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See accompanying notes to consolidated interim financial statements.
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See accompanying notes to consolidated interim financial statements.












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The accompanying consolidated financial statements of Capitol Federal Financial and subsidiary (the "Company") have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by generally accepted accounting principles in the United States of America ("GAAP") for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2003 Annual Report on Form 10-K to the Securities and Exchange Commission. Interim results are not necessarily indicative of results for a full year.

In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the valuation of mortgage servicing rights, allowances for losses on loans and derivative instruments. While management believes that these allowances are adequate, future additions to the allowances may be necessary based on changes in economic conditions.

The Company is the sole shareholder of Capitol Federal Savings Bank (the "Bank"). The Company's majority shareholder is Capitol Federal Savings Bank MHC ("MHC"), a federally chartered mutual holding company.

All dollar amounts are in thousands except per share data, unless otherwise indicated.

SEC Staff Accounting Bulletin ("SAB") No. 105 "Application of Accounting Principles to Loan Commitments" was released in March 2004. This release summarizes the SEC staff position regarding the application of GAAP to loan commitments accounted for as derivative instruments. The Company accounts for interest rate lock commitments issued on mortgage loans that will be held for sale as derivative instruments. Consistent with SAB No. 105, the Company considers the fair value of these commitments to be zero at the commitment date, with subsequent changes in fair value determined solely on changes in market interest rates. As of March 31, 2004, the Company had no interest rate lock commitments on mortgage loans to be held for sale. The Company's adoption of this bulletin did not have an initial impact on its consolidated financial statements.

The Company has adopted the disclosure requirements of Statement on Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure". The Company applies the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," as allowed by SFAS Nos. 123 and 148, and related interpretations in accounting for our stock-based compensation plans.

For purposes of the pro forma disclosures required by SFAS No. 148, the estimated fair value of the options is amortized to expense on a straight-line method over the options' vesting period. If the fair value provisions under SFAS No. 123 would have been adopted, salary and employee benefit expense would have been $11.3 million for the three months ended March 31, 2004 and $10.2 million for the same period last year. Compensation expense for the six months ended March 31, 2004 would have been $23.3 million and $21.0 million for the same period last year.

The following table presents the pro forma impact on earnings and earnings per share.

During the six months ended March 31, 2004, the Bank did not complete any mortgage loan sales. During the same period in the previous fiscal year, a total of $574.6 million in fixed-rate single family loans, originated at historically low interest rates, were sold into the secondary market. The Bank recognized a gain of $18.2 million, pre-tax, on the sale of these loans. As a result of retaining servicing rights on these mortgage loans sold, the Bank recorded an increase of $5.1 million in its mortgage servicing rights during the six months ended March 31, 2003. At March 31, 2004, the Bank had no single family mortgage loans held for sale.

For the quarter ended March 31, 2004, basic earnings per share were $0.14 and diluted earnings per share were $0.13. The Company accounts for the 3,024,574 shares acquired by its ESOP in accordance with SOP 93-6 and the shares acquired for its Recognition and Retention Plan ("RRP") in a manner similar to the ESOP shares. Shares acquired by the ESOP and the RRP are not considered in the basic average shares outstanding until the shares are committed for allocation or vested to an employee's individual account. The following is a reconciliation of the denominators of the basic and diluted earnings per share calculations.

On April 27, 2004, the Board approved a dividend of $0.50 per share which will be paid on May 21, 2004 to holders of record as of May 7, 2004.

On January 27, 2004, the Board approved a quarterly dividend of $0.50 per share which was paid on February 20, 2004 to holders of record as of February 6, 2004.

In November 2003, the Board adjusted its dividend policy for calendar year 2004 with the intent to pay its calendar year dividend in four equal quarterly installments. No dividend payout ratio has been targeted and one is not currently contemplated. See "Management's Discussion and Analysis - Capital" for information regarding Capitol Federal Savings Bank's ("Capitol Federal Savings" or the "Bank") ability to pay capital distributions to the Company.

On March 24, 2004, the Company established a Delaware business trust, Capitol Federal Financial Trust I (the "Trust"), of which the Company owns 100% of the common securities or 3% of the Trust. Outside investors own 100% of the capital securities or 97% of the Trust. The Trust was formed for the purpose of issuing Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures ("Trust Preferred Securities"). The Trust issued $53.6 million of Trust Preferred Securities on March 24, 2004. The Company purchased $1.6 million, or 3%, of the common securities which are reported in Other Assets in the March 31, 2004 consolidated balance sheet.

