 and 0.08% of total loans at September 30, 2019. Loans classified as special mention were $63.7 million at September 30, 2020 compared to $69.8 million at September 30, 2019. Loans classified as substandard were $31.1 million at September 30, 2020 compared to $30.1 million at September 30, 2019. The weighted average credit score for our one- to four-family loan portfolio was 768 at September 30, 2020 compared to 767 at September 30, 2019. We completed a credit score update from a nationally recognized consumer rating agency during September of 2020 and 2019.
The majority of the provision for credit losses recorded in the current fiscal year was to increase the ACL to account for the increase in the factors and the addition of the new qualitative factor in the formula analysis model as a result of management's assessment of the inherent losses in the loan portfolio due to the deterioration of economic conditions. Management will continue to closely monitor economic conditions and will work with borrowers as necessary to assist them through this challenging economic climate. If economic conditions worsen or do not improve in the near term, and if future government programs, if any, do not provide adequate relief to borrowers, it is possible the Bank's ACL will need to increase in future periods. Management seeks to apply the ACL methodology in a consistent manner; however, the methodology may be modified in response to changing conditions, such as was the case during the current fiscal year. Although management believes the ACL was at a level adequate to absorb inherent losses in the loan portfolio at September 30, 2020, the level of the ACL remains an estimate that is subject to significant judgment and short-term changes.
Accounting Standards Update ("ASU") 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments became effective for the Company on October 1, 2020. See "Part II, Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 1. Summary of Significant Accounting Policies" for additional information.
The following table presents ACL activity and related ratios at the dates and for the periods indicated.
|Year Ended September 30,|
|(Dollars in thousands)|
|Balance at beginning of period||$||9,226||$||8,463||$||8,398||$||8,540||$||9,443|
|One- to four-family:|
|Commercial real estate||(325)||—||—||—||—|
|Commercial and industrial||(24)||(124)||—||—||—|
|One- to four-family:|
|Commercial real estate||110||22||—||—||—|
|Commercial and industrial||—||2||—||—||—|
|Net recoveries (charge-offs)||1||13||65||(142)||(153)|
|Provision for credit losses||22,300||750||—||—||(750)|
|Balance at end of period||$||31,527||$||9,226||$||8,463||$||8,398||$||8,540|
|Ratio of net charge-offs during the period to|
|average loans outstanding during the period||—||%||—||%||—||%||—||%||—||%|
|Ratio of net (recoveries) charge-offs during the|
|period to average non-performing assets||(0.01)||(0.12)||(0.42)||0.56||0.48|
|ACL to non-performing loans at end of period||252.42||121.99||77.01||50.58||29.32|
|ACL to loans receivable, net at end of period||0.44||0.12||0.11||0.12||0.12|
|ACL to net charge-offs|
(1)This ratio is not presented for the time period noted due to loan recoveries exceeding loan charge-offs during the period.
The distribution of our ACL at the dates indicated is summarized below.
|% of||% of||% of||% of||% of|
|Amount||Loans to||Amount||Loans to||Amount||Loans to||Amount||Loans to||Amount||Loans to|
|of ACL||Total Loans||of ACL||Total Loans||of ACL||Total Loans||of ACL||Total Loans||of ACL||Total Loans|
|(Dollars in thousands)|
|One- to four-family:|
|Commercial real estate||16,869||8.6||3,448||7.9||1,801||5.7||1,242||2.6||774||1.6|
|Commercial and industrial||1,451||1.4||472||0.8||21||0.8||—||—||—||—|
|Total consumer loans||484||1.5||165||1.8||168||1.9||191||1.8||237||1.9|
The majority of the loans acquired in the CCB acquisition were not deemed purchased credit impaired ("PCI") as of the acquisition date ("non-PCI loans"). The net purchase discounts associated with non-PCI loans were compared to the amount of hypothetical ACL estimated for these loans at September 30, 2020, 2019, and 2018. See "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies – Allowance for Credit Losses" for additional information regarding management's estimation of the hypothetical ACL for non-PCI loans. As a result of this analysis, management determined the net purchase discounts were not sufficient, so ACL was recorded on those loans at September 30, 2020. At September 30, 2019 and 2018, the net purchase discounts were sufficient and no ACL was required on those loans.
