Capitol Federal Financial, Inc. — Q1 FY2023 Form 10-Q
Reporting period: Three months ended December 31, 2022. Capitol Federal Financial is a bank holding company whose consolidated business is conducted principally through Capitol Federal Savings Bank. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless otherwise noted.
Financial results and condition
| Metric | Q1 FY2023 / Dec. 31, 2022 | Comparable period / prior date |
|---|---|---|
| Net interest income | $45.8 million | $45.6 million, Q1 FY2022 |
| Net interest margin | 1.61% | 1.99%, Q1 FY2022; 1.71%, prior quarter |
| Net income / diluted EPS | $16.2 million / $0.12 | $22.2 million / $0.16, Q1 FY2022 |
| Efficiency ratio | 54.27% | 52.22%, Q1 FY2022 |
| Total assets | $9.93 billion | $9.62 billion, Sept. 30, 2022 |
| Loans, net | $7.78 billion | $7.46 billion, Sept. 30, 2022 |
| Deposits / borrowings | $6.07 billion / $2.65 billion | $6.19 billion / $2.13 billion, Sept. 30, 2022 |
| Stockholders’ equity | $1.05 billion; 10.6% of assets | $1.10 billion; 11.4% of assets, Sept. 30, 2022 |
| Operating cash flow | $14.6 million | $20.3 million, Q1 FY2022 |
- Year over year, interest and dividend income increased 46% to $91.3 million, but interest expense rose 170% to $45.5 million. The $3.7 million credit-loss provision, versus a $3.4 million provision release a year earlier, was the primary stated reason for lower net income.
- Net loans grew about $319 million during the quarter, mainly through correspondent one- to four-family loans and commercial lending. Deposits fell $120 million, principally from money market accounts; borrowings rose $513 million to fund loan growth and offset deposit outflows.
- Cash and cash equivalents were $49.7 million. AFS securities had a fair value of $1.53 billion and $188.1 million of gross unrealized losses, attributed primarily to higher market yields; management reported no credit-loss allowance on those securities. AOCI was a loss of $132.6 million, net of tax.
- Cash flow from investing was negative $291.1 million, largely reflecting $327.6 million of net loan growth; financing provided $277.0 million, including $512.6 million of net borrowing proceeds, offset by dividends, deposit outflows and share repurchases. Cash increased $0.5 million.
- Asset-quality measures remained low: 30–89-day delinquencies were 0.10% of loans, nonaccrual loans were 0.11%, and nonperforming assets were 0.08% of assets. Net charge-offs were $2,000. The loan allowance was $19.2 million, or 0.25% of loans.
Changes, outlook, and risks
- Management attributed margin compression to faster repricing and higher costs of deposits and borrowings than of assets. Excluding the leverage strategy, net interest margin was 1.88%, down from 1.99% a year earlier and 2.07% in the prior quarter. Management expects compression to continue and potentially worsen in the near term.
- The Bank used a short-term FHLB borrowing leverage strategy during the quarter, with an average balance of $1.87 billion; those borrowings were repaid before quarter-end. The strategy generated $763,000 of net income, but reduced reported margin. Management expects to use it only while profitable and when borrowing capacity is not needed for other liquidity purposes.
- Management expected to keep assets below $10 billion at September 30, 2023, while acknowledging that the threshold could be exceeded at some quarter-ends. It said it was working to limit asset growth and additional operating use of FHLB advances.
- FY2023 projections included approximately $24.5 million of IT expense, about $6.5 million above FY2022, including costs for a digital transformation expected to be operational by September 2023. Management also projected salary and employee-benefit costs about $3.5 million higher, federal insurance premiums about $2 million higher, and an effective tax rate of approximately 19%. IT expense was expected to decline about $3 million in FY2024 from FY2023 levels.
- The Bank’s Community Bank Leverage Ratio was 9.2%, above the 9% regulatory minimum; the Company’s was 10.0%. Management intended to maintain a 100% earnings payout to shareholders in FY2023, subject to financial, regulatory and liquidity constraints. The Company repurchased 2.73 million shares at an average $8.13 during the quarter.
- Interest-rate risk remains significant: the one-year gap was negative $1.02 billion, or 10.3% of assets. A modeled 200-basis-point rate increase reduced projected four-quarter net interest income by 1.58% and market value of portfolio equity by 28.85%; these are scenario estimates, not management earnings guidance.
- Other risks include deposit outflows and funding costs, commercial real estate and construction exposure, changing economic conditions and credit-loss assumptions, and execution and cost risks from the digital transformation. Two commercial loans in one relationship moved to special mention during the quarter. Management considered pending legal actions unlikely to have a material adverse effect. The filing reported no changes to previously disclosed risk factors and no material changes to internal control over financial reporting.
Key facts for investors to verify
- Whether deposit retention, borrowing costs and asset yields develop as expected, and whether further margin compression affects earnings.
- Commercial loan growth, construction commitments and the performance of the two commercial loans newly classified as special mention; monitor allowance levels and delinquencies.
- Liquidity and capital capacity if asset growth approaches or exceeds $10 billion, including the Bank’s reliance on FHLB funding and the continued availability of regulatory approvals.
- Actual losses, if any, realized on AFS securities and the effect of interest rates on securities values, AOCI and regulatory capital.
- Progress, timing and costs of the digital transformation, and whether projected expense increases and the planned shareholder payout remain sustainable.