Capitol Federal Financial, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended September 30, 2016; comparisons are primarily with fiscal 2015. This is an annual report, not a standalone fourth-quarter filing. Capitol Federal is a Kansas-focused community bank, principally engaged in residential mortgage lending and retail deposits.
Financial performance and position
- Earnings: Net income was $83.5 million, up 6.9% from $78.1 million; diluted EPS was $0.63 versus $0.58. Return on average assets was 0.88% and return on average equity was 5.78%, excluding the daily leverage strategy as presented by management.
- Revenue and margins: Net interest income increased 1.3% to $192.2 million. Net interest margin was 1.75% including the daily leverage strategy and 2.10% excluding it, compared with 1.73% and 2.07%, respectively, in FY2015. The efficiency ratio improved to 43.76% from 44.74%. Non-interest income rose to $23.3 million, mainly reflecting increased bank-owned life insurance income.
- Credit costs and asset quality: The Bank recorded a $750,000 negative provision for credit losses, versus a $771,000 provision in FY2015. Net charge-offs were $153,000. Non-performing loans were $29.1 million, or 0.42% of loans, compared with $25.9 million, or 0.39%, a year earlier; non-performing assets were 0.35% of assets. The allowance for credit losses was $8.5 million, 0.12% of net loans.
- Balance sheet: Total assets declined 5.9% to $9.27 billion. Net loans grew $333.0 million to $6.96 billion, while deposits increased $331.5 million to $5.16 billion. Securities declined $401.1 million to approximately $1.63 billion as cash flows were redirected toward loan growth. Stockholders’ equity was $1.39 billion, down from $1.42 billion.
- Debt and liquidity: FHLB borrowings were $2.37 billion and repurchase agreements were $200 million at year-end. Cash and cash equivalents were $281.8 million. Public unit deposits were $370.0 million; there were no brokered deposits. The Bank reported $894.5 million of eligible, unused securities collateral. Operating cash flow was $85.0 million; investing activities provided $99.5 million and financing activities used $675.3 million.
- Capital: The Bank was considered well capitalized and exceeded applicable capital requirements. Its Tier 1 leverage ratio was 10.9%; the Company’s was 12.3%.
Changes versus FY2015
- Net income increased $5.4 million, supported by higher net interest income, a $2.2 million increase in non-interest income, and the lower credit-loss provision. Deposit interest expense rose $4.7 million, partly offsetting lower expense on term borrowings.
- Loans grew as the Bank originated and refinanced $772.9 million and purchased $662.8 million of correspondent loans. Commercial real estate loans rose to $154.1 million from $120.8 million; related undisbursed balances were $193.3 million.
- Year-end assets and borrowings were lower chiefly because the daily leverage strategy was fully removed at September 30, 2016. The strategy had included up to $2.10 billion of FHLB line borrowings, repaid at quarter-end; it was reinstated on October 3, 2016. Management reported $2.3 million of FY2016 income from the strategy, down from $2.8 million.
- Non-performing loans increased in dollars and as a share of loans, despite lower early-stage delinquencies. Non-performing assets increased to 0.35% of total assets from 0.31%.
Outlook, commentary, risks and unusual items
- Management expected to continue the daily leverage strategy in FY2017. This is a management plan, not earnings guidance; the filing provides no explicit net income or EPS forecast.
- Management intended to distribute 100% of FY2017 earnings to stockholders, subject to financial performance, regulatory capital and the Bank’s ability to make distributions. FY2016 included $0.84 per share in dividends paid; a $0.29 per-share FY2016 true-up dividend was announced after year-end.
- Management anticipated FY2017 FDIC premium expense to be approximately $1.5 million lower than FY2016 and an effective tax rate of approximately 34%, partly due to a change in accounting for low-income housing partnership investments.
- Key risks include interest-rate and yield-curve changes, deposit pricing and retention, the long-term fixed-rate asset/shorter-term funding mismatch, local economic and real-estate conditions, and growth in larger commercial real-estate participations. The commercial real-estate portfolio has significant undisbursed commitments and exposure across property types and states.
- Management highlighted cybersecurity, technology and third-party service-provider risks, regulatory and compliance costs, and the possibility that regulators may require additional credit provisions or charge-offs. The allowance is based on estimates and significant judgment.
- The daily leverage strategy materially affects reported average assets and several financial ratios; management presents selected ratios excluding it for comparison. FY2016 BOLI income also included death benefits, making the year-over-year increase in that income item partly unusual.
- Management and the auditor reported effective internal control over financial reporting; the auditor issued an unqualified opinion on the consolidated financial statements. Management stated pending legal matters were not expected to have a material adverse effect.
Most important facts for investors to verify
- How earnings and net interest margin perform excluding versus including the daily leverage strategy, and whether the strategy remains profitable as funding costs change.
- Whether loan growth—particularly correspondent mortgage purchases and commercial real-estate participations—maintains underwriting quality, and how undisbursed commitments are funded.
- Trends in non-performing loans, TDRs, charge-offs and allowance coverage relative to portfolio growth and changing economic conditions.
- Deposit retention and repricing, the maturity schedule for certificates of deposit and FHLB advances, and the Bank’s continued access to wholesale funding and regulatory borrowing-limit approval.
- Whether the stated dividend payout intention remains supportable under regulatory capital and Bank distribution constraints, including the post-year-end FY2016 true-up dividend.
- The effects of the FY2017 low-income-housing accounting change and the projected tax-rate and FDIC-premium changes on reported results.