The ratio of ACL to loans receivable, by loan type, at the dates indicated is summarized below. As discussed above, the ACL increased during the current fiscal year resulting in an overall increase in the ACL to loans receivable ratio at September 30, 2020 compared to the other dates presented in the table below. The bulk purchased loan ACL to loans receivable ratio decreased at September 30, 2020 compared to September 30, 2019 due to the portion of the loan portfolio guaranteed by a third party representing more of the overall portfolio balance. Included in the commercial and industrial loan category at September 30, 2020 are PPP loans. PPP loans are 100% guaranteed by the SBA so the Bank did not record ACL on those loans at September 30, 2020.
|At September 30,|
|One- to four-family:|
|Commercial real estate||2.69||0.59||0.42||0.68||0.70|
|Commercial and industrial||1.49||0.77||0.03||—||—|
Federally chartered savings institutions have the authority to invest in various types of liquid assets, including U.S. Treasury obligations; securities of various federal agencies; government-sponsored enterprises ("GSEs"), including callable agency securities; municipal bonds; certain certificates of deposit of insured banks and savings institutions; certain bankers' acceptances; repurchase agreements; and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in investment grade commercial paper, corporate debt securities, and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. As a member of FHLB, the Bank is required to maintain a specified investment in FHLB stock. See "Regulation and Supervision – Federal Home Loan Bank System" and "Office of the Comptroller of the Currency" for a discussion of additional restrictions on our investment activities.
ALCO considers various factors when making investment decisions, including the liquidity, credit, interest rate risk, and tax consequences of the proposed investment options. The composition of the investment portfolio will be affected by various market conditions, including the slope of the yield curve, the level of interest rates, the impact on the Bank's interest rate risk, the trend of net deposit flows, repayments of borrowings, loan originations and purchases, and commercial construction loan funding.
The general objectives of the Bank's investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low, and to maximize earnings while satisfactorily managing liquidity risk, interest rate risk, reinvestment risk, and credit risk. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Cash flow projections are reviewed regularly and updated to ensure that adequate liquidity is maintained.
We have the ability to classify securities as either trading, available-for-sale ("AFS"), or held-to-maturity ("HTM") at the date of purchase. Securities that are purchased and held principally for resale in the near future are classified as trading securities and are reported at fair value with unrealized gains and losses reported in the consolidated statements of income. AFS securities are reported at fair value with unrealized gains and losses reported as a component of accumulated other comprehensive income (loss) ("AOCI") within stockholders' equity, net of deferred income taxes. HTM securities are reported at cost, adjusted for amortization of premium and accretion of discount. Effective September 30, 2019, the
Company adopted ASU 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities and certain components of ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments that are applicable to ASU 2017-12. As part of the adoption, the Company reclassified its entire portfolio of HTM securities, totaling $444.7 million at amortized cost, to AFS securities.
On a quarterly basis, management reviews securities for the presence of an other-than-temporary impairment. The process involves monitoring market events and other items that could impact issuers. See "Part II, Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 1. Summary of Significant Accounting Policies" for additional information. Management does not believe any other-than-temporary impairments existed at September 30, 2020.
Investment Securities. Our investment securities portfolio consists primarily of debentures issued by GSEs (primarily Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC") and the Federal Home Loan Banks) and non-taxable municipal bonds. At September 30, 2020, our investment securities portfolio totaled $380.1 million. The portfolio consisted entirely of securities classified as AFS. See "Part II, Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 4. Securities" and "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Investment Securities" for additional information.
Mortgage-Backed Securities. At September 30, 2020, our MBS portfolio totaled $1.18 billion. The portfolio consisted entirely of securities classified as AFS and were primarily issued by GSEs. The principal and interest payments of MBS issued by GSEs are collateralized by the underlying mortgage assets with principal and interest payments guaranteed by the GSEs. The underlying mortgage assets are conforming mortgages that comply with FNMA and FHLMC underwriting guidelines, as applicable, and are therefore not considered subprime. See "Part II, Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 4. Securities" and "Management's Discussion and Analysis of Financial Condition and Results of Operations – Financial Condition – Mortgage-Backed Securities" for additional information.
MBS generally yield less than the loans that underlie such securities because of the servicing fee retained by the servicer and the cost of payment guarantees or credit enhancements retained by the GSEs that reduce credit risk. However, MBS are generally more liquid than individual mortgage loans and may be used to collateralize certain borrowings and public unit deposits of the Bank.
When securities are purchased for a price other than par value, the difference between the price paid and par is accreted to or amortized against the interest earned over the life of the security, depending on whether a discount or premium to par was paid. Movements in interest rates affect prepayment rates which, in turn, affect the average lives of MBS and the speed at which the discount or premium is accreted to or amortized against earnings.
