Capitol Federal Financial, Inc. quarterly report, Q3 FY2012

Capitol Federal Financial, Inc. — Form 10-Q Summary

Reporting period: Fiscal third quarter and nine months ended June 30, 2012. Balance-sheet comparisons are to September 30, 2011. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.

Business context and financial results

The company is a community-oriented savings institution whose primary business is originating and purchasing residential mortgage loans, funded mainly by retail deposits and borrowings. Its portfolio is concentrated in one- to four-family mortgages, particularly in Kansas and Missouri.

Metric	Three months ended June 30, 2012	Nine months ended June 30, 2012
Interest and dividend income	$80.6	$248.7
Net interest income	$46.2	$139.0
Provision for credit losses	$0	$2.0
Other income	$6.1	$18.4
Other expenses	$22.9	$66.9
Net income	$18.7	$56.8
Diluted earnings per share	$0.12	$0.35
Net interest margin	2.00%	2.01%

• At June 30, total assets were $9.42 billion, net loans $5.21 billion, deposits $4.59 billion, FHLB advances net $2.53 billion, other borrowings $365 million, and stockholders’ equity $1.83 billion. Equity was 19.5% of assets.
• For the nine months, operating cash flow was $77.0 million, investing cash flow was $67.7 million, and financing cash flow was negative $92.8 million. Cash and cash equivalents increased $51.9 million to $172.9 million.
• The Bank reported regulatory capital ratios of 14.6% Tier 1 core, 37.7% Tier 1 risk-based, and 38.1% total risk-based, above the filing’s stated well-capitalized thresholds.

Changes versus comparable periods

• Quarterly net income rose 8.2% from $17.3 million a year earlier. Net interest income increased 4.2%, as a $9.3 million reduction in interest expense more than offset a $7.4 million decrease in interest income. Quarterly net interest margin improved from 1.88% to 2.00% year over year, but declined from 2.06% in the preceding quarter.
• Nine-month net income increased from $21.6 million to $56.8 million. The prior-year period included a $40 million contribution to the Capitol Federal Foundation, with a $26 million after-tax effect. Excluding that item, management presented prior-year non-GAAP net income of $47.6 million and diluted EPS of $0.29, compared with 2012 GAAP net income of $56.8 million and diluted EPS of $0.35.
• Nine-month net interest income increased 11.3% to $139.0 million; interest expense fell 19.0%, partly offset by lower interest income. Net interest margin increased from 1.82% to 2.01% year over year.
• Total assets fell $30.2 million from September 30, 2011, as securities declined $150.3 million, partly offset by loan growth of $60.3 million and higher cash. Deposits increased $97.3 million. Stockholders’ equity decreased $106.7 million, primarily reflecting $113.7 million of share repurchases and $52.4 million of dividends, partly offset by earnings.
• Total loans 30–89 days delinquent declined to $23.8 million from $26.8 million; loans 90 or more days delinquent declined to $21.6 million from $26.5 million. Nonperforming assets were $35.8 million, or 0.38% of assets, versus $37.8 million, or 0.40%, at September 30, 2011.

Outlook, risks, and unusual items

• Management expected to open one Kansas City-area branch in calendar 2012 and another in 2013, and continued to consider expansion opportunities. No earnings or margin guidance was provided.
• Management cited moderate economic expansion, elevated unemployment, and a still-depressed housing sector. Kansas and Missouri unemployment rates were below the national rate cited in the filing; management described local property values as relatively stable.
• Key risks include mortgage-credit deterioration, unemployment and property-value declines, interest-rate and prepayment changes, funding costs and deposit flows, access to wholesale funding, and regulatory requirements. Approximately 75% of Bank loans were secured by Kansas property and 15% by Missouri property.
• The allowance for credit losses was $11.8 million, or 0.23% of loans and 45.6% of nonperforming loans, down from $15.5 million at September 30, 2011. A January 2012 change to comply with OCC reporting requirements led to $3.5 million of previously established specific valuation allowances being charged off; the charge-offs did not create an additional income-statement expense. Management said the allowance was adequate, while noting estimates and future adjustments are uncertain.
• Interest-rate modeling estimated net interest income would rise 3.31% under a +100 basis-point shock and 2.12% under +200 basis points, but fall 0.34% under +300 basis points. These are modeled scenarios, not management earnings guidance. Estimated market value of portfolio equity declined 5.30% and 14.73% under +200 and +300 basis-point shocks, respectively.
• Liquidity included $172.9 million in cash, $1.09 billion of FHLB excess borrowing capacity, and $2.15 billion of eligible but unused securities collateral. The Bank had $425 million of FHLB advances and $75 million of repurchase agreements scheduled to mature within 12 months. About $1.25 billion of certificates of deposit were due within one year.
• The company repurchased 7.46 million shares during the quarter for $87.6 million; the remaining authorization at June 30 was about $79.3 million. Subsequent to quarter-end, it repurchased another 610,712 shares. A $0.075-per-share dividend was declared July 20, payable August 17, 2012; dividends remain subject to the Bank’s ability to distribute capital and regulatory constraints.
• A $100 million FHLB advance maturing after quarter-end was renewed for four years at a fixed 0.83%. Home-office remodeling commitments totaled $16.1 million, of which $3.7 million remained outstanding; completion was expected in fiscal 2013. Management reported no material subsequent events, and considered routine litigation immaterial.
• Disclosure controls were reported effective as of June 30, 2012, with no material change in internal control over financial reporting during the quarter. The filing reported no material change to previously disclosed risk factors.

Important facts for investors to verify

• Whether improving delinquency and nonperforming-asset trends persist, and whether the smaller allowance remains adequate given the mortgage concentration and accounting-policy change.
• How sustained low loan yields, refinancing and prepayments, and funding repricing affect net interest margin and earnings.
• The renewal or runoff of near-term certificates, FHLB advances, and repurchase agreements, and the continued availability of wholesale funding and collateral capacity.
• The pace and price of buybacks and dividends, remaining repurchase authorization, and regulatory capacity for capital distributions from the Bank.
• How actual operating results compare with the filing’s interest-rate sensitivity scenarios and planned branch and home-office spending.