Interest on the Trust Preferred Securities is due quarterly in January, April, July and October until the maturity date of April 7, 2034. The interest rate, which resets at each interest payment, is based upon the three month LIBOR rate plus 275 basis points. The principal is due at maturity. The Trust Preferred Securities are callable, in part or whole, beginning on April 7, 2009, at par, at the option of the Trust. The Company has guaranteed the obligations of the Trust. The Trust is not included in the consolidated financial statements of the Company per revised Financial Accounting Standards Board ("FASB") Interpretation ("FIN") 46R, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51".

When the Trust Preferred Securities were issued, the Trust used the proceeds to purchase a like amount of Junior Subordinated Deferrable Interest Debentures (the "Debentures") of the Company. In connection with the Debentures, the Company capitalized $290 thousand of debt issuance costs to be amortized on a straight-line basis over 5 years. The Debentures bear the same terms and interest rates as the Trust Preferred Securities. The Debentures are the sole assets of the Trust. There are certain covenants that the Company is required to comply with in regards to the Debentures. These covenants include limitations on dividends in the event of default, certain certifications and financial information of the Company to the Trust and other covenants related to the payment of interest and principal and maintenance of the Trust.

On December 15, 2003, the Bank entered into interest rate swap agreements with a notional amount of $800.0 million. The Bank is utilizing the interest rate swaps to reduce the interest expense associated with some Federal Home Loan Bank ("FHLB") advances and to modify its interest rate risk profile. The Bank has agreed to receive interest from counterparties on the $800.0 million notional amount at a fixed rate matching the amounts paid by the Bank under the hedged FHLB advances and to pay interest at a variable rate indexed to the one month LIBOR rate plus an average spread of 248 basis points during the entire term of the interest rate swap and remaining term of the hedged FHLB advances.

The interest rate swaps are designated and qualify as fair value hedges under SFAS No. 133. The Bank has assumed no ineffectiveness in the hedging relationship as all of the terms in the interest rate swap agreements match the terms of the FHLB advances. The Bank is accounting for the interest rate swap agreements using the shortcut method, whereby, any gain or loss in the fair value on the interest rate swaps is offset by a gain or loss on the hedged FHLB advances. The fair value of the hedged FHLB advances will generally decrease when interest rates rise and increase when interest rates fall. The fair value of the Bank's interest rate swap agreements are estimated by discounting anticipated cashflows associated with the receive-fixed rate component of the swap and the pay-variable rate component of the swap over the remaining contractual terms of each swap. The pay-variable rate component cash flows are estimated using forward interest rate curves for the one month LIBOR as of March 31, 2004. The fair v alue of the interest rate swaps at March 31, 2004 was $18.3 million, which resulted in an increase of $18.3 million in the hedged FHLB advances at March 31, 2004.

In the normal course of business, the Company and its subsidiary are named defendants in various lawsuits and counter claims. In the opinion of management, after consultation with legal counsel, none of the suits are expected to have a materially adverse effect on the Company's consolidated financial statements for the current interim period.

Certain reclassifications have been made to the fiscal 2003 consolidated financial statements in order to conform with the fiscal 2004 presentation.

Capitol Federal Financial, and its wholly owned subsidiary, Capitol Federal Savings, may from time to time make written or oral "forward-looking statements", including statements contained in their filings with the Securities and Exchange Commission ("SEC").

Except for the historical information contained in this filing, the matters discussed may be deemed to be forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties, including changes in economic conditions in the Company's market areas, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company's market areas, competition, and other risks detailed from time to time in the Company's SEC reports. Actual strategies and results in future periods may differ materially from those currently expected. These forward-looking statements represent the Company's judgment as of the date of this filing. The Company disclaims, however, any intent or obligation to update these forward-looking statements.

The following discussion is intended to assist in understanding the financial condition and results of operations of the Company. The discussion includes comments relating to the Bank, since the Bank is wholly owned by the Company and comprises the majority of assets and principal source of income for the Company.

