Business context and reporting period
Capitol Federal Financial, Inc. is a bank holding company whose primary business is residential mortgage lending, funded by retail deposits, FHLB borrowings and repurchase agreements. This unaudited Form 10-Q covers the quarter and six months ended March 31, 2018; balance-sheet comparisons are to September 30, 2017.
Financial performance and condition
- Quarterly results: Net income was $23.3 million, or $0.17 per diluted share, versus $21.6 million, or $0.16, in the March 2017 quarter. Net interest income was $49.9 million; total interest and dividend income was $81.8 million.
- Six-month results: Net income was $55.2 million, or $0.41 per diluted share, versus $42.2 million, or $0.31, a 30.8% increase. Net interest income rose to $99.3 million from $96.4 million. Total interest and dividend income increased 6.2% to $162.4 million, while non-interest expense increased 4.8% to $45.6 million.
- Margins and expenses: Net interest margin was 1.86% for the quarter and 1.85% for the six months, up from 1.80% and 1.77%, respectively, a year earlier. The six-month efficiency ratio rose to 41.47% from 40.61%; quarterly ratio was 42.66% versus 40.16%.
- Assets and lending: Total assets were $9.12 billion, down $76.5 million from September 30. Net loans were $7.20 billion, essentially unchanged. Deposits increased $44.3 million to $5.35 billion. Cash and cash equivalents fell $211.1 million to $140.6 million; securities totaled $1.28 billion at amortized cost.
- Debt and capital: FHLB borrowings were $2.17 billion and repurchase agreements were $100.0 million, down from $200.0 million. Stockholders’ equity was $1.36 billion; equity was 15.0% of assets. The Bank’s regulatory ratios exceeded well-capitalized thresholds: Tier 1 leverage 10.9%, CET1 27.1%, Tier 1 capital 27.1% and total capital 27.3%.
- Cash flows and credit: Six-month operating cash flow was $66.8 million; investing cash use was $151.5 million and financing cash use was $126.3 million. Cash decreased $211.1 million. No provision for credit losses was recorded; net charge-offs were $8,000 for the six months. Non-performing loans were 0.20% of total loans and non-performing assets were 0.17% of assets at March 31.
Material changes versus comparable periods
- The higher six-month net income primarily reflected lower income tax expense following the Tax Act, rather than a comparable increase in pre-tax earnings. Six-month pre-tax income was $64.4 million versus $63.7 million.
- The Company recorded a $7.5 million reduction in tax expense in the December 2017 quarter from revaluing deferred tax assets and liabilities after the federal corporate tax rate reduction. Six-month effective tax rate was 14.4%, versus 33.8% a year earlier.
- Net interest margin improved as asset yields increased and the asset mix shifted toward loans; higher funding costs partly offset this. Interest expense increased 11.5% for the six months, including higher deposit and FHLB borrowing costs.
- Information technology expense rose, partly reflecting reclassification of professional and consulting costs and continued online banking enhancements. A one-time employee Tax Savings Bonus Plan is expected to cost approximately $1.0 million in fiscal 2018.
Outlook, commentary, risks and unusual items
- Management estimated an effective tax rate of 20%–21% for fiscal 2018 and approximately 22% for fiscal 2019. No formal earnings guidance was provided.
- Management targets liquidity of 15% and said significant loan growth was unlikely in the current environment. The Company continued a leverage strategy using short-term FHLB funding and FRB deposits; management reported the strategy’s net interest spread was negative and may suspend it if the spread worsens. Quarter-end balances do not reflect the strategy’s full in-quarter activity.
- Interest-rate risk is material: modeled +200 basis-point rates would reduce four-quarter net interest income 2.75% and market value of portfolio equity 26.11% from base case at March 31. These are model estimates, not management earnings forecasts.
- Credit and concentration risks include the large one- to four-family portfolio, geographic exposure in Kansas and Missouri, and growth in commercial real estate participations. Approximately $162.4 million of commercial real estate loan amounts were undisbursed; much of this related to construction lending.
- On April 30, 2018, the Company announced an agreement to acquire Capital City Bancshares for an aggregate stated deal value of $37.5 million in stock. Closing was expected by the end of October 2018, subject to customary conditions and regulatory approvals.
- Management said pending legal matters were not expected to have a material adverse effect, and reported no material changes to previously disclosed risk factors. Dividend distributions remain subject to regulatory limits; management intended to pay out 100% of fiscal 2018 earnings, subject to applicable conditions.
Important facts for investors to verify
- How much of the reported earnings increase is attributable to the one-time $7.5 million tax revaluation, and whether management’s estimated future tax rates are realized.
- Whether rising deposit and borrowing costs continue to outpace asset-yield improvements, and whether the leverage strategy remains profitable or is curtailed.
- Commercial real estate construction funding, geographic and borrower concentrations, and ongoing delinquency, non-performing loan and allowance trends.
- Regulatory approval, closing timing, consideration and integration costs or benefits of the Capital City Bancshares acquisition.
- Cash availability, refinancing and deposit retention as certificates and borrowings mature, and the capacity to sustain the stated dividend policy.