Capitol Federal Financial, Inc. — Form 10-Q Summary
Business context and period. Capitol Federal is a community-oriented savings institution focused primarily on residential mortgage lending, funded by retail deposits and borrowings. This fiscal 2014 first-quarter report covers the three months ended December 31, 2013; financial statements are unaudited. Comparisons below are with the three months ended December 31, 2012, or with September 30, 2013, as indicated.
Key financial results
| Metric | Quarter ended Dec. 31, 2013 | Comparable period / change |
|---|---|---|
| Interest and dividend income | $72.2 million | Down 7.0% year over year |
| Net interest income | $44.2 million | $45.6 million a year earlier |
| Provision for credit losses | $0.5 million | $0.2 million a year earlier |
| Non-interest income | $5.5 million | $5.8 million a year earlier |
| Non-interest expense | $22.8 million | Down 7.9% year over year |
| Net income | $17.8 million | $17.6 million a year earlier; up about 1.4% |
| Basic and diluted EPS | $0.12 | $0.12 a year earlier |
| Net interest margin | 1.98% | Down 3 bps year over year; up 2 bps from prior quarter |
| Efficiency ratio | 45.81% | 48.14% a year earlier; 51.22% in prior quarter |
Lower asset yields reduced interest income, particularly on mortgage-backed securities and investment securities. Lower funding costs partly offset that pressure: total interest expense fell 12.7% year over year, and the average cost of interest-bearing liabilities declined to 1.49% from 1.71%. Expense reduction—especially lower ESOP-related compensation—also supported earnings. Return on average assets was 0.78%, and return on average equity was 4.37%.
Financial condition, cash flow and liquidity
- Assets and lending: Total assets were $9.11 billion at December 31, down $75.4 million from September 30, 2013. Net loans rose $65.7 million, or 1.1%, to $6.02 billion. Management said it continued shifting cash flows from lower-yielding securities into loans; securities declined by about $125.9 million.
- Funding and debt: Deposits were $4.62 billion, up $9.5 million during the quarter. FHLB borrowings were $2.52 billion and repurchase agreements were $320 million. Total borrowings at par were $2.85 billion, approximately 31% of assets. The weighted average deposit rate was 0.71%.
- Cash flow: Operating activities provided $25.1 million, investing activities provided $52.6 million, and financing activities used $102.9 million. Cash and cash equivalents declined $25.2 million to $88.7 million. Financing outflows included $72.3 million of dividends and $7.0 million of share repurchases.
- Capital: Stockholders’ equity was $1.57 billion, or 17.2% of assets, versus $1.63 billion and 17.8% at September 30. The Bank reported regulatory capital ratios of 14.6% Tier 1 leverage, 34.5% Tier 1 risk-based capital, and 34.8% total risk-based capital, above stated well-capitalized thresholds.
- Liquidity: Management reported $1.65 billion of excess FHLB borrowing capacity and $1.33 billion of eligible, unused securities collateral. Approximately $1.26 billion of certificates of deposit were scheduled to mature within one year. Management expected sufficient funding from repayments, maturities, deposits and borrowings to meet current commitments, while noting deposit retention is not assured.
Material changes and asset quality
- Compared with the prior-year quarter, net interest income fell $1.4 million as declining yields outweighed lower funding costs. Average loan balances increased, while average balances in MBS and investment securities decreased. Net income rose modestly, with lower operating costs helping offset weaker net interest income.
- Compared with the September quarter, net income increased $1.7 million, primarily reflecting lower salaries and employee benefits, including lower ESOP expense. Net interest margin rose from 1.96% to 1.98% as the loan share of earning assets increased and funding costs eased.
- Non-performing loans were $27.7 million, or 0.46% of loans, up from $26.4 million, or 0.44%, at September 30, but below $28.7 million a year earlier. Non-performing assets were $31.4 million, or 0.34% of assets. Loans 30–89 days delinquent were $27.9 million, or 0.46% of net loans.
- The allowance for credit losses was $8.9 million, 0.15% of loans, versus $8.8 million at September 30 and $10.5 million a year earlier. The quarter included $0.4 million of net charge-offs and a $0.5 million provision. Management considered the allowance adequate but emphasized that it depends on estimates and judgment.
- Residential first mortgages dominate the loan portfolio, with substantial geographic concentration in Kansas and Missouri. Management cited local unemployment rates below the national rate and relatively stable regional home values, but identified economic weakness, unemployment and falling property values as potential sources of credit losses.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management estimated the fiscal 2014 effective tax rate at approximately 33%–34%.
- Management described continued portfolio reallocation toward loans, while noting that margin and earnings remain exposed to falling asset yields, deposit competition, loan demand, prepayments and funding costs. Most loans are fixed-rate, while many deposits reprice or mature in less than two years.
- Interest-rate models estimated that a parallel rate increase of 200 basis points would reduce four-quarter net interest income by 4.17% and market value of portfolio equity by 25.54%; a 300-basis-point increase showed estimated reductions of 7.39% and 38.53%, respectively. These are model sensitivities, not management earnings guidance.
- The company paid $72.3 million in dividends during the quarter, including a $0.25-per-share special “True Blue Too” dividend, a $0.18-per-share fiscal 2013 true-up, and a regular $0.075-per-share dividend. It also repurchased 578,880 shares for $7.0 million. After quarter-end through January 17, 2014, it repurchased a further 2,143,600 shares for $25.7 million. Future dividends depend in part on regulatory approval of Bank capital distributions.
- Unrealized securities losses were attributed primarily to higher market yields; management reported no other-than-temporary impairment. A trust preferred security remained subject to credit-rating-related unrealized losses, although management’s cash-flow analysis indicated expected recovery of amortized cost.
- Management reported no material subsequent events requiring adjustment, no material changes to previously disclosed risk factors, and no material effect expected from routine legal proceedings. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether loan growth and the shift from securities to loans can sustainably support net interest margin amid asset-yield and rate-repricing pressures.
- Trends in delinquencies, non-performing loans, charge-offs and the allowance, especially given the residential mortgage and Kansas–Missouri concentrations.
- Deposit renewal and funding costs as certificates mature, and the company’s ability to maintain liquidity and borrowing capacity.
- The sustainability of dividends and share repurchases, including the Bank’s regulatory ability to distribute capital to the holding company.
- Key assumptions behind the interest-rate sensitivity models and the valuation of securities and credit-loss reserves.