Our policies with respect to the methodologies used to determine the allowance for loan losses, the valuation of mortgage servicing rights and our policy regarding derivative instruments are our most critical accounting policies because they are important to the presentation of our financial condition and results of operations, involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. The use of different judgments, assumptions and estimates could cause reported results to differ materially. These critical accounting policies and their application are reviewed at least annually with our Audit Committee and Board of Directors. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in the Annual Report to Stockholders attached as Exhibit 13 to our Annual Report on Form 10-K for the year ended September 30, 2 003 for a discussion of our critical accounting policies. Following is a description of our critical accounting policies and an explanation of the methods and assumptions underlying their application.

Allowance for Loan Losses We maintain an allowance for loan losses to absorb losses known and inherent in the loan portfolio based upon ongoing, quarterly assessments of the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance, specific allowances for identified problem loans and portfolio segments and economic conditions that may lead to a concern about the loan portfolio or segments of the loan portfolio. In addition, the allowance incorporates the results of measuring impaired loans as provided in SFAS No. 114, "Accounting by Creditors for Impairment of a Loan" and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures." These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans.

The formula allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and non-performing loans affect the amount of the formula allowance. Loss factors are based both on our historical loss experience and on significant factors that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date. Loss factors for loans on residential properties with greater than four units, loans on construction and development and commercial properties are computed based on an evaluation of inherent losses on these loans. Loan loss factors for portfolio segments are representative of the credit risks associated with loans in those segments. The greater the credit risks associated with a particular segment, the greater the loss factor. Loss factors increase within each portfolio segment as loans become classified, delinquent, the foreclosure or repossession proce ss begins or as economic conditions warrant.

The appropriateness of the allowance is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas. Other conditions that management considers in determining the appropriateness of the allowance include, but are not limited to, changes to our underwriting standards primarily due to competitive pressures, credit quality trends (including changes in non-performing loans expected to result from existing conditions), trends in collateral values, loan volumes and concentrations, and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of those loans. The Bank has relaxed, over the past several years, the debt-to-income ratio and the loan-to-value ratio components of its overall underwriting standards in order to better compete for loan originations in our market areas.

Senior management reviews these conditions quarterly in discussions with our senior credit officers. To the extent that any of these conditions are evidenced by a specifically identifiable problem loan or portfolio segment as of the evaluation date, management's estimate of the effect of such condition may be reflected as a specific allowance applicable to such loan or portfolio segment. Where any of these conditions are not evidenced by a specifically identifiable problem loan or portfolio segment as of the evaluation date, management's evaluation of the loss related to these conditions is reflected in the unallocated allowance associated with our homogeneous population of mortgage loans. The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem loans or portfolio segments.

The amounts actually observed in respect to these losses can vary significantly from the estimated amounts. Our methodology permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in management's judgment, significant factors which affect the collectibility of the portfolio, as of the evaluation date, are not reflected in the current loss factors. By assessing the estimated losses inherent in our loan portfolios on a quarterly basis, we can adjust specific and inherent loss estimates based upon more current information.

Assessing the adequacy of the allowance for loan losses is inherently subjective as it requires making material estimates, including the amount and timing of future cash flows expected to be received on impaired loans or changes in the market value of collateral securing loans, that may be susceptible to significant change. In the opinion of management, the allowance when taken as a whole, is adequate to absorb reasonable estimated loan losses inherent in our loan portfolios.

Valuation of Mortgage Servicing Rights ("MSR") The Bank records MSR as a result of retaining the servicing on loans that are sold. Impairment exists if the carrying value of MSR exceeds the estimated fair value of the MSR. MSR are stratified by the underlying loan term and by interest rate. Individual impairment allowances for each stratum are established when necessary and then adjusted in subsequent periods to reflect changes in the measurement of impairment. The estimated fair value of each MSR stratum is determined through analysis of future cash flows incorporating numerous assumptions including: servicing income, servicing costs, market discount rates, prepayment speeds and other market driven data.

The fair value of MSR is highly sensitive to changes in assumptions. Changes in prepayment speed assumptions have the most significant impact on the fair value of MSR. Generally, as interest rates decline, prepayments accelerate due to increased refinance activity, which results in a decrease in the fair value of MSR. As interest rates rise, prepayments slow down which generally results in an increase in the fair value of MSR. All assumptions are reviewed for reasonableness on a quarterly basis and adjusted as necessary to reflect current and anticipated market conditions. Thus, any measurement of the fair value of MSR is limited by the conditions existing and the assumptions utilized as of a particular point in time, and those assumptions may not be appropriate if applied at a different point in time.

