Capitol Federal Financial, Inc. — Q1 FY2017 Form 10-Q
Reporting period: Three months ended December 31, 2016. The quarter is the company’s fiscal first quarter. Financial statements are unaudited. The company is a community-oriented bank focused primarily on residential mortgage lending in Kansas and Missouri.
Financial performance and condition
- Profitability: Net income was $20.6 million, or $0.15 per diluted share, versus $20.7 million, or $0.16, in the prior-year quarter. Income before tax was $31.0 million; income tax expense was $10.4 million, a 33.6% effective tax rate. Return on average assets was 0.73% and return on average equity was 5.91%.
- Revenue and margins: Net interest income was $47.3 million, down 1.4% year over year; net interest margin was 1.73%, down 2 basis points. Excluding the leverage strategy, management reported a 2.07% margin, down 4 basis points year over year. Total interest and dividend income rose 1.3% to $75.3 million, while interest expense rose 6.2% to $28.0 million. Non-interest income declined 5.4% to $5.3 million.
- Expenses: Non-interest expense fell 8.4% to $21.6 million. The efficiency ratio improved to 41.08% from 44.05%; the comparison reflects, in part, a change in accounting for affordable-housing partnership investments.
- Loans and credit: Net loans were $7.07 billion, up $113.4 million from September 30, 2016; quarterly loan growth was 6.5% annualized. The allowance for credit losses was $8.5 million, or 0.12% of loans. No provision was recorded and net charge-offs were $19,000. Non-performing loans were $28.8 million (0.41% of loans); non-performing assets were $32.2 million (0.35% of assets).
- Cash flow: Operating activities provided $27.0 million. Investing activities used $4.7 million and financing activities used $153.4 million, including $50.2 million of dividends paid. Cash and cash equivalents declined $131.2 million to $150.6 million, mainly as cash funded loan growth and a maturing FHLB advance was repaid.
- Balance sheet and funding: Total assets were $9.14 billion, down $127.7 million from fiscal year-end. Deposits increased $28.7 million to $5.19 billion; FHLB borrowings declined $99.6 million to $2.27 billion; repurchase agreements remained $200.0 million. Stockholders’ equity was $1.37 billion, down $24.8 million, primarily reflecting dividends.
- Capital and liquidity: Equity was 15.0% of total assets. The Bank’s regulatory ratios were 11.0% Tier 1 leverage, 28.3% Common Equity Tier 1, 28.3% Tier 1 capital, and 28.5% total capital; each exceeded the stated well-capitalized requirement. The Bank reported $751.9 million of eligible, unused securities collateral and $370.7 million of public unit deposits; it had no brokered deposits.
Material changes versus comparable periods
- Year over year, net income decreased $140,000 and diluted EPS decreased from $0.16 to $0.15. Deposit interest expense increased $1.6 million, while net interest income declined $676,000.
- Loan interest income increased $1.7 million, but MBS income fell $1.5 million and investment-security income fell $426,000. Management attributed margin pressure primarily to higher deposit costs and lower MBS yields, partly offset by a shift toward higher-yielding loans.
- Loans grew while securities balances declined; cash flows from securities helped fund loan growth and repayment of the $100 million maturing FHLB advance.
- Compared with the prior quarter, net income decreased $120,000 and net interest income decreased $426,000. The efficiency ratio improved from 44.85%, largely due to lower reported expenses, including the partnership-accounting change.
Outlook, commentary, risks, and unusual items
- Management estimated the fiscal 2017 effective tax rate at approximately 34%. It stated an intent to maintain a 100% earnings payout to stockholders for fiscal 2017, subject to financial condition, regulatory requirements and the Bank’s ability to distribute capital. A regular quarterly dividend of $0.085 per share was announced for payment in February 2017. The quarter’s declared dividend was $0.38 per share; cash dividends paid were $0.375 per share, including a $0.29 true-up and a $0.085 regular dividend.
- The Bank continued its leverage strategy, using short-term FHLB funding and depositing proceeds at the Federal Reserve. Management reported $642,000 of net income attributable to the strategy, versus $583,000 a year earlier. The strategy depends on funding costs, yields and regulatory borrowing approval.
- Management described interest-rate risk as its most significant market risk. At December 31, a modeled instantaneous +200 basis-point rate shock reduced projected four-quarter net interest income by 0.31% and market value of portfolio equity by 28.08%; these are scenario estimates, not earnings guidance. Management said higher rates could cause funding costs to reprice faster than asset yields under certain scenarios.
- Affordable-housing partnership accounting changed from the equity method to proportional amortization effective October 1, 2016, after two officers left operational management of the investment group. The change moved related operating losses and tax benefits into income tax expense rather than non-interest expense. The quarter included a net tax benefit of $577,000 from these investments.
- Key risks include interest-rate and market movements, deposit competition and outflows, access to cost-effective funding, loan origination and purchase volumes, local economic and real-estate conditions, credit losses, regulatory actions, and the Bank’s ability to make distributions to the holding company. Management said pending legal actions were not expected to have a material adverse effect; no material risk-factor changes were reported.
Important facts for investors to verify
- Whether loan growth and yields can offset rising deposit and borrowing costs and sustain net interest margin.
- How the leverage strategy’s earnings contribution, funding cost and regulatory borrowing approval evolve.
- Whether credit quality remains stable, including delinquency trends, non-performing loans, foreclosure activity and the adequacy of the allowance.
- Whether dividend plans remain supportable given earnings, regulatory capital-distribution limits and the Bank’s liquidity needs.
- The effect of the affordable-housing accounting change on future expense, tax-rate and period-to-period comparisons.
- Interest-rate sensitivity assumptions and modeled impacts, particularly the reported downside to market value of portfolio equity in rising-rate scenarios.