At September 30, 2020, the MBS portfolio included $70.5 million of collateralized mortgage obligations ("CMOs"). CMOs are special types of MBS in which the stream of principal and interest payments on the underlying mortgages or MBS are used to create investment classes with different maturities and, in some cases, different amortization schedules, as well as a residual interest, with each such class possessing different risk characteristics. We do not purchase residual interest bonds.
While MBS issued by FNMA and FHLMC carry a reduced credit risk compared to whole mortgage loans, these securities remain subject to the risk that a fluctuating interest rate environment, along with other factors such as the geographic distribution of the underlying mortgage loans, may alter the prepayment rate of the underlying mortgage loans and consequently affect both the prepayment speed and value of the securities. As noted above, the Bank, on some transactions, pays a premium over par value on MBS purchased. Large premiums could cause significant negative yield adjustments due to accelerated prepayments on the underlying mortgages. The balance of net premiums on our portfolio of MBS at September 30, 2020 was $11.9 million.
The following table sets forth the composition of our investment and MBS portfolios as of the dates indicated. At September 30, 2020, our investment securities portfolio did not contain securities of any issuer with an aggregate book value in excess of 10% of our stockholders' equity, excluding those issued by GSEs.
|Carrying||% of||Fair||Carrying||% of||Fair||Carrying||% of||Fair|
|(Dollars in thousands)|
The composition and maturities of the investment and MBS portfolio at September 30, 2020 are indicated in the following table by remaining contractual maturity, without consideration of call features or pre-refunding dates, along with associated weighted average yields. Yields on tax-exempt investments are not calculated on a fully taxable equivalent basis.
|1 year or less||More than 1 to 5 years||More than 5 to 10 years||Over 10 years||Total Securities|
|(Dollars in thousands)|
Sources of Funds
General. Our primary sources of funds are deposits, FHLB borrowings, repurchase agreements, repayments and maturities of outstanding loans and MBS and other short-term investments, and funds provided by operations.
Deposits. We offer a variety of retail deposit accounts and commercial deposit accounts and services. Our deposit account offerings have a wide range of interest rates and terms. Our deposits consist of savings accounts, money market deposit accounts, interest-bearing and non-interest-bearing checking accounts, and certificates of deposit. We rely primarily upon competitive pricing policies, marketing, and customer service to attract and retain deposits. The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates, and competition. The variety of deposit accounts we offer has allowed us to utilize strategic pricing to obtain funds and to respond with flexibility to changes in consumer demand. We seek to manage the pricing of our deposits in keeping with our asset and liability management, liquidity, and profitability objectives. Based on our experience, we believe that our deposits are stable sources of funds. Despite this stability, our ability to attract and maintain these deposits and the rates paid on them has been, and will continue to be, significantly affected by market conditions.
The Board of Directors has authorized the utilization of brokers to obtain deposits as a source of funds. Depending on market conditions, the Bank may use brokered deposits to fund asset growth and gather deposits that may help to manage interest rate risk. No brokered deposits were acquired during fiscal year 2020 and there were no brokered deposits outstanding at September 30, 2020 or 2019.
The Board of Directors also has authorized the utilization of public unit certificates of deposit as a source of funds. In order to qualify to obtain such deposits, the Bank must have a branch in each county in which it collects public unit certificates of deposit and, by law, must pledge securities as collateral for all such balances in excess of the FDIC insurance limits. At September 30, 2020 and 2019, the balance of public unit certificates of deposit was $254.8 million and $294.9 million, respectively.
As of September 30, 2020, the Bank's policy allows for combined brokered and public unit certificates of deposit up to 15% of total deposits. At September 30, 2020, that amount was approximately 4% of total deposits.
Borrowings. We utilize borrowings when we need additional capacity to fund loan demand or when they help us meet our asset and liability management objectives. Historically, our term borrowings have consisted primarily of FHLB advances. FHLB advances may be made pursuant to several different credit programs, each of which has its own interest rate, maturity, repayment, and embedded options, if any. At September 30, 2020, $1.15 billion of our FHLB advances were fixed-rate advances with no embedded options and $640.0 million of our FHLB advances were variable-rate, also with no embedded options. The variable-rate advances are tied to interest rate swaps, effectively converting the adjustable-rate borrowings into fixed-rate liabilities. At times, the Bank supplements FHLB borrowings with repurchase agreements, wherein the Bank enters into agreements with Board-approved counterparties to sell securities under agreements to repurchase them. These agreements are recorded as financing transactions as the Bank maintains effective control over the transferred securities. Repurchase agreements are made at mutually agreed upon terms between counterparties and the Bank. The use of repurchase agreements allows for the diversification of funding sources and the use of securities that were not being leveraged as collateral. The Bank also regularly uses its FHLB line of credit as a source of funding. The Bank's internal policy limits total borrowings to 55% of total assets.
