Capitol Federal Financial, Inc. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended March 31, 2015. Unless otherwise noted, amounts are in U.S. dollars; balance-sheet comparisons are to September 30, 2014.
Business context
Capitol Federal is a community-oriented savings institution whose principal business is funding residential mortgage lending with retail deposits. Its portfolio is concentrated in one- to four-family mortgages, with significant exposure to Kansas and Missouri. The filing is unaudited interim financial information.
Financial performance and position
- Quarterly results: Net income was $19.2 million, down 2.3% from $19.7 million a year earlier; diluted EPS was $0.14, unchanged. Net interest income was $46.8 million, up $1.1 million. Total interest and dividend income was $73.9 million; non-interest income was $5.3 million; non-interest expense was $22.9 million.
- Six-month results: Net income was $39.7 million, up 5.9% from $37.5 million; diluted EPS was $0.29 versus $0.26. Net interest income increased to $94.8 million from $90.0 million. Total interest and dividend income was $148.8 million, while non-interest expense was $46.0 million.
- Margins and efficiency: Net interest margin was 1.71% for the quarter versus 2.07% a year earlier, and 1.73% for six months versus 2.02%. Management said margins excluding the daily leverage strategy were 2.04% for the quarter and 2.08% for six months. The six-month efficiency ratio improved to 43.66% from 44.09%; the quarterly ratio increased to 43.91% from 42.42%.
- Balance sheet: Total assets were $10.02 billion, up from $9.87 billion. Net loans grew 2.1% to $6.37 billion; deposits rose $182.0 million to $4.84 billion. Cash and cash equivalents were $1.02 billion, up from $810.8 million.
- Debt and liquidity: FHLB borrowings were $3.37 billion and repurchase agreements were $220.0 million. The Bank had $800.0 million outstanding on its FHLB line of credit at 0.25% at quarter-end. Cash, available borrowing capacity, and $1.14 billion of eligible unused securities collateral supported liquidity. Of $2.61 billion in certificates of deposit, $1.18 billion was scheduled to mature within one year.
- Cash flow: Six-month operating cash flow was $44.2 million; investing activities provided $55.3 million and financing activities provided $110.8 million. Cash increased $210.3 million to $1.02 billion.
- Credit quality: Non-performing loans were $27.9 million, or 0.44% of loans, versus $24.9 million, or 0.40%, at September 30, 2014. Non-performing assets were $32.6 million, or 0.32% of assets, versus $29.0 million, or 0.29%. The allowance for credit losses was $9.4 million, 0.15% of loans; the six-month provision was $448,000.
- Capital and shareholder returns: Stockholders’ equity was $1.48 billion, down $16.2 million, primarily from dividends and repurchases, partly offset by earnings. The Bank and Company exceeded regulatory well-capitalized requirements; the Bank’s tier 1 leverage ratio was 11.6% and total capital ratio was 32.0%. Six-month dividends paid were $57.3 million. Management intended to maintain a 100% earnings payout for fiscal 2015, subject to regulatory and other constraints.
Material changes and management commentary
- Six-month net income improved on higher interest income, while quarterly net income declined due to higher expenses and lower non-interest income, partly offset by higher net interest income.
- The daily leverage strategy, begun in fiscal 2014, borrows through the FHLB line and places proceeds, net of required FHLB stock, at the Federal Reserve Bank. It materially affects reported average balances and margins. Management reported strategy-related net income of $682,000 for the quarter and $1.5 million for six months; its pre-tax yield was 0.20% and 0.21%, respectively. The strategy is intended to be adjusted to avoid remaining above $10 billion in assets in future quarters.
- Low-income housing partnership expense rose $1.5 million for six months, including impairment and amortization. Management expected fiscal 2015 expense to increase approximately $2.6 million versus fiscal 2014. Management estimated the fiscal 2015 effective tax rate at approximately 32%–33% and low-income housing tax-credit benefits at $4.3 million.
- Loan growth was primarily in correspondent-purchased residential mortgages. Most loans are fixed rate while many retail deposits reprice or mature within two years, creating interest-rate and funding sensitivity.
- Management reported no material subsequent events, no material change in off-balance-sheet arrangements or contractual obligations, and no material change in previously disclosed risk factors. Pending legal matters were not expected by management to have a material adverse effect. Disclosure controls were concluded to be effective.
Outlook, risks and unusual items
- No formal earnings or revenue guidance was provided. Management’s estimates for fiscal 2015 expenses and effective tax rate are noted above.
- Interest-rate risk is significant: the Bank projected net interest income declines under parallel rate increases of 100, 200 and 300 basis points of 0.27%, 1.86% and 4.84%, respectively, over a cumulative four-quarter period. Estimated market value of portfolio equity declined 5.98%, 14.90% and 24.96% under the same shocks. These are modeled sensitivities, not management earnings forecasts.
- Key risks include interest-rate and mortgage-prepayment movements; deposit retention and funding costs; loan demand, delinquencies, collateral values and allowance estimates; concentration in residential lending and regional markets; regulatory limits on Bank distributions to the holding company; and execution and costs of the leverage strategy.
- At March 31, 2015, assets temporarily exceeded $10 billion, a regulatory threshold. Management said it did not expect to exceed it in future quarters or trigger additional requirements because the threshold had not been exceeded for four consecutive quarters.
- The Bank had $10.3 million of agreements outstanding for a Kansas City operations-center renovation; additional project costs could continue through early fiscal 2017. Management expected the completed project to reduce utility and maintenance expenses.
Important facts for investors to verify
- How much of reported earnings and margin is attributable to the daily leverage strategy, and whether its funding, regulatory approval and economics remain sustainable.
- Deposit renewals and replacement of near-term maturities, including the brokered deposits maturing in one month at quarter-end and the $1.18 billion of certificates due within a year.
- Trends in non-performing loans, delinquent and restructured loans, charge-offs, and adequacy of the $9.4 million allowance.
- Whether increased low-income housing partnership impairments and amortization match management’s fiscal 2015 estimate, and the related tax-credit realization.
- Dividend capacity and the stated 100% payout intent in light of regulatory restrictions, capital needs and the Bank’s ability to distribute funds to the holding company.
- Interest-rate sensitivity assumptions and the effects of rising rates on mortgage prepayments, asset values, funding costs and net interest income.