Capitol Federal Financial, Inc. — Form 10-Q Summary
Business context and reporting period. This 10-Q covers the fiscal third quarter and nine months ended June 30, 2019. Capitol Federal is a Kansas-focused community banking company; its results are driven primarily by net interest income. The Bank completed integration of Capital City Bank in April 2019 following the August 2018 acquisition, expanding commercial lending, deposits, trust and brokerage services.
Key financial metrics
| Metric | Quarter ended June 30, 2019 | Nine months ended June 30, 2019 |
|---|---|---|
| Net interest income | $51.7 million, versus $49.4 million | $156.6 million, versus $148.7 million |
| Provision for credit losses | $0.45 million, versus zero | $0.45 million, versus zero |
| Net income | $22.9 million, versus $22.4 million | $71.8 million, versus $77.5 million |
| Diluted EPS | $0.17, unchanged | $0.52, versus $0.58 |
| Net interest margin | 2.29%, versus 1.92% a year earlier and 2.33% in the prior quarter | 2.30%, versus 1.87% |
| Non-interest expense | $27.7 million, up 13.0% year over year | $80.6 million, up 14.9% |
| Efficiency ratio | 48.28%, versus 44.68% a year earlier | 46.68%, versus 42.54% |
Amounts are in U.S. dollars. Total assets at June 30 were $9.29 billion, down $163.3 million from September 30, 2018. Net loans were $7.51 billion, broadly unchanged; one- to four-family loans declined $229.1 million while commercial loans grew by a similar amount to $798.7 million. Deposits were $5.58 billion, down 0.4% from fiscal year-end. Borrowings were $2.24 billion, including $2.14 billion of FHLB borrowings and $100 million of other borrowings.
For the nine months, operating cash flow was $55.5 million, compared with $90.1 million; investing activities provided $90.4 million, versus using $42.2 million; financing activities used $214.9 million, versus $217.5 million. Cash, cash equivalents and restricted cash totaled $70.1 million at period-end, including $27.0 million of restricted cash posted as derivative collateral. Stockholders’ equity was $1.33 billion. The Bank’s total capital ratio was 24.0%, and its tier 1 leverage ratio was 12.4%; both exceeded regulatory well-capitalized thresholds.
Material changes versus comparable periods
- Quarterly net income rose $0.5 million year over year, as higher net interest income and lower income tax expense more than offset higher non-interest expense. Sequentially, net income declined from $24.6 million to $22.9 million, primarily due to higher expense and interest costs.
- Nine-month net income fell 7.4%. Higher non-interest expense and the prior-year benefit from the Tax Act’s deferred-tax revaluation more than offset improved net interest income. CCB-acquired commercial loans contributed to higher loan yields and net interest income.
- Nine-month non-interest expense increased $10.5 million, mainly from CCB employee and integration costs, technology, occupancy and amortization of acquired deposit intangibles. The efficiency ratio worsened.
- The one- to four-family portfolio contracted while commercial lending expanded. Commercial loans increased from $569.6 million at September 30, 2018 to $798.7 million at June 30, 2019.
- Stockholders’ equity declined $64.5 million from fiscal year-end, chiefly reflecting $123.2 million in dividends, partly offset by $71.8 million of net income and other equity movements. AOCI shifted from $4.3 million of income to a $12.5 million loss, including losses on cash flow hedges.
Outlook, commentary and risks
- Management expected net interest margin to decrease in the quarter ending September 30, 2019 if rates stayed at then-current levels or fell, as loan and securities yields could reprice down faster than deposits and borrowings. It expected non-interest income and expense to remain generally consistent with prior periods. Management estimated a fiscal 2019 effective tax rate of approximately 22%.
- Management intended to reduce public-unit certificates of deposit to approximately $300 million by September 30, 2019, from $342.9 million at June 30, and to use lower-cost commercial deposits where available. It cited possible consideration of a lower cash-and-securities-to-assets target.
- The Bank’s leverage strategy was suspended for much of the nine-month period because the spread between FHLB borrowing costs and cash returns made it unprofitable. Strategy-related net income was $14,000, versus $1.7 million a year earlier; management would consider restarting it if profitable.
- Credit quality remained generally low-risk by reported delinquency measures, but a $50 million commercial real estate loan tied to a recently opened hotel and convention center was classified special mention. Management cited below-policy debt-service coverage, slower-than-expected surrounding development and construction delays; the borrower group provided personal guarantees. Management was monitoring the exposure. The quarter’s $450,000 provision reflected this classification and commercial loan growth.
- Interest-rate risk is significant: management’s modeled net interest income declined 3.55% under an immediate +200-basis-point shock, and modeled portfolio equity declined 14.44%. These are scenario estimates, not forecasts. The loan portfolio is concentrated in one- to four-family mortgages and geographically in Kansas and Missouri; commercial exposure also includes meaningful accommodation/food services and health-care lending.
- Management reported no material expected adverse effect from pending litigation and no material changes to previously disclosed risk factors. Dividend capacity remains subject to regulatory restrictions and the Bank’s ability to distribute capital.
Most important facts for investors to verify
- Whether commercial loan growth, especially the hotel/convention-center exposure and related commitments, affects asset quality, provision needs or concentration risk.
- Whether CCB integration costs moderate and whether acquired commercial and trust businesses deliver the anticipated earnings and funding benefits.
- Whether deposit pricing, public-unit certificate runoff and deposit retention meet management’s targets, and how funding costs affect net interest margin.
- Whether the projected margin pressure and interest-rate sensitivities develop as described, including mortgage prepayment and securities-premium amortization effects.
- Whether dividend distributions remain supportable given earnings, capital requirements, regulatory approvals and the company’s stated payout policy.
- Cash-flow comparability: nine-month results include a substantially different use of the leverage strategy than the prior year; evaluate operating performance separately from that strategy.