At September 30, 2020, we had $1.79 billion of FHLB advances, at par, outstanding and did not have a balance outstanding on the Bank's FHLB line of credit, for a total of 19% of Bank Call Report total assets as of September 30, 2020. Total FHLB borrowings are secured by certain qualifying loans pursuant to a blanket collateral agreement with FHLB. Per FHLB's lending guidelines, total FHLB borrowings cannot exceed 40% of Bank Call Report total assets without the pre-approval of FHLB senior management. The Bank's borrowing limit ranged from 50% to 55% of Bank Call Report total assets during fiscal year 2020, as approved by the president of FHLB. At September 30, 2020, the approved limit was 50%.
At September 30, 2020, the Bank did not have any repurchase agreements outstanding. The Bank may enter into repurchase agreements as management deems appropriate, not to exceed 15% of total assets and subject to the internal policy limit on total borrowings of 55%. The securities underlying the agreements continue to be reported in the Bank's securities portfolio.
The following table sets forth certain information relating to the category of borrowings for which the average short-term balance outstanding during the period was at least 30% of stockholders' equity at the end of each period shown. The maximum balance, average balance, and weighted average contractual interest rate during the fiscal years shown reflect borrowings that were scheduled to mature within one year at any month-end during those years.
|(Dollars in thousands)|
|Short-term FHLB borrowings:|
|Balance at end of period||$||843,000||$||1,090,000||$||975,000|
|Maximum balance outstanding at any month-end during the period||1,240,000||1,090,000||2,975,000|
|Weighted average contractual interest rate during the period||1.62||%||2.34||%||1.65||%|
|Weighted average contractual interest rate at end of period||0.76||2.15||2.00|
At September 30, 2020, the Company had one wholly-owned subsidiary, the Bank. The Bank provides a full range of retail banking services through 54 banking offices serving primarily the metropolitan areas of Topeka, Wichita, Lawrence, Manhattan, Emporia and Salina, Kansas and portions of the metropolitan area of greater Kansas City. At September 30, 2020, the Bank had two wholly-owned subsidiaries, Capitol Funds, Inc. and Capital City Investments, Inc. At September 30, 2020, Capitol Funds, Inc. had one wholly-owned subsidiary, Capitol Federal Mortgage Reinsurance Company ("CFMRC"), which historically served as a reinsurance company for certain PMI companies the Bank uses in its normal course of operations. CFMRC stopped writing new business for the Bank in January 2010. Capital City Investments, Inc. is a real estate and investment holding company. Each wholly-owned subsidiary is reported with the Company on a consolidated basis.
Regulation and Supervision
Set forth below is a description of certain laws and regulations that are applicable to Capitol Federal Financial, Inc. and the Bank. This description is intended as a brief summary of selected features of such laws and regulations and is qualified in its entirety by references to the laws and regulations applicable to the Company and the Bank.
General. The Bank, as a federally chartered savings bank, is subject to regulation and oversight by the OCC extending to all aspects of its operations. This regulation of the Bank is intended for the protection of depositors and other customers and not for the purpose of protecting the Company's stockholders. The Bank is required to maintain minimum levels of regulatory capital and is subject to some limitations on capital distributions to the Company. See "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Limitations on Dividends and Other Capital Distributions" for additional information regarding capital distributions and regulatory requirements. The Bank also is subject to regulation and examination by the FDIC, which insures the deposits of the Bank to the maximum extent permitted by law.
The Company is a unitary savings and loan holding company within the meaning of the Home Owners' Loan Act ("HOLA"). As such, the Company is registered with the FRB and subject to the FRB regulations, examinations, supervision, and reporting requirements. In addition, the FRB has enforcement authority over the Company. Among other things, this authority permits the FRB to restrict or prohibit activities that are determined to be a serious risk to the Bank.
The OCC and FRB enforcement authority includes, among other things, the ability to assess civil monetary penalties, to issue cease-and-desist or removal orders, and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed. Except under certain circumstances, public disclosure of final enforcement actions by the OCC or the FRB is required by law.
Office of the Comptroller of the Currency. The investment and lending authority of the Bank is prescribed by federal laws and regulations and the Bank is prohibited from engaging in any activities not permitted by such laws and regulations.