Derivative Instruments The Bank has entered into interest rate swap agreements to hedge certain FHLB advances. The Bank pays a variable rate of interest tied to the one month LIBOR and receives a fixed rate of interest matching the hedged FHLB advances. When the Bank entered into the interest rate swap agreements, they were designated as fair value hedges. All terms in the interest rate swap agreements relating to the pay-fixed rate components and timing of cash flows match the terms of the hedged FHLB advances. Therefore, the Bank has assumed no ineffectiveness in the hedging relationship and accounts for the interest rate swaps using the shortcut method. Any gain or loss in the fair value of the interest rate swaps is offset by a gain or loss on the hedged FHLB advances.

Before undertaking the hedge, management formally documented its risk management objectives, strategy and the relationship between the interest rate swap agreements and the hedged FHLB advances. To qualify for hedge accounting, the interest rate swaps and the related FHLB advances must be designated as a hedge. Both at the inception of the hedge and on an ongoing basis, management assesses whether the hedging relationship is expected to be highly effective in offsetting changes in fair values of the hedged FHLB advances. If at some point it is determined that the interest rate swaps are not highly effective as a hedge, hedge accounting will be discontinued. If hedge accounting is discontinued, changes in the fair value of the interest rate swaps will be recorded in earnings and the hedged FHLB advances will no longer be adjusted for changes in fair value.

Our strategy is to operate a retail oriented financial institution dedicated to serving the needs of customers in our market areas. Our commitment is to provide the broadest possible access to home ownership through our residential lending programs and to offer a complete set of personal financial products and services through our network of branch offices.

As a result of providing customers products they desire, the Bank's primary focus becomes one of managing cash flows. This is done through the setting of interest rates on loan and deposit products and the investment of cash flows not placed in our local markets through the origination of loans into investments that meet the long term objectives of earnings and liquidity management. The Bank manages all of its portfolios, both asset and liability portfolios, essentially as held-to-maturity portfolios. As such, changes in these portfolios do not typically occur quickly, especially in a rising rate environment. Because of this, management looks at changes over a period of time to determine trends that can be changed through various strategies in our local markets or by the investments we make.

The primary components of our strategy include:

• Single-Family Portfolio Lending. We are one of the largest originators of one- to four-family residential mortgage loans in the State of Kansas. We have primarily originated these loans for our own portfolio, rather than for sale, and we generally service the loans we originate. We provide retail customers with alternatives for their borrowing needs by offering both fixed and adjustable rate products with various terms to maturity and pricing alternatives. We combine with our lending products underwriting standards designed to limit our exposure to credit risk which has resulted in minimum levels of delinquent and non-performing loans. We offer special programs to individuals who may be first time home buyers, have low or moderate incomes or may have certain credit risk concerns in order to maximize our ability to deliver home ownership opportunities. We attract customers through our strong relationships with real estate agents, loan agents, reputation, pricing, walk-in customers and customers tha t apply on the internet.

• Retail Financial Services. We offer a wide array of deposit products and retail services for our customers. These products include checking, savings, money market accounts, certificates of deposit and retirement accounts. These are provided through a branch network of 35 locations, offering traditional branch locations and locations in retail stores, our call center which operates on extended hours, telephone bill payment services and internet based transaction services.
• Commitment to Cost Control. We are very effective at controlling our costs of operations. By using technology, we are able to increase productivity and centralize our lending and deposit support functions for efficient processing. Our retail orientation allows us to serve a broad range of customers through relatively few branch locations. Our average deposit base per traditional branch at March 31, 2004 was over $148.0 million. This allows us to service more customers through fewer branch locations, helping to control costs. Our single-family residential lending process, through effective management of credit risk, allows us to service a large portfolio of loans at efficient levels because there are reduced costs with servicing a portfolio of performing loans.
• Strong Capital Position. Our policy has always been to protect the safety and soundness of Capitol Federal Savings through conservative credit and operational risk management, balance sheet strength, consistent earnings and sound operations. The end result of these activities is a capital ratio that is in excess of the well-capitalized standards set by the Office of Thrift Supervision (the "OTS"). We believe that by maintaining a strong capital position we can best safeguard the long-term interests of the Company and stockholders.
• Risk Management. Interest rate volatility is our primary risk as our consolidated balance sheet is almost entirely comprised of interest-earning assets and interest-bearing liabilities. As such, fluctuations in interest rates have a significant impact on not only our net income but also the market value of our assets and liabilities. The interest rate environment during fiscal year 2003 and continuing into fiscal year 2004 was one of historical lows which caused compression in our net interest margin. To manage interest rate risk, our Asset and Liability Committee ("ALCO") meets weekly to discuss and monitor the current interest rate environment compared to interest rates offered on our loan and deposit products. Additionally, ALCO meets once a month to review reports that present the effects that the changes in interest rates will have on our earnings, the present market value of our equity and cashflows. The members of ALCO are the Chairman, Chief Executive Officer, the Chief Financial Officer, the Executive Vice President for Corporate Services, the Chief Lending Officer, the Executive Vice President for Retail Operations and the Controller. The Chief Financial Officer chairs our ALCO.

