Capitol Federal Financial, Inc. quarterly report, Q1 FY2020

Capitol Federal Financial, Inc. — Form 10-Q Summary

Reporting period: Fiscal first quarter ended December 31, 2019; comparative income and cash-flow data are for the three months ended December 31, 2018. Balance-sheet comparisons are principally to September 30, 2019. The company operates Capitol Federal Savings Bank, a community-oriented bank headquartered in Topeka, Kansas, with a lending concentration in one- to four-family residential mortgages.

Financial results and position

Metric	Quarter ended Dec. 31, 2019	Comparison
Net interest income	$48.7 million	Down 6.9% from $52.3 million a year earlier
Net interest margin	2.18%	2.27% a year earlier; 2.15% in the prior quarter
Provision for credit losses	$225,000	None a year earlier; related to certain acquired commercial loans renewed after the CCB acquisition
Net income / diluted EPS	$22.5 million / $0.16	Down from $24.4 million / $0.18 a year earlier
Efficiency ratio	48.89%	46.40% a year earlier
Net cash from operating activities	$26.8 million	$14.3 million a year earlier

At December 31, 2019, total assets were $9.24 billion, down 1.1% from September 30. Net loans were $7.43 billion, deposits $5.59 billion, borrowings $2.19 billion, and stockholders’ equity $1.31 billion. Cash and cash equivalents were $70.7 million; the cash-flow statement reports $97.3 million of cash, cash equivalents, restricted cash and restricted cash equivalents, including $26.6 million of restricted collateral.

Quarter cash flows included $40.8 million used in investing and $142.5 million used in financing, including $58.7 million of dividends and a net $50.0 million reduction in borrowings. Total cash, cash equivalents and restricted cash decreased $156.4 million.

The Bank’s reported regulatory capital ratios substantially exceeded well-capitalized thresholds: Tier 1 leverage 12.5% versus 5.0%, and total capital 24.3% versus 10.0%. Management considers a Bank equity-to-assets ratio of at least 10% appropriate; it was 12.7% at quarter end. The Company reported a consolidated equity-to-assets ratio of 14.1%.

Changes and operating drivers

• Year over year, net interest income fell $3.6 million as interest income declined $2.4 million while interest expense rose $1.2 million. Deposit interest expense increased $2.2 million, principally from higher costs and balances of retail/business certificates of deposit; borrowing expense decreased $1.0 million.
• Management said the net interest margin decline excluding the leverage strategy was 14 basis points year over year, to 2.18%, mainly because of certificate-of-deposit costs. The leverage strategy was not in place this quarter because the negative spread made it unprofitable; management said it could resume if returns become profitable.
• Net interest income declined $1.1 million sequentially from the September quarter, while reported net interest margin increased from 2.15% to 2.18%. Excluding the leverage strategy, margin declined six basis points sequentially.
• Loans increased $12.5 million from September, as growth in originated residential loans was partly offset by lower commercial balances, including the payoff of a $36.7 million participation loan. Total loans were predominantly one- to four-family residential loans.
• Deposits were nearly unchanged from September. Non-maturity deposits rose $71.3 million, offset by reductions in retail/business and public-unit certificates of deposit. The Bank had reduced rates on several certificate terms late in the quarter without a negative effect on retention of maturing fixed-rate certificates, according to management.
• Non-interest expense declined 1.1% year over year. Lower technology, regulatory/outside-service, and federal insurance costs partly offset higher salaries and advertising. Non-interest income rose 1.5%; a bank-owned life insurance death benefit contributed to other income.

Outlook, risks and unusual items

• Management expects net interest margin to continue declining if market rates remain at or below then-current levels, because loan and securities yields may reprice downward faster than deposits and borrowings. It said total loans were unlikely to increase materially during fiscal 2020.
• Management projected fiscal 2020 salaries and employee benefits expense to increase about $3.0 million from fiscal 2019, revising down its earlier estimate of $4.0 million. It anticipated an effective tax rate of about 22% in each remaining quarter and about 21% for fiscal 2020.
• One $50.0 million commercial real-estate participation loan, associated with a recently opened hotel and convention center, remained classified as special mention. Management cited debt-service coverage below policy, slower-than-expected surrounding development, and construction delays; it said the loan was being closely monitored and personal guarantees were in place.
• Non-performing loans were $7.1 million, or 0.10% of loans, and non-performing assets were $7.6 million, or 0.08% of assets. The allowance for credit losses was $9.4 million, 0.13% of net loans. Management considered the allowance adequate. The portfolio is concentrated in residential real estate and in Kansas and Missouri; the filing also identifies commercial lending, real-estate values, economic conditions, deposit flows, funding costs and interest rates as risks.
• Interest-rate modeling showed projected four-quarter net interest income down 1.39% in a +200-basis-point scenario and 3.03% in a −100-basis-point scenario. Estimated market value of portfolio equity fell 16.50% in the +200-basis-point scenario. These are modeled sensitivities, not management earnings guidance.
• A favorable tax-guidance benefit related to certain acquired BOLI policies reduced the quarter’s effective tax rate to 18.1%, compared with 21.2% a year earlier. The BOLI death benefit was also a nonrecurring contributor to other income. FDIC assessment credits fully offset premiums in the quarter; about $900,000 of credits remained at December 31.
• The company adopted lease accounting on October 1, 2019, recognizing a $15.7 million right-of-use asset and $15.5 million lease liability. Management could not reasonably estimate the impact of adopting the expected-credit-loss standard, scheduled for October 1, 2020.
• Management intended to elect the community bank leverage ratio framework for the Bank and Company in their March 2020 regulatory reports. It stated that no material changes had occurred to the risk factors in the prior Form 10-K and that pending litigation was not expected to have a material adverse effect.

Investor verification points

• Track net interest margin and certificate-of-deposit repricing, particularly against management’s expectation of continued margin pressure.
• Monitor the $50.0 million special-mention hotel/convention-center exposure, related commitments and any change in classification or loss allowance.
• Check loan delinquencies, non-performing assets, commercial portfolio concentrations and allowance adequacy in subsequent filings.
• Assess liquidity and funding needs against $1.44 billion of certificates of deposit scheduled to mature within 12 months and $990.0 million of FHLB advances scheduled to mature within 12 months.
• Verify delivery of the announced $0.085-per-share quarterly dividend and assess dividend capacity against regulatory limits; management stated its intent to pay out 100% of fiscal 2020 earnings, subject to relevant conditions.
• Review the actual adoption effects of the expected-credit-loss standard and the Bank’s and Company’s planned community bank leverage ratio election.