Capitol Federal Financial, Inc. annual report, FY2012

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Capitol Federal Financial, Inc. — FY2012 Form 10-K

Business context and reporting period. This annual filing covers the fiscal year ended September 30, 2012, not a standalone fourth quarter. Capitol Federal Financial is a bank holding company whose principal subsidiary, Capitol Federal Savings Bank, operates primarily in Kansas and Missouri. The Bank focuses on retail deposits and residential mortgage lending; 95.5% of loans receivable were one- to four-family residential loans.

Key financial metrics

  • Revenue, earnings, margins and cash flow: The supplied filing text refers to the consolidated financial statements and annual report but does not provide clear values for revenue, net income, net interest income, net interest margin, or operating cash flow.
  • Loans: Gross loans receivable rose $453.3 million, or about 8.7%, to $5.65 billion from $5.20 billion. Growth was driven largely by $629.8 million in one- to four-family loan purchases, including correspondent and bulk purchases. Net loans were $5.61 billion.
  • Deposits: Deposits increased $55.5 million to $4.55 billion. Non-certificate deposits grew to $1.98 billion, while certificates declined to $2.57 billion. Brokered deposits were $83.7 million, about 2% of deposits; public-unit deposits were $192.6 million, about 4%.
  • Investments: Investment securities totaled $961.8 million, down $482.6 million year over year, primarily due to maturities and calls. Mortgage-backed securities totaled $2.33 billion, down $79.1 million. Combined investment securities and MBS were approximately $3.29 billion.
  • Borrowings and liquidity: FHLB advances were $2.55 billion and repurchase agreements were $365.0 million, about 4% of total assets. Total assets were $9.32 billion. Management described deposits as a stable funding source and reported no discount-window borrowings at year-end.
  • Credit quality: Non-performing loans were $31.8 million, or 0.57% of loans, versus $26.5 million and 0.51% a year earlier. Non-performing assets were $39.9 million, or 0.43% of assets. The allowance for credit losses was $11.1 million, 0.20% of loans and 34.9% of non-performing loans, compared with $15.5 million and 0.30% at September 30, 2011.
  • Credit costs: The Bank recorded a $2.0 million provision for credit losses. Net charge-offs were $6.4 million, including $3.5 million of specific valuation allowances charged off following a change in regulatory reporting requirements; excluding those items, management reported net charge-offs of $2.9 million.
  • Capital: The Bank reported a 14.6% Tier 1 leverage ratio, 36.4% Tier 1 risk-based capital ratio and 36.7% total risk-based capital ratio, and was considered well capitalized.

Material changes versus the prior year

  • Loan growth accelerated, with total loan purchases and participations of $644.3 million versus $182.0 million in FY2011. Bulk purchases included a $342.5 million August 2012 package with seller recourse if a loan became 60 days delinquent.
  • Investment securities declined materially as maturities and calls exceeded purchases. Deposit growth also slowed, to $55.5 million from $108.9 million.
  • Reported allowance coverage fell partly because the OCC’s Call Report requirements led to a new charge-off policy and the removal of $3.5 million of previously recorded specific valuation allowances. These charge-offs did not create an additional income-statement expense in FY2012.
  • Reported non-performing loans increased in part because OCC guidance required certain Chapter 7 bankruptcy-discharge loans without borrower reaffirmation to be classified as troubled debt restructurings and nonaccrual, even when current. The Bank identified $8.9 million of such loans; $6.0 million of newly reported TDRs were current at year-end.
  • The Bank repurchased 2.98 million shares during the September 2012 quarter under a $193 million authorization. At quarter-end, approximately $44.0 million remained available under the plan.

Outlook, risks and unusual items

  • Management expected to open one branch in the Kansas City market area in calendar 2013 and continued to consider expansion. The filing provides no quantitative earnings or revenue guidance.
  • Key risks include interest-rate and yield-curve changes, the concentration of lending in Kansas and Missouri, housing-market weakness, credit losses on older purchased loans, and sensitivity to deposit competition and funding costs.
  • The portfolio is predominantly long-term, fixed-rate residential lending. Management cited a positive one-year interest-rate gap of 22.8% of assets; rising rates could benefit near-term net interest income, while falling rates could reduce it. Rate changes may also affect securities values, mortgage prepayments and ARM borrower payment burdens.
  • Roughly 70% of loans were secured by Kansas properties and 15% by Missouri properties. Older bulk-purchased loans remained a credit concern; $9.4 million of purchased loans 90 or more days delinquent or in foreclosure had been originated in 2004 or 2005.
  • About $3.06 billion, or 33% of assets, consisted of securities issued or guaranteed by Fannie Mae or Freddie Mac. Management noted uncertainty around the agencies’ future support and guarantees.
  • The filing describes proposed Basel III and related capital-rule changes but says final rules and timing were uncertain. It also warns that regulatory changes and FDIC assessments could increase costs.
  • The Company’s ability to pay dividends depends substantially on the Bank’s ability to distribute capital, subject to regulatory requirements. The filing reports a $26.6 million special year-end dividend for 2012, based on shares eligible on the November 23 record date.
  • Management stated that pending legal actions were not expected to have a material adverse effect on financial condition, results or liquidity. No securities were identified as other-than-temporarily impaired.

Most important facts for investors to verify

  • Review the incorporated annual report and audited financial statements for FY2012 revenue, net income, earnings per share, net interest income and margin, and operating cash flow; the supplied text does not state clear values.
  • Assess whether the large increase in loan purchases, particularly the August bulk package, changes future credit costs or concentration risk, and confirm the scope and enforceability of seller recourse.
  • Evaluate allowance adequacy and the effect of the OCC classification changes on reported non-performing loans, TDRs and charge-offs.
  • Check the maturity, repricing, duration and fair-value sensitivity of the loan, MBS and investment portfolios, along with the cost and maturity profile of FHLB advances and repurchase agreements.
  • Confirm dividend sustainability, remaining share-repurchase authorization and the extent of regulatory approval required for Bank capital distributions.