As a federally chartered savings bank, the Bank is required to meet a Qualified Thrift Lender ("QTL") test in order to avoid certain restrictions on its operations. This test requires the Bank to have at least 65% of its portfolio assets, as defined by statute, in qualified thrift investments at month-end for 9 out of every 12 months on a rolling basis. Under an alternative test, the Bank's business must consist primarily of acquiring the savings of the public and investing in loans, while maintaining 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code of 1986. Under either test, the Bank is required to maintain a significant portion of its assets in residential housing related loans and investments. An institution that fails to qualify as a QTL based upon one of these tests is immediately subject to certain restrictions on its operations, including a prohibition against capital distributions, except with the prior approval of both the OCC and the FRB, as necessary to meet the obligations of a company controlling the institution. If the Bank fails the QTL test and does not regain QTL status within one year, or fails the test for a second time, the Company must immediately register as, and become subject to, the restrictions applicable to a bank holding company. The activities authorized for a bank holding company are more limited than are the activities authorized for a savings and loan holding company. Three years after failing the test, an institution must divest all investments and cease all activities not permissible for both a national bank and a savings association. Failure to meet the QTL test is a statutory violation subject to enforcement action. As of September 30, 2020, the Bank met the QTL test.
The Bank is subject to a 35% of total assets limit on non-real estate consumer loans, commercial paper and corporate debt securities, and a 20% limit on commercial non-mortgage loans. At September 30, 2020, the Bank was in compliance with these limits.
The Bank's relationship with its depositors and borrowers is regulated to a great extent by federal laws and regulations, especially in such matters as the ownership of savings accounts and the form and content of mortgage requirements. In addition, the branching authority of the Bank is regulated by the OCC. The Bank is generally authorized to branch nationwide.
The Bank is subject to a statutory lending limit on aggregate loans to one person or a group of persons combined because of certain common interests. The general limit is equal to 15% of our unimpaired capital and surplus, plus an additional 10% for loans fully secured by readily marketable collateral. At September 30, 2020, the Bank's lending limit under this restriction was $180.1 million. The Bank has no loans or loan relationships in excess of its lending limit. Total loan commitments and loans outstanding to the Bank's largest borrowing relationship totaled $68.0 million at September 30, 2020, all of which was current according to its terms.
The Bank is subject to periodic examinations by the OCC. During these examinations, the examiners may require the Bank to increase its ACL, change the classification of loans, and/or recognize additional charge-offs based on their judgments, which can impact our capital and earnings. As a federally chartered savings bank, the Bank is subject to a semi-annual assessment, based upon its total assets, to fund the operations of the OCC.
The OCC has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure, and compensation and other employee benefits. Any institution regulated by the OCC that fails to comply with these standards must submit a compliance plan.
Insurance of Accounts and Regulation by the FDIC. The DIF of the FDIC insures deposit accounts in the Bank up to applicable limits. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") permanently increased the maximum amount of deposit insurance for banks, savings institutions, and credit unions to $250 thousand per separately insured deposit ownership right or category.
The FDIC assesses deposit insurance premiums on all FDIC-insured institutions quarterly based on annualized rates. Under these rules, assessment rates for an institution with total assets of less than $10 billion are determined by weighted average CAMELS composite ratings and certain financial ratios, and range from 1.5 to 30.0 basis points, subject to certain adjustments. For the fiscal year ended September 30, 2020, the Bank paid $914 thousand in FDIC premiums. Assessment rates are applied to an institution's assessment base, which is its average consolidated total assets minus its average tangible equity during the assessment period.
The FDIC has authority to increase insurance assessments, and any significant increases would have an adverse effect on the operating expenses and results of operations of the Company. Management cannot predict what assessment rates will be in the future. In a banking industry emergency, the FDIC may also impose a special assessment.
Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition, or violation that may lead to termination of our deposit insurance.
The Dodd-Frank Act required large institutions to bear the burden of raising the reserve ratio from 1.15% to 1.35%. To implement this mandate, large and highly complex institutions paid an annual surcharge of 4.5 basis points on their assessment base through December 28, 2018 as a result of the DIF ratio reaching 1.36%.
Since established small institutions contributed to the DIF while the reserve ratio was between 1.15% and 1.35%, the FDIC has provided assessment credits to the established small institutions for the portion of their assessments that contributed to the increase. The Bank received $2.8 million in credits to apply to FDIC assessments. Pursuant to regulatory guidance, once the reserve ratio exceeds 1.38%, credits are allocated to banks with less than $10 billion in assets. These credits were utilized to offset the Bank's premium assessments until they were exhausted. The Bank utilized $1.6 million and $1.2 million of the credit during fiscal year 2020 and 2019, respectively.
FDIC-insured institutions were required to pay additional quarterly assessments known as "FICO assessments" in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. The rate for these assessments was adjusted quarterly and was applied to the same base used for the deposit insurance assessment. These assessments were discontinued during fiscal year 2019 when the bonds matured. As such, the Bank did not pay any FICO assessments during fiscal year 2020.
