Capitol Federal Financial(CFFN) - 2024 Q2 - Quarterly Report

PART I -- FINANCIAL INFORMATION Item 1. Financial Statements This section presents the unaudited consolidated financial statements for the period ended March 31, 2024, including the balance sheets, income statements, statements of comprehensive income, stockholders' equity, and cash flows, along with detailed notes outlining significant accounting policies and financial instrument details Consolidated Financial Statements The consolidated financial statements show a decrease in total assets to $9.72 billion from $10.18 billion at September 30, 2023, primarily due to a securities strategy, with net income for the six months ended March 31, 2024, significantly decreasing to $16.3 million from $30.4 million in the prior-year period due to a net loss on securities transactions, and total stockholders' equity also seeing a slight decline to $1.02 billion Consolidated Balance Sheet Summary (in thousands) | Metric | March 31, 2024 | September 30, 2023 | | :--- | :--- | :--- | | Total Assets | $9,721,286 | $10,177,461 | | Loans receivable, net | $7,877,569 | $7,970,949 | | AFS securities, at fair value | $842,950 | $1,384,482 | | Total Liabilities | $8,696,383 | $9,133,407 | | Deposits | $6,141,711 | $6,051,220 | | Borrowings | $2,351,022 | $2,879,125 | | Total Stockholders' Equity | $1,024,903 | $1,044,054 | Consolidated Income Statement Summary (in thousands, except EPS) | Metric | Three Months Ended Mar 31, 2024 | Three Months Ended Mar 31, 2023 | Six Months Ended Mar 31, 2024 | Six Months Ended Mar 31, 2023 | | :--- | :--- | :--- | :--- | :--- | | Net Interest Income | $41,320 | $41,959 | $80,913 | $87,787 | | Provision for Credit Losses | $301 | $891 | $424 | $4,551 | | Net Loss from Securities Transactions | $0 | $0 | $(13,345) | $0 | | Net Income | $13,762 | $14,189 | $16,305 | $30,429 | | Diluted EPS | $0.11 | $0.11 | $0.12 | $0.23 | Consolidated Cash Flow Summary (Six Months Ended, in thousands) | Cash Flow From | March 31, 2024 | March 31, 2023 | | :--- | :--- | :--- | | Operating Activities | $15,168 | $24,734 | | Investing Activities | $674,270 | $(424,258) | | Financing Activities | $(491,530) | $410,537 | | Net Increase in Cash | $197,908 | $11,013 | Notes to Consolidated Financial Statements The notes detail the basis of presentation and significant accounting policies, including the adoption of ASU 2022-02 which eliminated Troubled Debt Restructuring (TDR) accounting, providing breakdowns of securities, loans, allowance for credit losses (ACL), borrowings, income taxes, and fair value measurements, with key disclosures covering the impact of the company's securities strategy on deferred tax assets and the composition of the loan portfolio - The Company adopted ASU 2022-02 on October 1, 2023, which eliminated the accounting guidance for Troubled Debt Restructurings (TDRs), resulting in a cumulative-effect adjustment to accumulated deficit of $27 thousand, net of tax[316] - The loan portfolio is primarily composed of one- to four-family loans, with a total net balance of $7.88 billion at March 31, 2024, down from $7.97 billion at September 30, 2023[32][333] - Borrowings decreased to $2.35 billion at March 31, 2024, from $2.88 billion at September 30, 2023, mainly due to the payoff of $500.0 million in borrowings from the Federal Reserve's Bank Term Funding Program (BTFP)[53] - Due to an anticipated taxable net loss in fiscal year 2024 from its securities strategy, the Company recorded a deferred tax asset of $42.3 million related to the net operating loss as of March 31, 2024[64] - The majority of the company's financial instruments measured at fair value, including Mortgage-Backed Securities (MBS) and interest rate swaps, are classified as Level 2, valued using observable market inputs rather than direct quoted prices[69][70] Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) This section provides management's perspective on the company's financial condition and operating results, detailing a significant securities strategy initiated in October 2023 to improve future earnings, covering performance metrics, balance sheet changes, strong asset quality, liquidity management, and detailed comparisons of operating results across different periods Executive Summary The company initiated a securities strategy in October 2023, selling $1.30 billion of low-yield securities and redeploying proceeds into higher-yielding assets and paying down debt, resulting in a $13.3 million net loss but expected future earnings improvement, with net income for the six months