Capitol Federal Financial, Inc. — Form 10-Q
Reporting period: Second fiscal quarter and six months ended March 31, 2023. The filing is unaudited; amounts are consolidated and generally in U.S. dollars.
Business context and financial performance
The company is a bank holding company whose results primarily reflect Capitol Federal Savings Bank. Its lending is concentrated in one- to four-family residential loans, with growing commercial real estate and construction lending.
- Six months: Net income was $30.4 million, or $0.23 per diluted share, versus $43.8 million, or $0.32, a year earlier. Net interest income was $87.8 million, down from $92.7 million; interest and dividend income rose to $180.9 million from $126.7 million, but interest expense increased to $93.1 million from $34.0 million.
- Quarter ended March 31: Net income was $14.2 million, or $0.11 per diluted share, compared with $21.6 million, or $0.16, a year earlier and $16.2 million, or $0.12, in the preceding quarter. Net interest income was $42.0 million, versus $47.1 million a year earlier and $45.8 million in the preceding quarter.
- Margins and efficiency: Six-month net interest margin was 1.59%, versus 1.83% a year earlier; excluding the leverage strategy, it was 1.79% versus 2.00%. Second-quarter margin was 1.56%, down from 1.69% a year earlier and 1.61% in the preceding quarter. The six-month efficiency ratio rose to 57.43% from 52.74%.
- Balance sheet at March 31: Assets were $10.09 billion; net loans $7.96 billion; AFS securities $1.51 billion; deposits $6.14 billion; borrowings $2.70 billion; and stockholders’ equity $1.07 billion. Net loans grew $494.4 million and deposits declined $50.4 million from September 30, 2022; borrowings increased $564.5 million.
- Credit and cash flow: The allowance for credit losses was $19.9 million, or 0.25% of net loans, compared with $16.4 million, or 0.22%, at September 30, 2022. Six-month provision expense was $4.6 million versus a $6.6 million provision release a year earlier. Net charge-offs were $16,000. Six-month operating cash flow was $24.7 million; investing cash outflow was $424.3 million and financing cash inflow was $410.5 million. Cash and cash equivalents ended at $60.2 million.
Material changes and management commentary
- Higher loan and cash yields lifted interest income, but sharp increases in borrowing and deposit costs more than offset the gains, compressing net interest margin and earnings. Management expects margin compression to continue.
- Loan growth was concentrated in correspondent residential mortgages and commercial loans. Management said it was working to reduce new correspondent purchases to near zero and limit balance-sheet growth.
- Money market deposits fell $284.5 million over the six months, partly offset by a $226.3 million increase in retail certificates of deposit. Management attributed outflows to customers seeking higher yields or spending funds. Approximately 10% of the Bank’s Call Report deposits—about $634.7 million—were estimated to be uninsured.
- The Bank used a short-term borrowing-and-deposit leverage strategy during the period; those borrowings had been repaid before March 31. Management expects to use the strategy when profitable and when capacity is not needed for operating needs.
- After quarter-end, the Bank repaid its FHLB line-of-credit borrowings and borrowed $500 million under the Federal Reserve Bank Term Funding Program, citing more favorable rates.
- The Bank exceeded $10 billion in assets at March 31 and may do so again at June 30. Management expects assets to be below $10 billion at September 30, 2023; it cited potential regulatory burdens and lost interchange revenue from sustained threshold crossings.
- Management expects the new core processing system to be operational by September 2023. It forecast fiscal 2023 technology expense of approximately $24 million, about $6 million above fiscal 2022, and fiscal 2024 technology expense about $3 million lower than fiscal 2023. Management expects fiscal 2023 salaries and benefits to remain flat year over year, FDIC insurance expense to increase about $1.3 million, and an effective tax rate near 19%.
Outlook, risks and contingencies
- Management estimated that higher money-market rates, the full-quarter effect of a certificate-of-deposit promotion, and repricing of deposits and FHLB advances—partly offset by higher loan yields—could reduce net interest margin by approximately 20 basis points in the June 2023 quarter, excluding the leverage strategy.
- The Bank’s estimated additional liquidity at March 31 was $2.85 billion. Its one-year interest-rate gap was negative $803.5 million, or 8.0% of assets, indicating more liabilities than assets expected to reprice within one year. Interest-rate and funding-cost changes remain important risks.
- AFS securities had $165.9 million of gross unrealized losses, attributed to higher market yields. Management reported no intent or expected requirement to sell the securities before recovery of amortized cost. AOCI included a $125.3 million after-tax unrealized loss on AFS securities.
- Asset quality indicators remained low: loans 30–89 days delinquent were 0.11% of net loans; loans 90 or more days delinquent or in foreclosure were 0.07%; and nonperforming assets were 0.06% of assets. Commercial special-mention loans increased from September 2022, mainly due to two loans in one relationship. Commercial real estate concentrations, economic conditions, and collateral values remain risks.
- The Bank’s community bank leverage ratio was 9.7%, above the 9.0% minimum. The company declared a regular $0.085-per-share quarterly dividend payable May 19, 2023. Dividend capacity depends in part on regulatory limits on Bank distributions.
- A putative class action alleging improper overdraft fees was dismissed with prejudice on April 5, 2023; the decision remained subject to appeal. Management said other pending legal actions were not expected to have a material adverse effect.
Most important facts for investors to verify
- Whether deposit outflows and deposit repricing continue, and how they affect funding costs and net interest margin.
- Whether management’s estimated 20-basis-point June-quarter margin decline and full-year expense outlook materialize.
- Commercial real estate exposures, classified-loan trends, credit-loss assumptions, and the adequacy of the allowance as the loan portfolio grows.
- Uninsured deposit levels, available borrowing capacity, and the cost and terms of the post-quarter-end $500 million BTFP borrowing.
- The Bank’s asset level relative to $10 billion, associated regulatory implications, and progress in reducing correspondent loan purchases.
- The scale and potential effect of AFS unrealized losses, capital and dividend capacity, and the status of the overdraft-fee case on appeal.