Capitol Federal® Financial, Inc. Announces The Acquisition Of Capital City Bancshares And Reports Second Quarter Fiscal Year 2018 Results

TOPEKA, Kan., April 30, 2018 /PRNewswire/ -- Capitol Federal^® Financial, Inc. (NASDAQ: CFFN) ("Capitol Federal" or the "Company") announced today the acquisition of Capital City Bancshares, Inc. ("CCB") and results for the quarter ended March 31, 2018.  Detailed results will be available in the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2018, which will be filed with the Securities and Exchange Commission ("SEC") on or about May 10, 2018 and posted on our website, http://ir.capfed.com.  For best viewing results, please view this release in Portable Document Format (PDF) on our website.

Highlights for the quarter include:

• net income of $23.3 million;
• basic and diluted earnings per share of $0.17;
• net interest margin of 1.86% (2.24% excluding the effects of the leverage strategy); and
• dividends paid of $11.4 million, or $0.085 per share.

Capitol Federal, the parent company of Capitol Federal^® Savings Bank ("Capitol Federal Savings" or the "Bank"), and CCB, the parent company of Capital City Bank, a state chartered bank headquartered in Topeka, KS, announced the signing of a definitive agreement and plan of merger pursuant to which CCB will merge with and into Capitol Federal.  Immediately upon closing the merger, Capital City Bank will merge with and into Capitol Federal Savings.  As of March 31, 2018 and excluding purchase accounting, the combined company would have had pro-forma total assets of $9.5 billion, gross loans of $7.5 billion, deposits of $5.7 billion and an equity position of approximately $1.4 billion.

With the acquisition of Capital City Bank, Capitol Federal Savings will enter the commercial banking business, through the origination of commercial lending products and offering of commercial deposit services, for the first time in its 125 year history.  While Capitol Federal Savings has built a small, but meaningful, portfolio of mostly commercial real estate loan participations through its network of correspondent banks over the course of the last five years (which portfolio totaled approximately $462 million in gross loans as of March 31, 2018), this merger with Capital City will enable the Company to offer a full array of commercial lending and deposit products and services.  With the talented and experienced commercial banking teams from Capital City Bank joining Capitol Federal Savings, the Company will be able to introduce these lines of banking into its branches in overlapping communities upon closing of the merger, while working to expand to the other communities served by Capitol Federal.

• Strategically and financially attractive acquisition of a $400 million commercial bank
• Enhances deposit franchise and provides entry into commercial banking business lines
• Delivers scalable banking platform, while remaining under $10 billion in assets

John B. Dicus, Chairman and President of Capitol Federal, stated: "We are pleased to be merging with Capital City Bank to introduce a full commercial banking experience to our customer base and communities.  Capital City Bank has a long history of building a conservative, customer focused community bank, with an overlapping geographic focus in markets highly familiar to us - Topeka, Lawrence and the Overland Park market of Kansas City.  Through the leadership of the Sabatini family, Capital City Bank has built a well-regarded company over the course of many decades, driven by the people and platforms we need to enter the commercial banking business in the right way and in a meaningful way.  Through the many years of knowing the team at Capital City Bank, it is obvious to us that we hold a shared cultural approach to banking, focused on risk management and customer service.  In addition, we are able to complete this merger and remain under $10 billion in assets, allowing us to continue our current dividend policy of paying 100% of earnings, while providing a positive upside."

Comparison of Operating Results for the Three Months Ended March 31, 2018 and December 31, 2017

For the quarter ended March 31, 2018, the Company recognized net income of $23.3 million, or $0.17 per share, compared to net income of $31.8 million, or $0.24 per share, for the quarter ended December 31, 2017.   The decrease in net income was due primarily to higher income tax expense in the current quarter compared to the prior quarter.  The effective income tax rate in the current quarter was 26.5% compared to 2.6% in the prior quarter.  In the prior quarter, the Tax Cuts and Jobs Act (the "Tax Act") was enacted which reduced the federal corporate income tax rate from 35% to 21% effective January 1, 2018.  In accordance with accounting principles generally accepted in the United States of America ("GAAP"), the Company revalued its deferred tax assets and liabilities as of December 22, 2017 to account for the lower corporate income tax rate.  The revaluation of the Company's deferred income tax assets and liabilities reduced income tax expense by $7.5 million in the prior quarter.  The impact of the enactment of the Tax Act was an increase in basic and diluted earnings per share of $0.08 in the prior quarter.  Management estimates the effective tax rate for the third and fourth quarter of fiscal year 2018 to be approximately the same as the current quarter effective income tax rate of 26.5%, resulting in an effective income tax rate of 20% to 21% for fiscal year 2018.  Management estimates the effective income tax rate for fiscal year 2019 will be approximately 22%.