ended March 31, 2024, at $16.3 million ($0.12/share), down from $30.4 million ($0.23/share) year-over-year, primarily due to the securities loss, while the loan portfolio shifted towards commercial loans and asset quality remained strong, and digital transformation efforts improved customer engagement - In October 2023, a securities strategy was launched, selling $1.30 billion of securities with a 1.22% yield, with proceeds used to purchase $632.0 million of securities yielding 5.75% and pay down $500.0 million of borrowings with a 4.70% cost[99] - Net income for the six months ended March 31, 2024, was $16.3 million ($0.12/share), compared to $30.4 million ($0.23/share) for the prior-year period, with the decrease mainly due to a $13.3 million net loss on the securities sale[101] - Total assets decreased by $456.2 million to $9.72 billion at March 31, 2024, from September 30, 2023, primarily due to the securities strategy[103] - The company is advancing its digital transformation, resulting in a 64% increase in person-to-person payment volume and a 40% increase in payment amounts year-over-year for the current quarter following the integration of Zelle[107] Financial Condition As of March 31, 2024, total assets were $9.72 billion, a decrease from September 30, 2023, driven by the securities strategy, with the loan portfolio decreasing slightly to $7.88 billion, deposits increasing to $6.14 billion, and borrowings significantly decreasing to $2.35 billion after paying off BTFP debt, while asset quality remained strong with low delinquency rates, stockholders' equity decreased to $1.02 billion due to dividends and share repurchases, and the company maintains a well-capitalized status Financial Condition Summary (in thousands) | Metric | March 31, 2024 | Dec 31, 2023 | Sept 30, 2023 | | :--- | :--- | :--- | :--- | | Total assets | $9,721,286 | $9,576,064 | $10,177,461 | | Loans receivable, net | $7,877,569 | $7,947,510 | $7,970,949 | | Deposits | $6,141,711 | $6,021,595 | $6,051,220 | | Borrowings | $2,351,022 | $2,373,064 | $2,879,125 | | Stockholders' equity | $1,024,903 | $1,034,121 | $1,044,054 | - The loan portfolio is shifting, with one-to-four family loans decreasing by $88.0 million and commercial loans increasing by $20.3 million during the current quarter[121] - Asset quality remains strong: At March 31, 2024, loans 30 to 89 days delinquent were 0.19% of total loans, and net charge-offs were only $1 thousand for the six-month period[105] - During the six months ended March 31, 2024, the Company repurchased 3,280,110 shares of common stock for $19.3 million, and a new $75 million share repurchase plan was approved by the FRB in February 2024[171] Operating Results This section provides a detailed comparative analysis of operating results, showing net income rising to $13.8 million from $2.5 million for Q2'24 vs Q1'24, mainly due to the prior quarter's $13.3 million loss from the securities strategy, and a decrease in net income for the six months ended March 31, 2024 vs 2023, from $30.4 million to $16.3 million, also due to the securities loss, with the net interest margin improving to 1.76% from 1.59% YoY due to the absence of a low-margin leverage strategy, and highlighting the expected tax recapture of pre-1988 bad debt reserves due to an anticipated tax loss in FY2024 - Q2'24 vs Q1'24: Net income increased to $13.8 million from $2.5 million, with the prior quarter including a $13.3 million loss on securities sales, and absent this loss, EPS would have been $0.10 in Q1'24 vs $0.11 in Q2'24, while the net interest margin improved 11 basis points to 1.82%[181] - 6M'24 vs 6M'23: Net income decreased to $16.3 million from $30.4 million, driven by the $13.3 million securities loss, and net interest margin increased 17 bps to 1.76%, primarily because a low-margin leverage strategy was not used in the current period[196][203] - Tax Impact: An anticipated taxable net loss for FY2024 will cause any capital distributions from the Bank to the Company to trigger a recapture of pre-1988 bad debt reserves, resulting in additional income tax expense[198] Rate/Volume Analysis of Net Interest Income Change (6M'24 vs 6M'23, in thousands) | Component | Change Due to Volume | Change Due to Rate | Total Change | | :--- | :--- | :--- | :--- | | Interest Income | $(33,159) | $37,254 | $4,095 | | Interest Expense | $(27,779) | $38,748 | $10,969 | | Net Interest Income | $(5,380) | $(1,494) | $(6,874) | Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate risk, managed by analyzing the impact of hypothetical rate changes on Net