Business context and reporting period
Capitol Federal Financial, Inc. is a community-oriented bank holding company focused primarily on residential mortgage lending, funded by retail deposits and borrowings. This unaudited Form 10-Q covers the three months ended December 31, 2017, the first quarter of fiscal 2018; comparisons below are generally with the three months ended December 31, 2016. Balance-sheet comparisons are with September 30, 2017.
Financial performance and position
| Metric | Quarter / period-end result | Comparison |
|---|---|---|
| Net interest income | $49.4 million | Up 4.4% year over year |
| Net interest margin | 1.83% | Up 10 basis points year over year; 2.20% excluding the leverage strategy, up 13 basis points |
| Net income / diluted EPS | $31.8 million / $0.24 | Compared with $20.6 million / $0.15 |
| Non-interest income / expense | $5.4 million / $22.0 million | Income up 1.7%; expense up 2.0% year over year |
| Efficiency ratio | 40.26% | Improved from 41.08% |
| Total assets | $8.99 billion | Down $202.8 million from September 30 |
| Loans receivable, net | $7.19 billion | Down $5.3 million from September 30 |
| Deposits / FHLB borrowings / repurchase agreements | $5.27 billion / $2.17 billion / $100 million | Deposits down $43.7 million and repurchase agreements down $100 million from September 30 |
| Stockholders’ equity | $1.35 billion | Down $17.7 million; equity was 15.0% of assets |
| Operating / investing / financing cash flow | $43.3 million / $(135.9) million / $(230.0) million | Cash and cash equivalents fell $322.5 million to $29.1 million |
The $11.3 million year-over-year increase in net income was driven principally by the Tax Act: the deferred-tax revaluation reduced tax expense by $7.5 million, and applying the lower blended rate to current-quarter pretax income reduced it by a further $3.0 million. Pretax income increased to $32.7 million from $31.0 million, while tax expense fell to $0.9 million from $10.4 million. The reported 2.6% effective tax rate is therefore unusually low and not indicative of management’s full-year estimate.
Credit indicators remained low overall: no provision for credit losses was recorded; net charge-offs were $28,000; loans 30–89 days delinquent were 0.25% of loans; nonperforming loans were 0.21%; and nonperforming assets were 0.18% of assets. The allowance for credit losses was $8.37 million, or 0.12% of loans. Regulatory capital ratios exceeded well-capitalized thresholds: the Bank’s leverage ratio was 10.9%, CET1 and Tier 1 ratios were 27.3%, and its total capital ratio was 27.5%.
Changes, outlook, risks and unusual items
- Tax Act: Management estimates an effective tax rate of 20%–21% for fiscal 2018 and approximately 22% for fiscal 2019. The quarter’s net income benefited from the one-time deferred-tax revaluation as well as the lower blended tax rate.
- Leverage strategy: The Bank temporarily borrowed up to $2.10 billion during the quarter, placing proceeds at the Federal Reserve Bank of Kansas City and holding required FHLB stock; borrowings were repaid before quarter-end. The strategy contributed $767,000 of net income. Quarter-end cash was consequently much lower than the September 30 balance.
- Funding and liquidity: The Bank reported $600.8 million of eligible, unused securities collateral and access to FHLB and Federal Reserve borrowing facilities. $1.03 billion of certificates of deposit, including $243.6 million of public-unit deposits, was scheduled to mature within one year. Management expected most maturing retail certificates to renew or transfer to other Bank products, but gave no assurance.
- Interest-rate exposure: The one-year repricing gap was $185.2 million at quarter-end, versus $641.6 million at September 30. In a modeled +200-basis-point scenario, projected net interest income declined 2.89% and market value of portfolio equity declined 21.52%. These are modeled sensitivities, not management earnings guidance; results depend on assumptions including prepayments and deposit behavior.
- Portfolio concentrations and commitments: Lending is concentrated in one- to four-family residential loans, with approximately 67% of those loans secured by properties in Kansas and Missouri. Commercial real estate loans totaled $285.1 million, with $131.3 million of undisbursed amounts; management intends to continue growing this portfolio through participations.
- Shareholder distributions: The quarter included $50.4 million of cash dividends, including a $0.29-per-share fiscal 2017 true-up and a regular dividend. Management stated its intent to pay out 100% of fiscal 2018 earnings, subject to financial condition and regulatory limitations. The next regular dividend of $0.085 per share was announced for payment February 16, 2018.
- Other matters: The Company sold $2.1 million of trust preferred securities, recognizing a $9,000 gain. Management said pending legal matters were not expected to have a material adverse effect, and reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Separate recurring operating performance from the $7.5 million deferred-tax revaluation benefit and the additional $3.0 million tax-rate benefit when assessing earnings sustainability.
- Review deposit retention, certificate maturities and funding costs as rates rise, alongside the substantial use of FHLB borrowings and the effect of the temporary leverage strategy.
- Monitor net interest margin and modeled interest-rate sensitivity, particularly the reported declines in net interest income and portfolio equity under rising-rate scenarios.
- Track credit quality, the allowance relative to loan growth, and the residential and geographic concentrations; also monitor funding of commercial real estate construction commitments.
- Confirm that dividend plans remain consistent with regulatory approval, Bank capital requirements and available holding-company funds.