5. Fair Value of Financial Instruments

Fair Value Measurements – The Company uses fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures in accordance with Accounting Standard Codification (“ASC”) 820 and ASC 825. The Company did not have any liabilities that were measured at fair value at June 30, 2014 or September 30, 2013. The Company’s AFS securities are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets or liabilities on a non-recurring basis, such as OREO and loans individually evaluated for impairment. These non-recurring fair value adjustments involve the application of lower-of-cost-or-fair value accounting or write-downs of individual assets.

The Company groups its assets at fair value in three levels based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models, and similar techniques. The results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability.

The Company bases its fair values on the price that would be received from the sale of an asset in an orderly transaction between market participants at the measurement date. The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value.

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

AFS Securities – The Company’s AFS securities portfolio is carried at estimated fair value, with any unrealized gains and losses, net of taxes, reported as AOCI in stockholders’ equity. The majority of the securities within the AFS portfolio were issued by GSEs. The Company primarily uses prices obtained from third party pricing services and recent trades to determine the fair value of its securities. The Company’s major security types, based on the nature and risks of the securities, are:

GSE Debentures – Estimated fair values are based on a discounted cash flow method. Cash flows are determined by taking any embedded options into consideration and are discounted using current market yields for similar securities. On a quarterly basis, management corroborates a sample of the prices obtained from the pricing service by comparing them to another independent source. (Level 2)

MBS – Estimated fair values are based on a discounted cash flow method. Cash flows are determined based on prepayment projections of the underlying mortgages and are discounted using current market yields for benchmark securities. On a quarterly basis, management corroborates a sample of the prices obtained from the pricing service by comparing them to another independent source. (Level 2)

Municipal Bonds – Estimated fair values are based on a discounted cash flow method. Cash flows are determined by taking any embedded options into consideration and are discounted using current market yields for securities with similar credit profiles. On a quarterly basis, management corroborates a sample of the prices obtained from the pricing service by comparing them to another independent source. (Level 2)

Trust Preferred Securities – Estimated fair values are based on a discounted cash flow method. Cash flows are determined by taking prepayment and underlying credit considerations into account. The discount rates are derived from secondary trades and bid/offer prices. (Level 3)

The following tables provide the level of valuation assumption used to determine the carrying value of the Company’s assets measured at fair value on a recurring basis, which consists of AFS securities, at the dates presented.


	June 30, 2014
			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable
	Carrying		for Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)(1)
	(Dollars in thousands)
AFS Securities:
GSE debentures	$	550,431	$	--	$	550,431	$	--
MBS		303,443		--		303,443		--
Trust preferred securities		2,356		--		--		2,356
Municipal bonds		1,142		--		1,142		--
	$	857,372	$	--	$	855,016	$	2,356


	September 30, 2013
			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable
	Carrying		for Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)(2)
	(Dollars in thousands)
AFS Securities:
GSE debentures	$	702,228	$	--	$	702,228	$	--
MBS		363,964		--		363,964		--
Municipal bonds		1,352		--		1,352		--
Trust preferred securities		2,423		--		--		2,423
	$	1,069,967	$	--	$	1,067,544	$	2,423

(1)

The Company’s Level 3 AFS securities had no activity during the nine months ended June 30, 2014, except for principal repayments of $106 thousand and reductions in net unrealized losses recognized in other comprehensive income. Reductions in net unrealized losses included in other comprehensive income for the nine months ended June 30, 2014 were $1 thousand.

(2)

The Company’s Level 3 AFS securities had no activity during fiscal year 2013, except for principal repayments of $424 thousand and reductions in net unrealized losses recognized in other comprehensive income. Reductions in net unrealized losses included in other comprehensive income for the year ended September 30, 2013 were $276 thousand.

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

Loans Receivable – The balance of loans individually evaluated for impairment at June 30, 2014 and September 30, 2013 was $28.4 million and $27.3 million, respectively. Substantially all of these loans were secured by residential real estate and were individually evaluated to ensure that the carrying value of the loan was not in excess of the fair value of the collateral, less estimated selling costs. When no impairment is indicated, the carrying amount is considered to approximate fair value. Fair values were estimated through current appraisals or listing prices. Fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3. Based on this evaluation, the Bank charged-off any loss amounts at June 30, 2014 and September 30, 2013; therefore, there was no ACL related to these loans.

