Capitol Federal Financial, Inc. — Form 10-Q
Reporting period: Three and nine months ended June 30, 2018 (fiscal third quarter). Amounts are in U.S. dollars; financial statement amounts are rounded to millions unless noted.
Business context and reporting period
Capitol Federal is a community-oriented savings institution whose principal business is gathering retail deposits and investing primarily in residential mortgage loans. Its loan portfolio is concentrated in one- to four-family residential real estate, particularly in Kansas and Missouri. The Bank also originates and participates in commercial real estate loans.
Financial performance and condition
- Quarterly earnings: Net income was $22.4 million, or $0.17 per diluted share, versus $21.4 million, or $0.16, in the prior-year quarter. Net interest income was $49.4 million, nearly unchanged year over year. Pre-tax income declined to $30.3 million from $32.2 million; lower income tax expense more than offset higher operating expenses.
- Nine-month earnings: Net income was $77.5 million, or $0.58 per diluted share, up from $63.5 million, or $0.47. Net interest income rose to $148.7 million from $145.7 million.
- Margins and expenses: Net interest margin was 1.92% for the quarter, versus 1.81% a year earlier, and 1.87% year to date, versus 1.78%. The nine-month efficiency ratio worsened to 42.54% from 40.84%, primarily reflecting higher non-interest expense.
- Tax: Nine-month effective tax rate was 18.2%, versus 33.7%, mainly due to the Tax Act and a $7.5 million reduction in tax expense from remeasuring deferred taxes. Management estimated a 20%–21% effective rate for fiscal 2018 and approximately 22% for fiscal 2019.
- Balance sheet: Total assets were $9.05 billion, down from $9.19 billion at September 30, 2017. Net loans were $7.24 billion, up from $7.20 billion; deposits were $5.32 billion, broadly stable; and total borrowings, including repurchase agreements, were approximately $2.27 billion. Stockholders’ equity was $1.34 billion, down $27.0 million, mainly reflecting $106.9 million of dividends, partly offset by net income.
- Cash flow: Nine-month operating cash flow was $90.1 million, investing cash flow was a $42.2 million use, and financing cash flow was a $217.5 million use. Cash and cash equivalents declined $169.6 million to $182.1 million, largely as cash flows were used to repay maturing borrowings.
- Credit quality: The allowance for credit losses was $8.3 million, with no provision recorded for the quarter or nine-month period. Nine-month net charge-offs were $54,000. Non-performing loans were 0.16% of total loans and non-performing assets were 0.14% of total assets at June 30.
- Capital and liquidity: The Bank’s equity-to-assets ratio was 13.0%, and all reported regulatory capital ratios exceeded well-capitalized thresholds. The Bank reported $624.6 million of eligible, unused securities collateral and no brokered deposits. Management targets liquidity of 15%; cash and securities were 15.5% of assets.
Material changes versus comparable periods
- Quarterly net income increased $1.0 million year over year, primarily because of lower taxes, while non-interest expense rose 8.2% to $24.5 million. Year-to-date non-interest expense increased 6.0% to $70.1 million, including higher technology, salary, and other costs.
- Year-to-date net interest margin improved by nine basis points. Management attributed the gain mainly to higher yields on interest-earning assets and a shift from securities toward higher-yielding loans. Deposit costs rose as market rates increased.
- From September 30, 2017, cash declined $169.6 million and repurchase agreements declined $100.0 million following repayment of a maturing agreement. Loan balances increased modestly.
- Delinquency and non-performing measures were generally lower than at September 30, 2017: loans 30–89 days delinquent were 0.19% of loans versus 0.26%, and non-performing loans were 0.16% versus 0.23%.
Outlook, management commentary, risks and unusual items
- Capital City Bancshares transaction: The Company signed a merger agreement on April 30, 2018, with closing then expected in the fourth quarter of fiscal 2018. It had recognized approximately $0.5 million of acquisition expenses and expected approximately $0.7 million more. The deal is intended to add commercial lending, commercial deposits, and trust services, with potential funding and revenue diversification benefits.
- Leverage strategy: The Bank periodically borrowed short-term from the FHLB and placed proceeds at the Federal Reserve, also holding required FHLB stock. The strategy generated $212,000 of net income in the quarter and $1.7 million year to date, below prior-year levels. Management suspended it at times when the interest spread made it unprofitable and said it would resume if profitability improved.
- Interest-rate exposure: The modeled one-year repricing gap was negative $303.6 million, or 3.36% of assets; under a 200-basis-point rate increase, it was projected at negative 7.47% of assets. A 200-basis-point instantaneous rate increase was modeled to reduce four-quarter net interest income by 4.79% and market value of portfolio equity by 26.06%. These are model estimates, not earnings guidance.
- Funding and dividends: $1.04 billion of certificates of deposit were scheduled to mature within one year. Management expected most retail certificates to renew or transfer to other Bank products, but gave no assurance. Management intended to distribute 100% of fiscal 2018 earnings, subject to financial, regulatory, and other constraints. A regular quarterly dividend of $0.085 per share was announced for payment in August 2018.
- Other items: A one-time 2018 Tax Savings Bonus Plan was expected to cost approximately $1.0 million; $667,000 had been recognized through June, with the balance expected in the fourth quarter. Management reported no material change in previously disclosed risk factors, and believed pending legal matters were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether the Capital City Bancshares merger closed as expected, its final costs, and the resulting integration and financial effects.
- Whether deposit pricing, certificate maturities, and rising funding costs affect margins, liquidity, or customer retention.
- How the Bank manages its negative repricing gap and interest-rate sensitivity, including changes to assumptions and the leverage strategy.
- Whether commercial real estate growth, undisbursed construction balances, geographic and property-type concentrations, and residential loan concentrations change credit risk or the allowance requirement.
- Whether dividend distributions remain consistent with earnings, regulatory limits, and the Bank’s capital and liquidity needs.