Net interest income increased $515 thousand, or 1.0%, from the prior quarter to $49.9 million for the current quarter.  The net interest margin increased three basis points from 1.83% for the prior quarter to 1.86% for the current quarter.  Excluding the effects of the leverage strategy, the net interest margin would have increased four basis points from 2.20% for the prior quarter to 2.24% for the current quarter.  The increase in net interest margin was due mainly to a decrease in the cost of borrowings not related to the leverage strategy, along with a reduction in interest expense resulting from fewer days in the current quarter.

Interest and Dividend Income

The weighted average yield on total interest-earning assets for the current quarter increased eight basis points from the prior quarter, to 3.06%, while the average balance of interest-earning assets decreased $71.5 million between the two periods.  Absent the impact of the leverage strategy, the weighted average yield on total interest-earning assets would have increased four basis points from the prior quarter, to 3.35%, while the average balance of interest-earning assets would have decreased $69.5 million.  The following table presents the components of interest and dividend income for the time periods presented, along with the change measured in dollars and percent.

The table above includes interest income on cash and cash equivalents associated and not associated with the leverage strategy.  Interest income on cash and cash equivalents not related to the leverage strategy decreased $165 thousand from the prior quarter due to a $79.9 million decrease in the average balance primarily resulting from cash being used to pay off certain maturing term borrowings during the prior quarter, partially offset by a 25 basis point increase in the weighted average yield.  Interest income on cash associated with the leverage strategy increased $945 thousand from the prior quarter due to a 23 basis point increase in the weighted average yield.  In both cases, the increase in the weighted average yield was related to balances held at the Federal Reserve Bank of Kansas City (the "FRB of Kansas City").

Interest Expense

The weighted average rate paid on total interest-bearing liabilities for the current quarter increased six basis points from the prior quarter, to 1.35%, while the average balance of interest-bearing liabilities decreased $33.3 million between the two periods.  Absent the impact of the leverage strategy, the weighted average rate paid on total interest-bearing liabilities for the current quarter would have increased one basis point from the prior quarter, to 1.30%, while the average balance of interest-bearing liabilities would have decreased $31.3 million.  The following table presents the components of interest expense for the time periods presented, along with the change measured in dollars and percent. 

The table above includes interest expense on FHLB borrowings associated and not associated with the leverage strategy.  Interest expense on FHLB borrowings not related to the leverage strategy decreased $218 thousand from the prior quarter due to a three basis point decrease in the weighted average rate paid, to 2.05% for the current quarter.  Interest expense on FHLB borrowings associated with the leverage strategy increased $1.1 million from the prior quarter due to a 24 basis point increase in the weighted average rate paid as a result of an increase in interest rates between periods.

The increase in interest expense on deposits was due primarily to a five basis point increase in the weighted average rate paid, to 0.96% for the current quarter.  The increase in the weighted average rate paid was primarily due to increases in the money market deposit portfolio rate and retail certificate of deposit portfolio rate, which increased 12 basis points and five basis points, respectively.

The decrease in interest expense on repurchase agreements was due to the maturity of a $100.0 million repurchase agreement during the prior quarter.

Provision for Credit Losses

The Bank did not record a provision for credit losses during the current quarter or the prior quarter.  Based on management's assessment of the allowance for credit losses ("ACL") formula analysis model and several other factors, it was determined that no provision for credit losses was necessary.  Net loan recoveries were $20 thousand during the current quarter compared to net charge-offs of $28 thousand in the prior quarter.  At March 31, 2018, loans 30 to 89 days delinquent were 0.19% of total loans and loans 90 or more days delinquent or in foreclosure were 0.16% of total loans.  At December 31, 2017, loans 30 to 89 days delinquent were 0.25% of total loans and loans 90 or more days delinquent or in foreclosure were 0.15% of total loans.

