Capitol Federal Financial, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended March 31, 2019. The unaudited consolidated results cover Capitol Federal Financial and its banking subsidiary. The company provides banking services primarily in Kansas and Missouri. Its acquisition of Capital City Bank closed in August 2018; integration of that bank’s operations was completed in April 2019, after quarter-end.
Financial performance and position
| Metric | Quarter ended March 31, 2019 | Six months ended March 31, 2019 |
|---|---|---|
| Net interest income | $52.6 million | $104.9 million |
| Net income | $24.6 million; $0.18 per diluted share | $48.9 million; $0.36 per diluted share |
| Net interest margin | 2.33% | 2.30% |
| Non-interest income | $5.0 million | $10.4 million |
| Non-interest expense | $26.1 million | $52.9 million |
- Balance sheet at March 31: Total assets were $9.53 billion; net loans were $7.57 billion; deposits were $5.70 billion; borrowings were $2.34 billion; and stockholders’ equity was $1.36 billion. Equity was 14.2% of consolidated assets. The Bank’s equity-to-assets ratio was 12.8%.
- Credit and liquidity: The allowance for credit losses was $8.6 million, or 0.11% of loans. No provision was recorded for the six-month period; net recoveries were $156,000. Non-performing loans were 0.17% of loans and non-performing assets were 0.15% of assets. Cash and securities were 15.7% of assets, versus management’s approximate 15% target.
- Cash flows, six months: Operating activities provided $32.1 million, investing activities provided $1.0 million, and financing activities provided $59.3 million. Cash, cash equivalents and restricted cash totaled $231.5 million at period-end; balance-sheet cash and cash equivalents were $218.1 million.
- Capital: The Bank exceeded regulatory well-capitalized thresholds. Its Tier 1 leverage ratio was 12.9%, Common Equity Tier 1 ratio 24.7%, and total capital ratio 24.8%.
Changes versus comparable periods
- Quarterly net income rose $1.2 million from the March 2018 quarter, supported mainly by higher net interest income and lower income tax expense, partly offset by higher non-interest expense. Net interest income increased 5.4% to $52.6 million.
- Six-month net income declined $6.2 million, or 11.3%, from 2018. The comparison includes a $7.5 million deferred-tax revaluation benefit in the prior-year period following the Tax Act; current-period expenses also increased. Higher net interest income, driven partly by acquired commercial loans, partly offset the decline.
- Six-month net interest margin rose from 1.85% to 2.30%; excluding the leverage strategy, it increased from 2.22% to 2.33%. The strategy was suspended for much of the period because its funding-versus-cash spread was unfavorable. Its six-month net income contribution was $14,000, compared with $1.5 million a year earlier.
- Six-month non-interest expense increased 16.0% to $52.9 million, including higher compensation, technology, occupancy and acquisition-related intangible amortization. The efficiency ratio increased to 45.89% from 41.47%.
- Net loans grew modestly from September 30, 2018, while commercial loans grew to $729.7 million from $569.6 million. Deposits increased 2.6% during the March quarter, partly reflecting a certificate-of-deposit campaign. Stockholders’ equity declined $35.6 million from fiscal year-end, mainly due to dividends.
Outlook, risks and unusual items
- No specific earnings guidance was provided. Management estimated a fiscal 2019 effective tax rate of approximately 22%, aimed to keep cash and securities near 15% of assets, and said substantial net loan growth was unlikely in the current environment.
- Management plans to use cash flows from correspondent residential loans to support commercial lending growth. The commercial strategy is intended to diversify revenue and potentially replace higher-cost borrowings with lower-cost commercial deposits; realization of those benefits is not assured.
- The company intended to distribute 100% of fiscal 2019 earnings through dividends, subject to financial condition, regulatory requirements and the Bank’s ability to distribute capital. A regular $0.085-per-share dividend payable in May 2019 was announced after quarter-end.
- Interest-rate risk is a key exposure. The filing’s modeled four-quarter net interest income declined 3.33% under an instantaneous +200 basis-point rate shock; estimated market value of portfolio equity declined 18.38% in that scenario. These are model estimates, not management earnings forecasts.
- Other stated risks include deposit flows and funding costs, loan demand and credit quality, real-estate values and local economic conditions, acquisition integration and expected benefits, regulation, and cybersecurity. Management said pending legal matters were not expected to have a material adverse effect; no material change in commitments or off-balance-sheet arrangements was reported.
- Unrealized securities losses were attributed primarily to market yields and were considered temporary; management reported no other-than-temporary impairment. Cash-flow hedge fair-value losses contributed to negative accumulated other comprehensive income. The company adopted revenue-recognition guidance in October 2018, recording a $394,000 increase to opening retained earnings; management said the adoption did not materially affect results or financial condition.
Investor verification priorities
- Assess whether commercial-loan growth and the completed Capital City Bank integration deliver the expected yields, deposit growth and cost benefits without weakening underwriting.
- Track deposit pricing, certificate maturities, FHLB borrowing costs and the company’s dependence on wholesale funding; $990 million of FHLB advances was scheduled to mature within 12 months.
- Monitor commercial credit concentrations and construction-loan funding: commercial real estate was concentrated in health care, real estate, and accommodation/food services, and had $156.8 million in undisbursed loan amounts.
- Review credit trends and allowance adequacy as commercial lending expands, including delinquency, nonaccrual loans and future adoption of the expected-credit-loss standard.
- Verify dividend capacity and the sustainability of the 100% payout intention against capital needs, regulatory permissions and earnings performance.
- Compare reported results with the filing’s interest-rate sensitivity models and evaluate the assumptions for mortgage prepayments, deposit repricing and hedge performance.