Business context and reporting period
Capitol Federal Financial, Inc. is a community-oriented savings institution whose primary business is attracting deposits and investing mainly in residential first-mortgage loans, with additional consumer and commercial real estate lending and securities investments. This unaudited Form 10-Q covers the fiscal quarter and nine months ended June 30, 2016; balance-sheet comparisons are to September 30, 2015.
Financial performance and position
| Metric | Three months ended June 30, 2016 | Nine months ended June 30, 2016 |
|---|---|---|
| Net interest income | $47.9 million | $144.5 million |
| Net income | $20.6 million; diluted EPS $0.15 | $62.8 million; diluted EPS $0.47 |
| Net interest margin | 1.73% | 1.75% |
| Efficiency ratio | 43.72% | 43.40% |
| Operating cash flow | $62.1 million for the nine-month period |
At June 30, assets were $9.24 billion, net loans $6.84 billion, deposits $5.09 billion, FHLB borrowings $2.47 billion, repurchase agreements $200 million, and equity $1.38 billion. Equity was 14.9% of period-end assets. The Bank and Company exceeded regulatory capital requirements; the Bank’s Tier 1 leverage ratio was 10.9% and total capital ratio was 29.0%.
Cash and cash equivalents were $152.8 million, down from $772.6 million at September 30. The reported decline primarily reflects quarter-end removal of the daily leverage strategy; the full $2.10 billion strategy was reinstated July 1. Nine-month cash flows were $62.1 million provided by operations, $11.3 million used in investing, and $670.6 million used in financing, producing a $619.8 million net cash decrease.
Material changes versus comparable periods
- Quarterly net income rose 4.8% year over year, from $19.6 million; nine-month net income rose 5.9%, from $59.3 million. Quarterly net interest income increased $0.9 million year over year; nine-month net interest income increased $2.6 million.
- Year-to-date non-interest income increased $1.9 million, mainly from bank-owned life insurance (BOLI) income, including death-benefit proceeds. Non-interest expense increased $1.2 million.
- Net loans grew $214.1 million from September 30, funded mainly by securities cash flows and deposit growth. Deposits increased $252.6 million, while FHLB borrowings declined $798.5 million, largely due to quarter-end removal of the daily leverage strategy.
- Quarterly net interest margin increased two basis points year over year but declined five basis points from the March 2016 quarter, to 1.73%. Management attributed the sequential decline mainly to higher deposit costs and lower loan and MBS yields. Excluding the daily leverage strategy, quarterly margin was 2.09%, down from 2.13% in the prior quarter.
- Asset quality remained relatively strong: non-performing loans were 0.41% of loans and non-performing assets 0.35% of assets. The allowance for credit losses was $9.3 million, or 0.14% of net loans; no provision was recorded in the current quarter or nine-month period.
Outlook, commentary, risks and unusual items
- Management intended to continue removing the daily leverage strategy at each fiscal quarter-end in 2016 and reinstating it at the start of the next quarter; it was reinstated July 1. Management reported $1.12 billion of eligible, unused securities collateral for borrowing or liquidity needs.
- Management intended to pay out 100% of fiscal 2016 earnings to stockholders, subject to financial condition, regulatory limits and Bank distributions. A regular $0.085-per-share dividend was declared for payment in August. The $70 million stock-repurchase authorization remained unused at June 30.
- Management estimated fiscal 2016 salaries and benefits would be approximately $500,000 below fiscal 2015, and the fiscal 2016 effective tax rate approximately 32%. Beginning October 1, 2016, the Bank expected to change its accounting for low-income housing partnerships; management estimated that, had the change applied in fiscal 2016, the effective tax rate would have been about 250 basis points higher and the efficiency ratio about 175 basis points lower.
- Commercial real estate lending is expanding through participations. Loans, undisbursed amounts and commitments totaled $349.9 million, with notable concentration in accommodation and food services (40.7%) and Texas (43.6%). Management cautioned that these loans can be larger, geographically different and riskier than residential loans.
- Interest-rate risk is material: most loans are fixed rate while many deposits reprice or mature within two years. The filing’s modeled +200-basis-point shock reduced market value of portfolio equity by 16.58%; modeled net interest income increased 1.78%. These are scenario estimates, not earnings guidance, and depend on assumptions including deposit behavior and prepayments.
- Other risks include deposit withdrawals or migration to higher-cost products, competition for loans and funding, local economic and property-value changes, credit losses, regulatory capital-distribution limits, and execution of lending and cost-control plans. Management said pending legal matters were not expected to have a material adverse effect; no material risk-factor changes were reported.
Important facts for investors to verify
- Whether deposit pricing and certificate-of-deposit maturities pressure funding costs and net interest margin.
- Performance, concentration and commitments of the growing commercial real estate portfolio, especially food-service and Texas exposures.
- Credit trends, including delinquency and non-performing loan movements, and whether the $9.3 million allowance remains adequate as the portfolio grows.
- Effects of the daily leverage strategy’s reinstatement on reported assets, borrowings, liquidity and earnings.
- Whether regulatory conditions and Bank capital distributions support the stated dividend intentions and any future share repurchases.
- Implementation effects of the planned low-income-housing accounting change and the interest-rate and deposit-behavior assumptions underlying sensitivity estimates.