Capitol Federal Financial, Inc. — Q2 FY2012 10-Q
Business context and reporting period. Capitol Federal is a community-oriented savings institution focused primarily on residential mortgage lending in Kansas and Missouri, funded through retail deposits and borrowings. This unaudited report covers the quarter and six months ended March 31, 2012; the balance-sheet comparison is with September 30, 2011.
Financial results and condition
| Metric | Three months ended March 31, 2012 | Six months ended March 31, 2012 |
|---|---|---|
| Interest and dividend income | $83.3 million, down 2.0% year over year | $168.1 million, down 2.4% |
| Net interest income | $47.5 million, up 17.0% | $92.8 million, up 15.2% |
| Net income | $19.3 million, up 23.5% | $38.1 million, versus $4.4 million |
| Diluted earnings per share | $0.12, versus $0.10 | $0.24, versus $0.03 |
| Net interest margin | 2.06%, up 36 basis points | 2.02%, up 24 basis points |
The six-month net-income comparison is substantially affected by a $40.0 million contribution to the Capitol Federal Foundation in the prior-year period ($26.0 million after tax). Excluding that contribution, prior-year six-month net income was $30.4 million on the company’s non-GAAP presentation. The efficiency ratio was 40.96% for the quarter and 41.87% for the six-month period.
Balance sheet at March 31, 2012: Total assets were $9.57 billion, up $122.3 million from September 30. Net loans were $5.22 billion; deposits were $4.66 billion; FHLB advances, net, were $2.53 billion; and other borrowings were $365.0 million. Stockholders’ equity was $1.91 billion, or 20.0% of assets, down $27.1 million since September 30, primarily from dividends and share repurchases, partly offset by earnings.
Cash flow and liquidity: For the six months, operating activities provided $50.7 million, investing activities used $114.3 million, and financing activities provided $86.2 million. Cash and cash equivalents increased $22.6 million to $143.7 million. The Bank reported $942.3 million of excess FHLB borrowing capacity and $2.20 billion of eligible but unused securities collateral. The Bank’s regulatory capital ratios exceeded well-capitalized thresholds; tier 1 core capital was 14.5%, tier 1 risk-based capital 37.6%, and total risk-based capital 37.9%.
Material changes versus comparable periods
- Quarterly net income improved year over year, chiefly because interest expense fell 19.3% to $35.8 million. Lower deposit and borrowing costs more than offset lower interest income.
- Six-month net interest income rose $12.3 million, while the prior-year Foundation contribution makes reported net-income growth unusually large.
- Loans increased $74.4 million from September 30, mainly from residential originations and purchases. Deposits grew $161.8 million, led by checking and money market accounts. The average loan portfolio rate declined to 4.45% from 4.69%.
- Thirty-to-89-day delinquencies declined to $21.7 million from $26.8 million at September 30. Nonperforming loans were $30.4 million, or 0.58% of loans, versus $26.5 million, or 0.51%, including nonaccrual troubled debt restructurings (TDRs). Nonperforming assets were $42.2 million, or 0.44% of assets.
- The allowance for credit losses fell to $12.6 million from $15.5 million. Its coverage of nonperforming loans declined to 41.4% from 58.3%.
Outlook, risks, and unusual items
- No quantified earnings or growth guidance is provided. Management described moderate economic expansion, elevated unemployment, and a still-depressed housing sector; it cited local unemployment of 6.2% in Kansas and 7.4% in Missouri versus 8.2% nationally.
- Management expects any additional loan growth to be funded principally by deposit growth and/or repayments from securities. Two Kansas City-area branches were expected to open in calendar 2012.
- The Bank prepaid a $200 million FHLB advance bearing 3.88% and replaced it with a 46-month advance at a 0.86% contractual rate. The $7.9 million penalty is deferred and raises the replacement advance’s effective rate to 1.94%.
- In January 2012, the Bank changed its charge-off policy following OCC reporting requirements and charged off $3.5 million of prior-period special valuation allowances. The charge-offs did not affect current-period provision expense. The six-month credit-loss provision was $2.0 million.
- The Bank received a HUD notice concerning lender qualification guidelines. It expected a non-material civil penalty and non-monetary penalties, anticipated no impairment to FHA lending ability, and expected resolution in the June 2012 quarter.
- Credit exposure is concentrated in residential real estate, especially Kansas and Missouri; management identifies unemployment, falling property values, and borrower repayment capacity as key risks. Interest-rate risk is also material: modeled net interest income rises 1.64% under a +100-basis-point shock but falls 1.01% under +300 basis points; modeled market value of portfolio equity falls 20.78% under +300 basis points. These are scenario estimates, not management earnings guidance.
- The company paid $40.5 million in dividends and repurchased 2.20 million shares for $26.1 million during the six months. A quarterly dividend of $0.075 per share was declared April 20, 2012. The company had a $193 million repurchase authorization; $166.9 million remained at March 31. Subsequent repurchases were also disclosed.
- Management stated pending routine lawsuits were not expected to materially affect results. The filing reported no material changes to previously disclosed risk factors and no material subsequent events requiring adjustment.
Most important facts for investors to verify
- Whether lower funding costs can continue to support net interest income as assets reprice at lower yields and deposits respond to changing rates.
- Credit performance and reserve adequacy, including the rising nonperforming-loan ratio, TDR delinquency, purchased-loan losses, and reduced allowance coverage.
- The timing, terms, and financial impact of the HUD matter and the Bank’s continued ability to make FHA loans.
- Deposit retention and funding capacity, particularly certificate maturities, public-unit deposits, FHLB borrowing availability, and collateral requirements.
- Whether dividends and share repurchases remain sustainable given capital-distribution rules, the Bank’s capital needs, and the company’s remaining repurchase authorization.