Non-Interest Income

The following table presents the components of non-interest income for the time periods presented, along with the change measured in dollars and percent.

The decrease in retail fees and charges was due mainly to a decrease in debit card income resulting from a reduction in transaction volume due to the seasonality of such activity.  The decrease in income from BOLI was due mainly to a one-time adjustment to the benchmark interest rate associated with one of the policies.  The increase in other non-interest income was due primarily to an increase in insurance commissions resulting from the receipt of annual commissions from certain insurance providers during the current quarter and no such commissions received during the prior quarter, along with a gain on the sale of loans during the current quarter compared to a loss on the sale of loans during the prior quarter as management continues to test loan sale processes for liquidity purposes.

Non-Interest Expense

The following table presents the components of non-interest expense for the time periods presented, along with the change measured in dollars and percent.

The increase in salaries and employee benefits expense was due primarily to the timing of expenses related to paid time-off usage and accruals, as well as to a new 2018 Tax Savings Bonus Plan.  The 2018 Tax Savings Bonus plan is a one-time bonus award to qualifying non-officer employees.  The anticipated expense associated with this plan will be recognized in fiscal year 2018 and is approximately $1.0 million, of which $333 thousand was recognized during the current quarter.  It is expected that the Bank will recognize approximately $333 thousand of expense per quarter in the third and fourth quarters of fiscal year 2018 related to this plan.  The increase in advertising and promotional expense was due primarily to the timing of media campaigns and sponsorships.

The Company's efficiency ratio was 42.66% for the current quarter compared to 40.26% for the prior quarter.  The change in the efficiency ratio was due primarily to higher non-interest expense in the current quarter compared to the prior quarter.  The efficiency ratio is a measure of a financial institution's total non-interest expense as a percentage of the sum of net interest income (pre-provision for credit losses) and non-interest income.  A lower value indicates that the financial institution is generating revenue with a proportionally lower level of expense.

Income Tax Expense

Income tax expense was $8.4 million for the current quarter, compared to $860 thousand for the prior quarter.  The effective tax rate was 26.5% for the current quarter compared to 2.6% for the prior quarter.  The lower effective income tax rate and income tax expense in the prior quarter were due primarily to revaluing the Company's deferred tax assets and liabilities as a result of the enactment of the Tax Act in December 2017.  Management estimates the effective tax rate for the third and fourth quarter of fiscal year 2018 to be approximately the same as the current quarter effective income tax rate of 26.5%.

Comparison of Operating Results for the Six Months Ended March 31, 2018 and 2017

The Company recognized net income of $55.2 million, or $0.41 per share, for the six month period ended March 31, 2018 compared to net income of $42.2 million, or $0.31 per share, for the six month period ended March 31, 2017.  The increase in net income was due primarily to a decrease in income tax expense resulting from the Tax Act being signed into law in December 2017.

The net interest margin increased eight basis points, from 1.77% for the prior year six month period to 1.85% for the current year six month period.  Excluding the effects of the leverage strategy, the net interest margin would have increased 11 basis points, from 2.11% for the prior year six month period to 2.22% for the current year six month period.  The increase in the net interest margin was due mainly to an increase in interest-earning asset yields, as well as a shift in the mix of interest-earning assets from relatively lower yielding securities to higher yielding loans and a net decrease in the cost of liabilities not related to the leverage strategy.

Interest and Dividend Income

The weighted average yield on total interest-earning assets increased 22 basis points, from 2.80% for the prior year six month period to 3.02% for the current year six month period, while the average balance of interest-earning assets decreased $163.7 million from the prior year six month period.  Absent the impact of the leverage strategy, the weighted average yield on total interest-earning assets would have increased 10 basis points, from 3.23% for the prior year six month period to 3.33% for the current year six month period, while the average balance of interest-earning assets would have decreased $152.2 million.  The following table presents the components of interest and dividend income for the time periods presented along with the change measured in dollars and percent.

