Capitol Federal Financial, Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and six months ended March 31, 2016, the second quarter and first half of fiscal 2016. Capitol Federal is a community-oriented savings institution primarily funding residential mortgage lending with retail deposits; it also invests in securities and is expanding commercial and multifamily lending.
Financial performance and position
- Quarter: Net income was $21.5 million, or $0.16 per diluted share, up 11.9% from $19.2 million, or $0.14, a year earlier. Net interest income increased 3.8% to $48.5 million; net interest margin rose to 1.78% from 1.71%. The efficiency ratio improved to 42.46% from 43.91%.
- First half: Net income was $42.2 million, or $0.32 per diluted share, up 6.4% from $39.7 million, or $0.29. Net interest income was $96.5 million versus $94.8 million; net interest margin was 1.76% versus 1.73%. The efficiency ratio improved to 43.25% from 43.66%.
- Income drivers: First-half interest and dividend income increased 0.8% to $150.0 million, while interest expense declined 0.9% to $53.5 million. Non-interest income rose 15.7% to $12.2 million, chiefly due to bank-owned life insurance (BOLI); non-interest expense increased 2.2% to $47.0 million. No provision for credit losses was recorded in the first half, compared with $448,000 a year earlier.
- Balance sheet at March 31: Assets were $9.32 billion, down from $9.84 billion at September 30, 2015. Net loans were $6.77 billion, up $144.2 million; deposits were $5.12 billion, up $287.3 million. FHLB borrowings were $2.47 billion, down from $3.27 billion; repurchase agreements remained $200 million. Stockholders’ equity was $1.40 billion, and equity was 15.1% of assets.
- Cash flow and liquidity: First-half operating cash flow was $43.7 million; investing cash flow was negative $34.7 million and financing cash flow negative $577.8 million. Cash and equivalents ended at $203.8 million, down $568.8 million from the fiscal-year opening balance, principally reflecting the quarter-end removal of the daily leverage strategy. The company reported $992.7 million of eligible, unused securities collateral for borrowing or other liquidity needs.
- Credit quality and capital: Non-performing loans were $25.7 million, or 0.38% of loans; non-performing assets were $31.6 million, or 0.34% of assets. The allowance for credit losses was $9.2 million, 0.14% of net loans. The Bank’s Tier 1 leverage ratio was 11.3%; its total capital ratio was 30.0%. Both the Bank and Company exceeded stated regulatory capital requirements.
Material changes and management commentary
- Management said loan growth was funded largely by securities cash flows and deposit growth. First-half originations/refinances totaled $348.3 million, correspondent loan purchases $291.9 million, and commercial/multifamily participations $112.0 million.
- Commercial and multifamily loans and construction commitments totaled $334.1 million, including $68.5 million of outstanding commitments. Management intends to continue growing this portfolio. Accommodation and food services represented 42.7% of the reported commercial/multifamily exposure and commitments; Texas represented 44.5% geographically.
- The daily leverage strategy was removed at March 31, reducing reported cash, FHLB stock and borrowings, and reinstated in full on April 1, 2016. Management said it intended to remove and reinstate the strategy at fiscal quarter-ends during fiscal 2016.
- Quarterly earnings benefited from $1.2 million of additional BOLI income versus the prior-year quarter, including a death benefit. First-half BOLI income rose $1.6 million year over year, also reflecting a new BOLI investment.
- Management estimated fiscal 2016 salary and benefits expense would increase approximately $500,000 from fiscal 2015, and IT and communications expense approximately $700,000. It estimated a fiscal 2016 effective tax rate of about 32%. These are management estimates, not earnings guidance.
Outlook, risks and contingencies
Management identified interest-rate risk as its most significant market risk. Its modeled four-quarter net interest income increased 0.12% under a +100 basis-point shock but declined 0.91% under +200 basis points and 3.16% under +300 basis points. Risks also include deposit pricing and retention, loan demand, funding access and cost, credit losses, real-estate values, and the larger, geographically broader commercial construction and participation exposures. A substantial portion of loans are fixed-rate while many deposits reprice or mature sooner.
Management anticipated most maturing retail certificates would renew or move to other Bank products, and most maturing public-unit deposits would be replaced, but gave no assurance. The company said dividend capacity depends on Bank distributions and regulatory conditions; management intended to maintain a 100% earnings payout in fiscal 2016, subject to those constraints. A $70 million share repurchase authorization remained unused at March 31. Pending ordinary-course legal matters were not expected by management to have a material adverse effect; disclosed risk factors were unchanged from the prior 10-K.
Important facts for investors to verify
- Whether loan growth and commercial/multifamily commitments continue without deterioration in delinquency, charge-off, or collateral trends.
- How deposit costs, certificate renewals, and wholesale funding needs develop as rates change, and the earnings effect of the daily leverage strategy after its April 1 reinstatement.
- Whether BOLI-related income is repeatable; the reported period included death-benefit income and a new investment.
- Whether regulatory capital and Bank distribution capacity support the stated dividend policy and any future repurchases.
- Progress and costs for the Kansas City operations-center remodel, and execution of management’s expense and tax-rate estimates.