Transactions with Affiliates. Transactions between the Bank and its affiliates are required to be on terms as favorable to the institution as transactions with non-affiliates, and certain of these transactions are restricted to a percentage of the Bank's capital, and, in the case of loans, require eligible collateral in specified amounts. In addition, the Bank may not lend to any affiliate engaged in activities not permissible for a bank holding company or purchase or invest in the securities of affiliates.
Regulatory Capital Requirements. The Bank and Company are required to maintain specified levels of regulatory capital under regulations of the OCC and FRB, respectively.
In September 2019, the regulatory agencies, including the OCC and FRB, adopted a final rule, effective January 1, 2020, creating a community bank leverage ratio ("CBLR") for institutions with total consolidated assets of less than $10 billion and that meet other qualifying criteria related to off-balance sheet exposures and trading assets and liabilities. The CBLR provides for a simple measure of capital adequacy for qualifying institutions. Management has elected to use the CBLR framework for the Bank and Company.
The CBLR is calculated as Tier 1 Capital to average consolidated assets as reported on an institution's regulatory reports. Tier 1 Capital, for the Company and the Bank, generally consists of common stock plus related surplus and retained earnings, adjusted for goodwill and other intangible assets and AOCI-related amounts. Qualifying institutions that elect to use the CBLR framework and that maintain a leverage ratio of greater than 9% will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the regulatory agencies' capital rules, and to have met the well-capitalized ratio requirements. In April 2020, as directed by Section 4012 of the CARES Act, the regulatory agencies introduced temporary changes to the CBLR. These changes, which subsequently were adopted as a final rule, temporarily reduce the CBLR requirement to 8% through the end of 2020. Beginning in 2021, the CBLR requirement will increase to 8.5% for the calendar year before returning to 9% in 2022. A qualifying institution utilizing the CBLR framework that fails to maintain a leverage ratio greater than the required percentage is allowed a two-quarter grace period in which to increase its leverage ratio back above the required percentage. During the grace period, a qualifying institution will still be considered well capitalized so long as it maintains a leverage ratio of no more than one percent less than the required percentage. If an institution either fails to meet all the qualifying criteria within the grace period, or fails to maintain a leverage ratio of no more than one percent less than the required percentage, it becomes ineligible to use the CBLR framework and must instead comply with generally applicable capital rules, sometimes referred to as Basel III rules.
For the quarter ended September 30, 2020, the Bank reported in its Call Report quarterly average assets of $9.45 billion and a CBLR of 12.4%, and the Company reported to the FRB quarterly average assets of $9.45 billion and a CBLR of 13.7%. At September 30, 2020, the Bank was considered well capitalized under OCC regulations. See "Part II, Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 14. Regulatory Capital Requirements" and "Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources" for additional regulatory capital information.
The OCC has the ability to establish individual minimum capital requirements for a particular institution which vary from the capital levels that would otherwise be required under the applicable capital regulations based on such factors as concentrations of credit risk, levels of interest rate risk, the risks of non-traditional activities, and other circumstances. The OCC has not imposed any such requirement on the Bank.
The OCC is authorized and, under certain circumstances, required to take certain actions against federal savings banks that are considered not to be adequately capitalized because they fail to meet the minimum requirements associated with their elected capital framework. Any such institution must submit a capital restoration plan for OCC approval and may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and may not make capital distributions. The OCC may impose further restrictions. The plan must include a guaranty by the institution's holding company limited to the lesser of 5% of the institution's assets when it became undercapitalized, or the amount necessary to restore the institution to adequately capitalized status.
Community Reinvestment and Consumer Protection Laws. In connection with its lending activities, the Bank is subject to a number of federal laws designed to protect borrowers and promote lending to various sectors of the economy and population. These include the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 ("SAFE Act"), and the Community Reinvestment Act ("CRA"). In addition, federal banking regulators, pursuant to the Gramm-Leach-Bliley Act, have enacted regulations limiting the ability of banks and other financial institutions to disclose nonpublic consumer
information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with non-affiliated third parties. With respect to federal consumer protection laws, regulations are generally promulgated by the CFPB, but the OCC examines the Bank for compliance with such laws.
The CRA requires the appropriate federal banking agency, in connection with its examination of an FDIC-insured institution, to assess its record in meeting the credit needs of the communities served by the institution, including low and moderate income neighborhoods. The federal banking regulators take into account the institution's record of performance under the CRA when considering applications for mergers, acquisitions, and branches. Under the CRA, institutions are assigned a rating of outstanding, satisfactory, needs to improve, or substantial non-compliance. The Bank received a satisfactory rating in its most recently completed CRA evaluation.