OREO – OREO primarily represents real estate acquired as a result of foreclosure or by deed in lieu of foreclosure and is carried at lower-of-cost or fair value. Fair value is estimated through current appraisals or listing prices, less estimated selling costs. As these properties are actively marketed, estimated fair values may be adjusted by management to reflect current economic and market conditions and, as such, are classified as Level 3. The fair value of OREO at June 30, 2014 and September 30, 2013 was $3.3 million and $3.9 million, respectively.

The following tables provide the level of valuation assumption used to determine the carrying value of the Company’s assets measured at fair value on a non-recurring basis at the dates presented.


		June 30, 2014
			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable
	Carrying		for Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Loans individually evaluated for impairment	$	28,354	$	--	$	--	$	28,354
OREO		3,278		--		--		3,278
	$	31,632	$	--	$	--	$	31,632


		September 30, 2013
			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable
	Carrying		for Identical Assets		Inputs		Inputs
	Value		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Loans individually evaluated for impairment	$	27,327	$	--	$	--	$	27,327
OREO		3,882		--		--		3,882
	$	31,209	$	--	$	--	$	31,209

Fair Value Disclosures – The Company determined estimated fair value amounts using available market information and from a variety of valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amount the Company could realize in a current market exchange. The use of different market assumptions and estimation methodologies may have a material impact on the estimated fair value amounts. The fair value estimates presented herein were based on pertinent information available to management as of the dates presented.

The carrying amounts and estimated fair values of the Company’s financial instruments, at the dates presented, were as follows:


	June 30, 2014				September 30, 2013
			Estimated				Estimated
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
	(Dollars in thousands)
Assets:
Cash and cash equivalents	$	88,424	$	88,424	$	113,886	$	113,886
AFS securities		857,372		857,372		1,069,967		1,069,967
HTM securities		1,637,043		1,663,917		1,718,023		1,741,846
Loans receivable		6,132,520		6,352,851		5,958,868		6,132,239
BOLI		60,496		60,496		59,495		59,495
FHLB stock		112,876		112,876		128,530		128,530
OREO		3,278		3,278		3,882		3,882
Liabilities:
Deposits		4,654,862		4,680,230		4,611,446		4,646,263
FHLB borrowings		2,468,420		2,537,909		2,513,538		2,599,749
Repurchase agreements		320,000		329,941		320,000		333,749

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

Cash and Cash Equivalents – The carrying amounts of cash and cash equivalents are considered to approximate their fair value due to the nature of the financial assets. (Level 1)

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

Loans Receivable – The fair value of one- to four-family mortgages and home equity loans are generally estimated using the present value of expected future cash flows, assuming future prepayments and using discount factors determined by prices obtained from securitization markets, less a discount for the cost of servicing and lack of liquidity. The estimated fair value of the Bank’s multi-family, commercial, and consumer loans are based on the expected future cash flows assuming future prepayments and discount factors based on current offering rates. (Level 3)

BOLI – The carrying value of BOLI is considered to approximate its fair value due to the nature of the financial asset. (Level 1)

FHLB stock – The carrying value and estimated fair value of FHLB stock equals cost, which is based on redemption at par value. (Level 1)

Deposits – The estimated fair value of demand deposits, savings, and money market accounts is the amount payable on demand at the reporting date. The estimated fair value of these deposits at June 30, 2014 and September 30, 2013 was $2.13 billion and $2.07 billion, respectively. (Level 1) The fair value of certificates of deposit is estimated by discounting future cash flows using current London Interbank Offered Rates (“LIBOR”). The estimated fair value of certificates of deposit at June 30, 2014 and September 30, 2013 was $2.55 billion and $2.58 billion, respectively. (Level 2)

FHLB borrowings and Repurchase Agreements – The fair value of fixed-maturity borrowed funds is estimated by discounting estimated future cash flows using current offer rates. (Level 2)