Capitol Federal Financial, Inc. — FY2014 Form 10-K
Reporting period: Fiscal year ended September 30, 2014; comparison is primarily with FY2013. The filing also reports fourth-quarter FY2014 results. The Company operates through Capitol Federal Savings Bank, a Kansas-focused retail bank specializing in residential mortgage lending.
Financial performance and position
- Earnings: Net income was $77.7 million, up 12.0% from $69.3 million; diluted EPS was $0.56 versus $0.48. Fourth-quarter net income was $20.2 million.
- Income and margins: Interest and dividend income was $290.2 million, down 2.8%; net interest income rose 3.4% to $184.1 million as interest expense fell 11.9% to $106.1 million. Net interest margin increased to 2.00% from 1.97%; management said it would have been 2.07% excluding the new leverage strategy. Non-interest income was $23.0 million and non-interest expense declined 6.6% to $90.5 million. Efficiency ratio improved to 43.72% from 48.13%.
- Credit costs and asset quality: The Company recorded a $1.4 million provision for credit losses, versus a $1.1 million provision credit in FY2013; net charge-offs were $1.0 million. The allowance for credit losses was $9.2 million, 0.15% of net loans and 37.0% of non-performing loans. Non-performing assets were $29.0 million, or 0.29% of assets, down from $30.3 million and 0.33%.
- Balance sheet: Assets rose 7.4% to $9.87 billion. Net loans increased 4.6% to $6.23 billion; deposits increased 0.9% to $4.66 billion. Securities declined $394.5 million to $2.39 billion. Stockholders’ equity fell $139.2 million to $1.49 billion, principally reflecting dividends and share repurchases.
- Cash flow: Operating cash flow was $91.8 million, investing cash flow was $28.0 million, and financing cash flow was $577.2 million. Cash and cash equivalents increased $697.0 million to $810.8 million, mainly reflecting the leverage strategy.
- Funding and capital: FHLB borrowings were $3.37 billion on the balance sheet, including an $800 million line-of-credit balance; repurchase agreements were $220 million. The Bank reported a 13.2% Tier 1 leverage ratio and 33.2% total risk-based capital ratio and was well-capitalized under then-current standards.
Changes versus FY2013
- Net income improved on higher net interest income and $5.4 million lower salaries and benefits, largely due to reduced ESOP-related expense.
- Funding costs declined, while the mix of interest-earning assets shifted from securities toward higher-yielding loans. Loan growth was primarily funded by securities cash flows.
- Loan originations and refinances fell to $484.3 million from $849.9 million; correspondent loan purchases declined to $515.5 million from $585.0 million. Total net loans nevertheless grew.
- Non-performing loans declined to 0.40% of loans from 0.44%. The allowance increased from $8.8 million to $9.2 million.
- Share repurchases totaled $83.2 million in FY2014; dividends paid totaled $138.2 million. Shares outstanding declined.
Outlook, risks and unusual items
- Leverage strategy: Introduced in the fourth quarter, the strategy involves borrowing up to $2.10 billion from the FHLB and placing proceeds, net of required FHLB stock, at the Federal Reserve. It added $501,000 to FY2014 net income; its reported pre-tax yield was 0.21%. Management intended to continue monitoring and using the strategy. The FHLB temporarily approved a borrowing limit of 55% of Bank assets for one year; the filing notes borrowing could exceed the ordinary 40% threshold at times.
- Management outlook: Management intended to distribute 100% of FY2015 earnings to stockholders, subject to earnings, capital, regulatory limits and holding-company cash. It anticipated FY2015 retail fees and charges would decrease about $1.3 million, higher compliance and operating costs, and an effective tax rate of approximately 32%–33%. These are expectations, not guarantees.
- Dividends: After year-end, the Board declared a regular $0.075-per-share quarterly dividend and a $0.26-per-share special dividend for FY2014 earnings. The filing states FY2015 regular dividends of $0.075 per quarter were intended, with a possible year-end special dividend tied to earnings.
- Interest-rate exposure: Most mortgage assets are long-term and fixed-rate, while many funding costs can reprice sooner. A 200-basis-point parallel rate increase was projected to reduce four-quarter net interest income by 5.54% and market value of portfolio equity by 21.00%. The one-year gap was negative 0.82% of assets in the base case.
- Credit and concentration risks: About 63% of loans were secured by Kansas property and 19% by Missouri property; residential mortgages dominate the portfolio. Regional economic weakness, unemployment, falling property values, and borrower payment resets could increase losses. Regulators may require higher allowances or additional charge-offs.
- Other items: The Company reported no material adverse expected effect from pending litigation and no material off-balance-sheet arrangements. It disclosed $10.4 million of commitments for a Kansas City operations-center remodel expected to be completed in early FY2017. Basel III capital rules were scheduled to take effect beginning January 2015; management expected the Company and Bank to remain well-capitalized.
Important facts for investors to verify
- Whether the FHLB-funded leverage strategy continues to earn an adequate spread after funding costs, FHLB stock requirements and deposit-insurance expenses.
- How the negative one-year gap and rising-rate sensitivity affect actual net interest income and asset values as rates and prepayments change.
- Whether loan credit performance and the $9.2 million allowance remain adequate, particularly given geographic concentration and the declining allowance coverage of non-performing loans.
- Whether planned dividend distributions remain supportable by earnings, Bank capital distributions and regulatory approvals; FY2014 dividends exceeded annual earnings.
- Execution and cost of the planned branch and operations-center changes, and the expected increase in compliance, technology and insurance costs.