In May 2020, the OCC released a final rule amending its regulations under the CRA. The final rule clarifies and expands the activities that qualify for CRA credit, updates where activities count for such credits and seeks to provide more consistent and objective measures for evaluating performance. The final rule became effective on October 1, 2020 but compliance with the amended requirements is not mandatory for the Bank until January 1, 2023.
Bank Secrecy Act /Anti-Money Laundering Laws. The Bank is subject to the Bank Secrecy Act and other anti-money laundering laws, including the USA PATRIOT Act of 2001 and regulations thereunder. These laws and regulations require the Bank to implement policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing and to verify the identity and source of deposits and wealth of its customers. Violations of these laws and regulations can result in substantial civil and criminal sanctions. In addition, provisions of the USA PATRIOT Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing mergers and acquisitions.
Federal Securities Law. The common stock of the Company is registered with the SEC under the Securities Exchange Act of 1934, as amended. The Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Securities Exchange Act of 1934.
The Company stock held by persons who are affiliates of the Company may not be resold without registration or unless sold in accordance with certain resale restrictions. For this purpose, affiliates are generally considered to be executive officers, directors and principal stockholders. If the Company meets specified current public information requirements, each affiliate of the Company generally may sell in the public market, without registration, a limited number of shares in any three-month period.
Federal Reserve System. The FRB requires all depository institutions to maintain reserves at specified levels against their transaction accounts, primarily checking accounts. In response to the COVID-19 pandemic, the FRB reduced reserve requirement ratios to zero percent effective on March 26, 2020, to support lending to households and businesses. At September 30, 2020, the Bank was in compliance with the reserve requirements in place at that time and is still in compliance with the reserve requirements through the date of this filing.
The Bank is authorized to borrow from the Federal Reserve Bank "discount window." An eligible institution need not exhaust other sources of funds before going to the discount window, nor are there restrictions on the purposes for which the institution can use primary credit. At September 30, 2020, the Bank had no outstanding borrowings from the discount window.
Federal Home Loan Bank System. The Bank is a member of one of 11 regional Federal Home Loan Banks, each of which serves as a reserve, or central bank, for its members within its assigned region and is funded primarily from proceeds derived from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes loans, called advances, to members and provides access to a line of credit in accordance with policies and procedures established by the Board of Directors of FHLB, which are subject to the oversight of the Federal Housing Finance Agency.
As a member, the Bank is required to purchase and maintain capital stock in FHLB. The minimum required FHLB stock amount is generally 4.5% of the Bank's FHLB advances and outstanding balance against the FHLB line of credit, and 2% of the outstanding principal of loans sold into the Mortgage Partnership Finance program. At September 30, 2020, the Bank had a balance of $93.9 million in FHLB stock, which was in compliance with this requirement. In past years, the Bank has received dividends on its FHLB stock, although no assurance can be given that these dividends will continue. On a quarterly basis, management conducts a financial review of FHLB to determine whether an other-than-temporary impairment of the FHLB stock is present. At September 30, 2020, management concluded there was no such impairment.
Federal Savings and Loan Holding Company Regulation. The HOLA prohibits a savings and loan holding company (directly or indirectly, or through one or more subsidiaries) from acquiring another savings association, or holding company thereof, without prior written approval from the FRB; acquiring or retaining, with certain exceptions, more than 5% of a non-subsidiary savings association, a non-subsidiary holding company, or a non-subsidiary company engaged in activities other than those permitted by the HOLA; or acquiring or retaining control of a depository institution that is not federally insured. In evaluating applications by savings and loan holding companies to acquire savings associations, the FRB must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community, competitive factors, and other factors.
The FRB has long set forth in its regulations its "source of strength" policy, which requires holding companies to act as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress. The Dodd-Frank Act extended to savings and loan holding companies and codified the FRB's "source of strength" doctrine, which had applied to bank holding companies before the FRB regulated savings and loan holding companies in addition to bank holding companies.
Economic Growth, Regulatory Relief and Consumer Protection Act and Other Regulations. In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the "Regulatory Relief Act"), was enacted to modify or remove certain financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act. While the Regulatory Relief Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks with assets of more than $50 billion. Many of these changes could result in meaningful regulatory changes for community banks such as the Bank, and their holding companies.
