Business context and reporting period
Capitol Federal Financial, Inc. is a bank holding company whose subsidiary, Capitol Federal Savings Bank, conducts the substantial majority of its business. This unaudited Form 10-Q covers the fiscal third quarter and nine months ended June 30, 2021; balance-sheet comparisons are to September 30, 2020. Amounts below are in U.S. dollars.
Financial performance and condition
| Metric | Quarter ended June 30, 2021 | Nine months ended June 30, 2021 |
|---|---|---|
| Net interest income | $42.6 million | $129.5 million, down 9.9% year over year |
| Provision for credit losses | Negative $2.7 million | Negative $7.2 million, versus expense of $22.3 million in prior year |
| Net income | $18.2 million; diluted EPS $0.13 | $57.5 million; diluted EPS $0.42, versus $46.3 million and $0.34 |
| Net interest margin | 1.84%, down 23 basis points year over year and 4 basis points sequentially | 1.88%, down 27 basis points year over year |
| Efficiency ratio | 57.73%, versus 51.58% a year earlier | 57.36%, versus 49.81% |
| Operating cash flow | Not separately presented for the quarter | $51.4 million, versus $69.1 million |
At June 30, total assets were $9.65 billion, loans receivable net of allowance were $7.03 billion, and available-for-sale securities were $2.02 billion. Deposits were $6.64 billion, up 7.2% from September 30; borrowings were $1.58 billion, down 11.6%. Cash and cash equivalents were $95.3 million; cash-flow-statement cash, including restricted cash, was $126.5 million. The latter declined $113.2 million over the nine-month period. Operating, investing, and financing cash flows were $51.4 million, negative $274.4 million, and positive $109.8 million, respectively.
Stockholders’ equity was $1.24 billion, down 3.7%; equity to total assets was 12.8%. The Bank’s Community Bank Leverage Ratio was 11.5%, above the minimum requirements. The allowance for credit losses was $20.7 million, or 0.29% of loans, and the off-balance-sheet credit-exposure reserve was $6.2 million.
Material changes versus comparable periods
- Nine-month net income rose 24.4% year over year, primarily because the credit-loss provision swung from a $22.3 million expense to a $7.2 million credit. This offset lower net interest income and higher taxes.
- Asset yields and mix pressured earnings: nine-month net interest margin fell 27 basis points as loan yields declined and loan cash flows were invested in lower-yielding securities. Lower deposit and borrowing costs partly mitigated the impact.
- Quarterly net income was down 6.6% year over year. Net interest income declined $3.7 million; the negative credit provision partly offset the decline.
- Securities grew $454.7 million from September 30, while net loans fell $169.0 million. Deposit growth funded maturing borrowing repayments and securities purchases.
- Non-interest income for the nine months included a $7.4 million gain on the sale of Visa Class B shares. Non-interest expense included a $4.8 million loss on interest-rate-swap termination and higher FDIC insurance premiums.
Outlook, risks, contingencies and unusual items
- Management said margin could continue to decline if earning assets reprice downward faster than funding costs, or if funds continue to shift from loans into lower-yielding securities. It noted elevated loan prepayments, refinancing and endorsement activity may further reduce loan yields.
- Management anticipated an approximately 20% effective tax rate for fiscal 2021. It stated the Board intended to continue a 100% earnings payout in fiscal 2021, subject to financial results, regulatory requirements and the Bank’s ability to distribute capital. A regular quarterly dividend of $0.085 per share was announced for payment in August 2021.
- Credit estimates remain sensitive to economic forecasts and management judgments. Risks identified include COVID-19 effects, uneven recovery, unemployment, real-estate values, commercial borrowers, and the end of foreclosure moratoria. Of COVID-modified loans that had exited deferral, $4.4 million of one- to four-family loans were 30–89 days delinquent and $2.1 million were 90 or more days delinquent; no such commercial loans were delinquent.
- Non-performing loans were $14.2 million, or 0.20% of loans; non-performing assets were 0.15% of total assets. Commercial special-mention loans were $100.0 million, including two COVID-affected loans totaling $50.0 million that had resumed full payments but remain under monitoring.
- Interest-rate risk is significant. The modeled change in market value of portfolio equity was negative 19.85% under a 200-basis-point rate increase; the model projected four-quarter net interest income up 3.51% in that scenario. These are model sensitivities, not management forecasts. The one-year repricing gap was negative $478.2 million.
- The company identified $302.2 million of adjustable-rate one- to four-family loans and $440.0 million of swaps tied to LIBOR. The Bank began transitioning LIBOR-linked advances and swaps to SOFR instruments in July 2021; transition costs, disputes and earnings effects are possible.
- Management said pending litigation was not expected to have a material adverse effect. It reported no material changes to commitments or contractual obligations and concluded disclosure controls were effective.
Important facts for investors to verify
- Whether loan yields and net interest margin continue to decline, and how much is attributable to prepayments, endorsements and securities reinvestment.
- Whether the favorable credit-provision trend persists, given the $50.0 million of commercial special-mention loans, COVID-modified loan performance and forecast-sensitive allowance estimates.
- Deposit retention and funding costs as certificates mature, and the Bank’s ability to manage its interest-rate exposure and securities duration.
- Progress, costs and contractual outcomes of the LIBOR-to-SOFR transition, including the identified loans and swaps.
- Whether dividends and any share repurchases remain supportable under regulatory distribution limits and capital needs.