Capitol Federal Financial, Inc. — FY2017 Form 10-K
Business context and reporting period. Community-focused savings bank headquartered in Topeka, Kansas, serving Kansas and parts of Missouri through 47 branches. Its primary business is residential mortgage lending funded mainly by retail deposits and borrowings. Fiscal year ended September 30, 2017; comparisons are primarily with FY2016.
Key financial results and position
| Metric | FY2017 / September 30, 2017 | Comparison |
|---|---|---|
| Interest and dividend income | $313.2 million | Up 4.0% from $301.1 million |
| Net interest income | $195.4 million | Up 1.7% from $192.2 million |
| Net income / diluted EPS | $84.1 million / $0.63 | $83.5 million / $0.63 |
| Net interest margin | 1.79% | Up 4 basis points; 2.15% excluding the leverage strategy |
| Efficiency ratio | 41.21% | Improved from 43.76% |
| Operating cash flow | $85.4 million | Compared with $85.0 million |
| Total assets | $9.19 billion | Down $74.3 million |
| Loans, net | $7.20 billion | Up $237.0 million |
| Deposits | $5.31 billion | Up $145.9 million |
| FHLB borrowings and repurchase agreements | $2.37 billion combined | FHLB borrowings down $198.6 million; repo balance unchanged at $200 million |
| Stockholders’ equity | $1.37 billion | Down $24.7 million |
Net interest income after provision was $195.4 million; non-interest income was $22.2 million and non-interest expense was $89.7 million. The effective tax rate rose to 34.2% from 31.5%. Return on average assets was 0.75% and return on average equity was 6.09%. Dividends paid were $0.88 per share, including special and true-up dividends.
Credit quality remained strong by the company’s reported measures: non-performing loans were $16.6 million, or 0.23% of loans, versus $29.1 million, or 0.42%, in FY2016. Non-performing assets were 0.20% of assets versus 0.35%. The allowance for credit losses (ACL) was $8.4 million, 0.12% of net loans; there was no provision in FY2017 and net charge-offs were $142,000.
Material changes versus FY2016
- Net income increased modestly, supported by $3.2 million higher net interest income and lower non-interest expense; non-interest income fell $1.1 million, partly because FY2016 included a BOLI death benefit.
- Loans grew while securities declined $384.6 million, as cash flows from securities were redirected toward loan growth and repayment of maturing borrowings. Commercial real estate loans rose to $270.0 million from $154.1 million.
- Deposits increased while FHLB borrowings declined as some maturities were not replaced. Total assets fell slightly.
- Reported non-performing loans declined, but management refined its TDR and impaired-loan classification methods during FY2017; it said the effects were not material and that fewer loans qualified as TDRs.
- A change in accounting for low-income housing partnerships moved related expenses from non-interest expense into income tax expense. Management attributed much of the higher effective tax rate to this change.
Outlook, commentary and risks
Management expected to continue the FHLB-funded leverage strategy in FY2018. The strategy generated $2.8 million of FY2017 net income, but reduced reported net interest margin; management can discontinue it at any time. Management also stated its intent to distribute 100% of FY2018 earnings through regular quarterly dividends and a year-end true-up, subject to financial results, capital needs and regulatory limits. The filing is not a guarantee of future results or dividends.
Interest-rate risk is a key exposure: long-term, largely fixed-rate assets are funded in part by shorter-term liabilities. The modeled one-year gap was $641.6 million, but under a 200-basis-point rate increase it fell to $81.3 million. In the +300-basis-point scenario, projected annual net interest income decreased 0.81%, and modeled market value of portfolio equity fell 33.60%. These are scenario estimates based on assumptions, not forecasts. The Bank had $812.8 million of LIBOR-indexed adjustable-rate loans and $200.0 million of LIBOR-linked swaps; LIBOR was expected to be phased out by the end of 2021.
Other principal risks include continued growth and geographic/property concentration in commercial real estate, borrower and collateral deterioration in economic downturns, deposit competition and repricing, access to wholesale funding, cyber and technology incidents, regulatory changes, and dependence on Bank distributions to fund parent-company dividends. CRE loans outstanding were $270.0 million, with $105.9 million of undisbursed amounts; the largest CRE loan commitment was $50.0 million. The Bank’s deposit-funding mix included $460.0 million of public-unit deposits. Management reported no material adverse effect expected from pending litigation. Auditors issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Track the composition, performance and underwriting of the expanding CRE portfolio, including construction exposures, undisbursed commitments, large borrower relationships and geographic concentrations.
- Assess whether the low ACL and absence of a current-year provision remain appropriate as loan growth and economic conditions change; account for the TDR classification refinement when comparing asset-quality trends.
- Review the assumptions behind rate-sensitivity scenarios, the LIBOR transition plan and the effect of rising funding costs on margin and asset values.
- Monitor the leverage strategy’s net contribution, borrowing limits and funding risks, along with maturities and renewal rates for certificates of deposit and public-unit deposits.
- Confirm the sustainability of the stated 100% earnings-payout intent and the Bank’s capacity to upstream capital while meeting regulatory requirements.