Capitol Federal Financial, Inc. — Form 10-Q Summary
Reporting period: Third quarter of fiscal 2011, three months ended June 30, 2011; year-to-date results cover the nine months ended June 30, 2011. Balance-sheet comparisons are to September 30, 2010. Dollar amounts below are in millions unless noted.
Business context and significant events
Capitol Federal is a community-oriented thrift focused primarily on residential first-mortgage lending, funded by retail deposits and borrowings. In December 2010, the company completed its conversion from mutual holding company ownership to a publicly traded stock company, raising approximately $1.18 billion gross and $1.13 billion net. Half of net proceeds was contributed to the Bank; proceeds were largely invested in securities. The company also contributed $40 million to the Capitol Federal Foundation and redeemed $53.6 million of debentures in April 2011.
Financial performance
| Metric | Three months ended June 30, 2011 | Three months ended June 30, 2010 | Nine months ended June 30, 2011 | Nine months ended June 30, 2010 |
|---|---|---|---|---|
| Net interest income | $44.3 | $40.9 | $124.9 | $128.4 |
| Provision for credit losses | $1.2 | $1.8 | $2.4 | $8.1 |
| Net income | $17.3 | $16.8 | $21.6 | $52.4 |
| Diluted earnings per share | $0.10 | $0.10 | $0.13 | $0.32 |
| Net interest margin | 1.88% | 1.97% | 1.82% | 2.09% |
- Quarterly net income increased $0.5 million year over year as higher net interest income and a lower credit-loss provision more than offset reduced other income and higher expenses.
- Nine-month net income fell $30.8 million. The principal driver was the $40 million Foundation contribution, with a reported $26 million after-tax impact. Lower other income, including the absence of the prior-year $6.5 million securities gain, and lower net interest income also weighed on results.
- Year-to-date net interest income declined despite lower funding costs. Loan interest income decreased $23.9 million, reflecting lower average balances and yields; total interest expense declined $20.3 million. Management attributed margin pressure to deploying offering proceeds into lower-yielding securities.
- Quarterly net interest margin improved from 1.70% in the prior quarter to 1.88%, primarily because securities purchased with offering proceeds generated a full quarter of earnings.
Financial position, cash flow, and liquidity
- At June 30, 2011, total assets were $9.60 billion, up $1.12 billion from September 30, 2010, mainly reflecting the stock offering and securities purchases. Loans receivable, net, were $5.16 billion, approximately flat with period-end 2010; securities grew substantially.
- Deposits were $4.56 billion, up $172.3 million. FHLB advances were $2.45 billion, up $105.3 million; other borrowings were $565.0 million, down $103.6 million. Total reported borrowings were approximately $3.02 billion.
- Cash and cash equivalents were $161.9 million, up $96.7 million. For the nine months, operating cash flow was $39.9 million, investing cash outflow was $1.04 billion, and financing cash inflow was $1.10 billion, principally reflecting stock-offering proceeds and dividend payments.
- Stockholders’ equity rose to $1.93 billion from $962.0 million; equity was 20.1% of assets. The Bank reported a 14.7% tangible equity ratio and regulatory capital ratios above well-capitalized thresholds.
- Management reported $1.22 billion of unused FHLB borrowing capacity and $1.99 billion of eligible, unused securities collateral. The Bank had $1.53 billion of certificates of deposit due within one year; management expected most maturing retail certificates to renew or move to other deposit products, but gave no assurance.
Credit quality, outlook, and risks
- Non-performing loans declined to $28.0 million, or 0.54% of net loans, from $32.0 million, or 0.62%, at September 30, 2010. Non-performing assets were $38.1 million, or 0.40% of assets. Loans 30–89 days delinquent were $24.7 million, broadly unchanged.
- The allowance for credit losses was $14.9 million, 0.29% of loans and 53.0% of non-performing loans. Nine-month provision was primarily related to specific valuation allowances on purchased loans and lower home-price index values, including in Kansas and Missouri. Management considered the allowance adequate but emphasized its estimation uncertainty.
- Residential real estate loans dominate the portfolio, with meaningful concentration in Kansas and Missouri. Management cited weak economic conditions, unemployment, declining property values, loan prepayments, and competition as risks. Purchased interest-only adjustable-rate mortgages totaled $173.3 million; $10.8 million were non-performing.
- Interest-rate sensitivity modeling showed projected four-quarter net interest income down 0.50% under a +100-basis-point shock, 3.45% under +200 basis points, and 7.91% under +300 basis points. Estimated market value of portfolio equity fell 3.54%, 10.86%, and 19.77%, respectively. These are model scenarios, not management earnings guidance.
- Management estimated the fiscal 2011 effective tax rate at approximately 33% and fiscal 2012 at approximately 36%. No branches were planned for fiscal 2011; two Kansas City-area branches were scheduled for fiscal 2012, while an in-store branch was to close in late fiscal 2011.
- A quarterly dividend of $0.075 per share was declared in July 2011. Dividends remain subject to Bank capital-distribution limits and other regulatory and financial conditions. Share repurchases were restricted during the first year after reorganization; the company had applied to begin repurchases earlier, but no repurchase plan was then in place.
- Management said routine pending lawsuits were not expected to materially affect the company. It could not estimate potential costs related to foreclosure-servicing deficiencies at third-party servicers for loans the Bank had purchased; the Bank itself was not among the 14 organizations cited in the regulators’ enforcement actions. The filing reported no material change to previously disclosed risk factors.
Most important facts for investors to verify
- Whether core earnings and net interest margin can withstand reinvestment at low rates and continued loan refinancing and prepayments.
- Trends in purchased-loan delinquencies, non-performing loans, REO, interest-only adjustable-rate loans, and the adequacy of the allowance.
- Deposit retention and funding costs as certificates mature, and continued access to FHLB and other borrowing capacity.
- The actual recurring impact of the Foundation contribution, securities yields, and the company’s high dividend payout on future earnings and capital distributions.
- Any subsequent developments involving third-party foreclosure servicing, regulatory approvals for share repurchases, or the planned branch openings and closure.