Interest rates generally remained at low levels during the first six months of our fiscal year 2004. The low interest rates continued to fuel prepayments on our mortgage-related assets. From September 30, 2003 to March 31, 2004, the Bank received $547.8 million in repayments on its mortgage-related securities, of which $206.7 million, or 37.7%, was in the second quarter. Additionally, $60.0 million of our agency bonds were called and $370.2 million matured during the six month period ended March 31, 2004. These maturing agency bonds were short-term agency bonds purchased during the quarter ended December 31, 2002 as part of the Bank's then strategy to maintain cashflows that would be available for reinvestment in about a twelve month time frame. Loan repayments during the six months ended March 31, 2004 were $459.7 million, of which $216.8 million, or 47.2%, was in the second quarter. The funds from the repayments, maturities and called bonds were used to purchase mortgage-related securities, investme nt securities and fund loan originations and purchases and deposit withdrawals.

Since September 30, 2003, there has been growth in all deposit categories except certificates of deposit. The pace at which certificates decreased slowed during the second quarter compared to the first quarter, however the decrease in certificates more than offset the growth in all other deposit categories. During March 2004, the Company issued $53.6 million of Debentures to Capitol Federal Financial Trust I. This transaction increased the Company's borrowings and cash. The Company paid dividends of $34.7 million during the six months ended March 31, 2004, of which $9.6 million was paid in the second quarter.

The following table presents selected balance sheet data for the Company at the dates indicated.

Assets.  Total assets of the Company decreased $116.4 million from $8.58 billion at September 30, 2003 to $8.47 billion at March 31, 2004. The decrease was primarily due to a $283.6 million decrease in investment securities, partially offset by an increase of $46.1 million in mortgage-related securities, an increase in loans receivable of $60.0 million and an increase in cash and cash equivalents of $47.9 million.

• Mortgage-related securities increased from $2.94 billion at September 30, 2003 to $2.99 billion at March 31, 2004. The increase was due to the purchase of fixed and adjustable rate mortgage-related securities of $594.1 million with an average yield of 3.58% and an estimated weighted average life ("WAL") of 8.64 years, with the adjustable-rate mortgage-related securities averaging 3.65 years until their first reset at the time of purchase. The increase was offset by repayments of $547.8 million and $10.4 million of net premium amortization. The following table provides a summary of the activity of mortgage-related securities for the periods presented.

• Investment securities decreased from $1.02 billion at September 30, 2003 to $738.8 million at March 31, 2004. The following table provides a summary of the activity of investment securities for the periods presented.

• Cash and cash equivalents increased from $41.9 million at September 30, 2003 to $89.9 million at March 31, 2004. During March 2004, the Company issued $53.6 million of Debentures to Capitol Federal Trust I which caused the increase in cash and cash equivalents.
• The loan portfolio increased from $4.31 billion at September 30, 2003 to $4.37 billion at March 31, 2004. During the six months ended March 31, 2004, the Bank originated, refinanced and purchased loans totaling $526.4 million at an average yield of 5.04%. This volume of originations and purchases was offset by loan repayments of $459.7 million.

The following tables present loan origination, refinance, purchase, and modification activity and mortgage-related securities purchased for the periods indicated.

The following table presents the Company's loan portfolio at the dates indicated.