The Regulatory Relief Act, among other matters, expands the definition of qualified mortgages which may be held by a financial institution and simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single CBLR, as described above, under "Regulatory Capital Requirements." In addition, the Regulatory Relief Act includes regulatory relief for community banks regarding regulatory examination cycles, call reports, the Volcker Rule (proprietary trading prohibitions), mortgage disclosures and risk weights for certain high-risk commercial real estate loans.
Regulations have been adopted which allow a federal savings association with total consolidated assets of $20 billion or less as of December 31, 2017 to operate as a covered savings association, having generally the same rights, privileges, duties, restrictions, limitations and conditions as a national bank.
Amendments to the Volcker Rule exclude from the definition of "banking entity" certain firms that have total consolidated assets equal to $10 billion or less and total trading assets and liabilities equal to five percent or less of total consolidated assets.
Effective November 24, 2019, the minimum asset threshold for federal savings associations covered by the company-run stress testing requirement was raised from $10 billion to $250 billion in total consolidated assets.
Federal Taxation. The Company and the Bank are subject to federal income taxation in the same general manner as other corporations. The Company files a consolidated federal income tax return. The Company is no longer subject to federal income tax examination for fiscal years prior to 2017. For federal income tax purposes, the Bank currently reports its income and expenses on the accrual method of accounting and uses a fiscal year ending on September 30 for filing its federal income tax return. Changes to the corporate federal income tax rate would result in changes to the Company's effective income tax rate and would require the Company to remeasure its deferred tax assets and liabilities based on the tax rate in the years in which those temporary differences are expected to be recovered or settled.
State Taxation. The earnings/losses of Capitol Federal Financial, Inc., Capitol Funds, Inc. and Capital City Investments, Inc. are combined for purposes of filing a consolidated Kansas corporate tax return. The Kansas corporate tax rate is 4.0%, plus a surcharge of 3.0% on earnings greater than $50 thousand.
The Bank files a Kansas privilege tax return. For Kansas privilege tax purposes, the minimum tax rate is 4.5% of earnings, which is calculated based on federal taxable income, subject to certain adjustments. The Bank has not received notification from the state of any potential tax liability for any years still subject to audit.
Additionally, the Bank files state tax returns in various other states where it has significant purchased loans and/or foreclosure activities. In these states, the Bank has either established nexus under an economic nexus theory or has exceeded enumerated nexus thresholds based on the amount of interest derived from sources within the state.
Employees and Human Capital Resources
At September 30, 2020, we had a total of 793 employees, including 125 part-time employees. The full-time equivalent of our total employees at September 30, 2020 was 757. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be good. We believe our ability to attract and retain employees is a key to our success. Accordingly, we strive to offer competitive salaries and employee benefits to all employees and monitor salaries in our market areas. In addition, we are committed to developing our staff through continuing education when applicable and specialty education within banking, using universities that offer Banking Management programs. Leadership development is supported through our Leadership Forum series, on a biannual basis, for mid-level leaders within the organization. We have also used outside consultants for business simulations in the past for training purposes, and this is expected to continue.
Information about our Executive Officers
John B. Dicus. Age 59 years. Mr. Dicus is Chairman of the Board of Directors, Chief Executive Officer, and President of the Bank and the Company. He has served as Chairman since January 2009 and Chief Executive Officer since January 2003. He has served as President of the Bank since 1996 and of the Company since its predecessor's inception in March 1999. Prior to accepting the responsibilities of Chief Executive Officer, he served as Chief Operating Officer of the Bank and the Company. Prior to that, he served as the Executive Vice President of Corporate Services for the Bank for four years. He has been with the Bank in various other positions since 1985.
Kent G. Townsend. Age 59 years. Mr. Townsend serves as Executive Vice President and Chief Financial Officer of the Bank, its subsidiary, and the Company. Mr. Townsend also serves as Treasurer for the Company, Capitol Funds, Inc. and CFMRC. Mr. Townsend was promoted to Executive Vice President, Chief Financial Officer and Treasurer on September 1, 2005. Prior to that, he served as Senior Vice President, a position he held since April 1999, and Controller of the Company, a position he held since March 1999. He has served in similar positions with the Bank since September 1995. He served as the Financial Planning and Analysis Officer with the Bank for three years and has held other financial-related positions since joining the Bank in 1984.
Rick C. Jackson. Age 55 years. Mr. Jackson serves as Executive Vice President, Chief Lending Officer and Community Development Director of the Bank and the Company. He also serves as the Chief Executive Officer of Capitol Funds, Inc., a subsidiary of the Bank, and President of CFMRC. He has been with the Bank since 1993 and has held the position of Community Development Director since that time. He has held the position of Chief Lending Officer since February 2010.