Capitol Federal Financial, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter ended June 30, 2015, with nine-month results for the period ended June 30, 2015. The filing was signed August 4, 2015. Amounts below are in U.S. dollars; financial statement amounts are rounded to millions unless noted.
Business context and financial performance
Capitol Federal is a community-oriented savings institution whose principal business is residential mortgage lending funded mainly by retail deposits. Its portfolio is concentrated in one- to four-family mortgages, with significant exposure to Kansas and Missouri. The Bank accounts for almost all consolidated assets and liabilities.
| Metric | Q3 FY2015 | Comparable period | Nine months FY2015 | Comparable period |
|---|---|---|---|---|
| Net interest income | $47.0m | $46.2m, Q3 FY2014 | $141.8m | $136.2m, nine months FY2014 |
| Net income | $19.6m | $20.0m, Q3 FY2014 | $59.3m | $57.5m, nine months FY2014 |
| Diluted EPS | $0.14 | $0.14 | $0.43 | $0.41 |
| Net interest margin | 1.71% | 2.09%, Q3 FY2014 | 1.72% | 2.04%, nine months FY2014 |
| Non-interest income | $5.1m | $5.6m, Q3 FY2014 | $15.7m | $16.8m, nine months FY2014 |
| Non-interest expense | $23.1m | $22.4m, Q3 FY2014 | $69.1m | $67.0m, nine months FY2014 |
Q3 net income declined 1.9% year over year as lower non-interest income and higher expenses more than offset the benefit from the daily leverage strategy. Nine-month net income rose 3.2%, primarily due to that strategy. Excluding its effect, management reported net interest margin of 2.05% for Q3 and 2.07% for the nine-month period. The Q3 efficiency ratio was 44.30%, versus 43.19% a year earlier; the nine-month ratio was 43.88%, versus 43.78%.
Financial position, cash flow and asset quality
- Balance sheet: Total assets were $9.13bn at June 30, 2015, down $733.8m from September 30, 2014. Net loans rose $263.3m, or 4.2%, to $6.50bn. Deposits increased $157.9m, or 3.4%, to $4.81bn.
- Funding and liquidity: FHLB borrowings were $2.57bn and repurchase agreements were $220.0m; stockholders’ equity was $1.43bn. Cash and cash equivalents fell to $46.7m from $810.8m, chiefly because the daily leverage strategy was removed at quarter-end. The full strategy was reinstated July 1, 2015. The Bank reported $1.27bn of securities eligible but unused as borrowing collateral and $320.4m of public unit deposits; it had no brokered deposits.
- Cash flows, nine months: Operating activities provided $62.2m, investing activities used $31.2m, and financing activities used $795.2m. Cash decreased $764.2m to $46.7m. Financing outflows included $102.8m of dividends and $29.8m of share repurchases; borrowing proceeds and repayments were $5.4bn and $6.2bn, respectively.
- Credit quality: Non-performing loans were $25.1m, or 0.39% of loans; non-performing assets were $30.0m, or 0.33% of assets. The allowance for credit losses was $9.6m, or 0.15% of loans. Nine-month provision expense was $0.8m and net charge-offs were $0.4m.
- Capital: The Company and Bank exceeded regulatory well-capitalized requirements. At the Bank, the tier 1 leverage ratio was 11.3% and total capital ratio was 31.0%; corresponding Company ratios were 12.6% and 34.7%.
Material changes, outlook and risks
- The daily leverage strategy involves short-term FHLB line borrowings invested largely in Federal Reserve Bank deposits and FHLB stock. It generated $0.7m of Q3 net income and $2.2m over nine months, but reduced reported NIM. The strategy was absent at June 30 and fully reinstated July 1; this also explains much of the quarter-end decline in assets, cash and borrowings.
- Management attributed loan growth largely to correspondent mortgage purchases. New loan production and purchases carried lower average rates than the existing portfolio, contributing to a lower total loan yield. Mortgage-backed securities balances and income also declined as principal cash flows were used largely to fund loan growth.
- Management estimated a fiscal 2015 effective tax rate of approximately 32%–33%, anticipated retail fee income about $0.1m below fiscal 2014, and expected low-income-housing partnership expense to rise approximately $2.6m year over year. Management stated its intent to pay out 100% of fiscal 2015 earnings, subject to financial, regulatory and other conditions. A regular quarterly dividend of $0.085 per share was declared July 22, 2015.
- Interest-rate exposure is material. The Bank’s modeled four-quarter net interest income declined 1.47% under a +100 basis-point shock and 6.45% under +300 basis points; modeled market value of portfolio equity declined 8.90% and 31.44%, respectively. Management cautioned these estimates depend on assumptions and are not earnings guidance.
- Key risks include interest-rate and mortgage prepayment changes, deposit competition and retention, wholesale funding access, local economic and real-estate conditions, loan credit losses, regulatory limits on Bank distributions to the parent, and the execution and expense of business initiatives. The filing reported no material change to previously disclosed risk factors, no material subsequent event requiring adjustment, and no pending litigation expected by management to have a material adverse effect.
Important facts for investors to verify
- Whether the reinstated daily leverage strategy continues to contribute positively to earnings after funding costs, regulatory fees and balance-sheet effects.
- Loan growth, production yields and credit performance, especially in correspondent-purchased mortgages and interest-only adjustable-rate loans; $20.7m of interest-only loans remained in their initial payment period at June 30, 2015.
- Deposit retention and repricing as certificates mature: $1.19bn of certificates of deposit was scheduled to mature within one year.
- Actual margin and earnings sensitivity to rate changes, compared with the filing’s model estimates and assumptions.
- The sustainability of the stated dividend payout intent, given capital-distribution rules, cash at the holding company and ongoing share repurchases.