Interest Income (NII) and the Market Value of Portfolio Equity (MVPE), with the one-year interest rate gap at $(1.10) billion, or (11.3)% of total assets, as of March 31, 2024, and projections showing NII increasing by 8.9% in a +200 bps rate shock scenario while MVPE would decrease by 20.4%, indicating increased balance sheet sensitivity to rate changes due to a higher cash balance following the recent securities strategy - The company's most significant market risk is interest rate risk, managed through Net Interest Income (NII) and Market Value of Portfolio Equity (MVPE) analysis[257][258] - The one-year interest rate sensitivity gap was $(1.10) billion, or (11.3)% of total assets, at March 31, 2024[262] Interest Rate Sensitivity Analysis (at March 31, 2024) | Change in Rates (bps) | Change in Net Interest Income (next 4 qtrs) | Change in Market Value of Portfolio Equity (MVPE) | | :--- | :--- | :--- | | +300 | +13.2% | -31.5% | | +200 | +8.9% | -20.4% | | +100 | +4.6% | -9.9% | | -100 | -5.0% | +9.4% | | -200 | -10.0% | +16.5% | | -300 | -15.6% | +16.5% | Controls and Procedures Management, with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated the company's disclosure controls and procedures as of March 31, 2024, concluding their effectiveness in ensuring timely recording, processing, and reporting of information required for SEC filings, with no material changes to internal control over financial reporting occurring during the quarter - Management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of March 31, 2024[276] - There were no changes in the Company's internal control over financial reporting during the quarter ended March 31, 2024, that have materially affected, or are reasonably likely to materially affect, internal controls[277] PART II -- OTHER INFORMATION Legal Proceedings The company is involved in a putative class action lawsuit concerning overdraft fees, which was dismissed with prejudice by the court in April 2023 but is currently under appeal by the plaintiffs, though management does not believe this or any other pending legal action will have a material adverse effect on the company's financial condition or operations - A putative class action lawsuit regarding overdraft fees, filed against the Bank, was dismissed with prejudice on April 5, 2023, but the plaintiffs have appealed this decision[285] - Management believes it is unlikely that any pending legal actions will have a material adverse effect on the company's financial condition, results of operations, or liquidity[278] Risk Factors This section supplements the risk factors from the annual report, highlighting that the company's ability to pay dividends and repurchase shares depends on the Bank's ability to make capital distributions, which is subject to regulatory approval, and a significant new risk has emerged where the Bank's anticipated tax loss for fiscal year 2024 will cause capital distributions to the holding company to trigger a recapture of pre-1988 bad debt reserves, resulting in additional tax expense that could impact future dividends and share repurchases - The Company's ability to pay dividends and repurchase shares is primarily dependent on the Bank's ability to make capital distributions, which are subject to regulatory oversight[280] - A key risk is that the Bank's anticipated net loss for tax purposes in FY2024 will cause capital distributions to the holding company to trigger the recapture of pre-1988 bad debt reserves, resulting in additional tax expense, reducing earnings available for distribution[286] Unregistered Sales of Equity Securities and Use of Proceeds This section details the company's stock repurchase activity for the quarter ended March 31, 2024, where a total of 1,246,110 shares were repurchased at an average price of $6.00 per share, with $2.0 million remaining under the existing repurchase plan, and a new, larger $75 million repurchase plan approved by the FRB set to become active after the completion of the current program Stock Repurchase Activity (Q1 2024) | Period | Total Shares Purchased | Average Price Paid per Share | | :--- | :--- | :--- | | Jan 2024 | 199,400 | $6.53 | | Feb 2024 | 572,289 | $5.99 | | Mar 2024 | 474,421 | $5.78 | | Total | 1,246,110 | $6.00 | - As of March 31, 2024, approximately $2.0 million remained available for repurchase under the existing plan[289] - In February 2024, the FRB approved a new share repurchase plan of up to $75 million, which will commence after the existing plan is completed, with the FRB's approval for this new plan expiring in February 2025[289]