Capitol Federal Financial, Inc. — Form 10-Q Summary
Reporting period: Fiscal first quarter of 2012, the three months ended December 31, 2011; filed February 6, 2012. The filing’s financial statements are unaudited. Dollar amounts below are in millions unless stated otherwise.
Business context
Capitol Federal is a community-oriented savings institution whose principal business is funding residential mortgage lending with retail deposits and borrowings. Its loan portfolio is concentrated in one- to four-family mortgages, particularly in Kansas and Missouri.
Financial and operating results
- Net income: $18.8 million, or $0.12 per diluted share, versus a net loss of $11.3 million, or $0.07 per share, a year earlier. The comparison is heavily affected by a $40.0 million Foundation contribution in the prior-year quarter. Excluding that contribution’s $26.0 million after-tax effect, prior-year net income was $14.7 million on a non-GAAP basis.
- Net interest income: $45.4 million, up 13.4% year over year. Interest income declined 2.8% to $84.8 million, while interest expense fell 16.5% to $39.5 million. Net interest margin rose to 1.98% from 1.88% a year earlier and 1.89% in the prior quarter.
- Expenses and credit provision: Other expenses were $22.1 million, compared with $63.3 million in the prior-year quarter, primarily because that quarter included the Foundation contribution. Provision for credit losses was $0.5 million versus $0.7 million a year earlier and $1.7 million in the prior quarter.
- Balance sheet at December 31: Total assets were $9.42 billion, down $29.8 million from September 30. Net loans were $5.22 billion, up $75.2 million; deposits were $4.50 billion, up $6.0 million. Stockholders’ equity was $1.93 billion, or 20.5% of assets.
- Funding and debt: FHLB advances were $2.53 billion and other borrowings, primarily repurchase agreements, were $365 million. The reported balance-sheet debt total was therefore approximately $2.90 billion. FHLB advances rose during the quarter while other borrowings declined.
- Cash flow and liquidity: Operating cash flow was $29.0 million; investing activities provided $75.4 million and financing activities used $55.2 million. Cash and cash equivalents increased $49.1 million to $170.2 million. The Bank reported $741.9 million of excess FHLB borrowing capacity and $1.99 billion of eligible, unused securities collateral.
- Credit quality: Non-performing loans increased to $28.4 million (0.54% of net loans) from $26.5 million (0.51%) at September 30. Non-performing assets were $39.6 million, or 0.42% of assets. The allowance for credit losses was $15.6 million, 0.30% of loans and 54.9% of non-performing loans.
Changes, outlook, risks and unusual items
- Reported earnings improved substantially year over year, but the prior-year Foundation contribution explains much of the change. Against prior-year adjusted net income of $14.7 million, current-quarter net income of $18.8 million was higher.
- Mortgage endorsements and refinances continued to lower portfolio yields: the Bank endorsed $341.2 million of loans at an average rate reduction of 114 basis points and refinanced $93.2 million of customer loans. Management said ongoing endorsements and refinances, low market rates and a flatter yield curve could pressure future margins, despite recent margin improvement.
- Beginning with the March 2012 reporting period, OCC reporting requirements require loan charge-offs rather than specific valuation allowances. The Bank planned to implement a charge-off policy in fiscal Q2 and charge off $3.5 million of existing specific valuation allowances. Management said this would reduce the allowance and related loan balances, but would not affect current-period earnings because the amounts had been expensed previously.
- After quarter-end, the Bank prepaid a $200 million FHLB advance bearing 3.88% and replaced it with a 46-month advance at 0.86%. It incurred a $7.9 million penalty, to be amortized over the new advance’s term; management stated the refinancing should reduce interest expense and exposure to rising rates.
- Management anticipated an approximately 36% effective tax rate for fiscal 2012 and expected two Kansas City-area branches to open during calendar 2012. No specific earnings guidance was provided.
- The Board authorized up to $193 million of common-stock repurchases; none occurred during the quarter. The Company paid $28.3 million in dividends during the quarter, including a special dividend, and declared a further $0.075-per-share quarterly dividend payable in February 2012.
- Key risks include residential real-estate and borrower-credit conditions, the regional concentration of mortgage lending, interest-rate and prepayment risk, funding availability and cost, and regulatory review of credit-loss estimates and capital distributions. Management cited local unemployment of 7.4% versus 8.5% nationally, while noting local unemployment remained above historical levels. Routine litigation was described as immaterial; management reported disclosure controls were effective and no material change in internal controls.
Important facts for investors to verify
- How much of the reported earnings improvement reflects the prior-year Foundation contribution versus underlying operating performance; review the filing’s non-GAAP comparison and its reconciliation.
- Whether net interest margin can be sustained as loans reprice, customers endorse or refinance mortgages, and the yield curve and funding costs change.
- Credit trends in delinquent, non-performing and restructured loans, especially purchased mortgages and loans with interest-only terms; assess the planned $3.5 million charge-off’s effect on reported credit metrics.
- Liquidity and refinancing capacity, including certificate maturities, reliance on FHLB advances and repurchase agreements, and the effect and accounting treatment of the $7.9 million prepayment penalty.
- Dividend and buyback capacity in light of regulatory restrictions on Bank distributions, capital needs, and the Company’s authorized $193 million repurchase plan.