The increase in interest income on loans receivable was due mainly to a $118.3 million increase in the average balance of the portfolio, as well as a four basis point increase in the weighted average yield on the portfolio to 3.57% for the current year six month period.  The increase in the weighted average yield was due primarily to adjustable-rate loans repricing to higher market rates, along with the origination and purchase of new loans at higher market rates.

The table above includes interest income on cash and cash equivalents associated and not associated with the leverage strategy.  Interest income on cash and cash equivalents not related to the leverage strategy increased $794 thousand from the prior year six month period due to a 72 basis point increase in the weighted average yield.  Interest income on cash associated with the leverage strategy increased $7.1 million from the prior year six month period due to a 74 basis point increase in the weighted average yield.  In both cases, the increase in the weighted average yield was related to balances held at the FRB of Kansas City. 

The decrease in interest income on the MBS portfolio was due to a $227.4 million decrease in the average balance of the portfolio, partially offset by a 12 basis point increase in the weighted average yield on the portfolio to 2.28% for the current year six month period.  Cash flows not reinvested were used primarily to fund loan growth and pay off certain maturing term borrowings.  The increase in the weighted average yield was due primarily to adjustable-rate MBS repricing to higher market rates, as well as a decrease in the impact of net premium amortization.  Net premium amortization of $1.6 million during the current year six month period decreased the weighted average yield on the portfolio by 35 basis points.  During the prior year six month period, $2.3 million of net premiums were amortized which decreased the weighted average yield on the portfolio by 40 basis points.  As of March 31, 2018, the remaining net balance of premiums on our portfolio of MBS was $7.4 million.

Interest Expense

The weighted average rate paid on total interest-bearing liabilities increased 15 basis points, from 1.17% for the prior year six month period to 1.32% for the current year six month period, while the average balance of interest-bearing liabilities decreased $134.6 million from the prior year six month period.  Absent the impact of the leverage strategy, the weighted average rate paid on total interest-bearing liabilities would have decreased one basis point, from 1.30% for the prior year six month period to 1.29% for the current year six month period, and the average balance of interest-bearing liabilities would have decreased $123.0 million.  The following table presents the components of interest expense for the time periods presented, along with the change measured in dollars and percent.

The table above includes interest expense on FHLB borrowings associated and not associated with the leverage strategy.  Interest expense on FHLB borrowings not related to the leverage strategy decreased $3.9 million from the prior year six month period due to a 22 basis point decrease in the weighted average rate paid on the portfolio, to 2.06% for the current year six month period, and a $140.9 million decrease in the average balance of the portfolio.  The decrease in the weighted average rate paid was due to certain advances maturing between periods being replaced at lower effective interest rates.  The decrease in the average balance was a result of using cash flows from the securities portfolio and funds generated from deposit growth to pay off certain advances that matured between periods.  Interest expense on FHLB borrowings associated with the leverage strategy increased $7.7 million from the prior year six month period due to a 77 basis point increase in the weighted average rate paid as a result of an increase in interest rates between periods.

The increase in interest expense on deposits was due primarily to a 13 basis point increase in the weighted average rate, to 0.93% for the current year six month period.  The increase in the weighted average rate was primarily related to the certificate of deposit portfolio, which increased 19 basis points to 1.53% for the current year six month period.  The weighted average rate paid on wholesale certificates increased 64 basis points, to 1.38% for the current year six month period.

Non-Interest Income

The following table presents the components of non-interest income for the time periods presented, along with the change measured in dollars and percent.

The increase in retail fees and charges was due mainly to increases in debit card income due to higher transaction volume in the current year and a reduction in waived fees as customers and vendors have become more accustomed to the chip card technology.  The decrease in income from BOLI was due mainly to a one-time adjustment to the benchmark interest rate associated with one of the policies.

Non-Interest Expense

The following table presents the components of non-interest expense for the time periods presented, along with the change measured in dollars and percent.

The increase in salaries and employee benefits expense was due primarily to the 2018 Tax Savings Bonus Plan as previously discussed.  The increase in information technology and related expense and the decrease in regulatory and outside services were due mainly to a change in the presentation of certain information technology professional and consulting expenses beginning in fiscal year 2018.  Information technology professional and consulting expenses are now being reported in information technology and related expenses rather than regulatory and outside services.  Additionally, these expenses increased compared to the prior year due primarily to ongoing enhancements to the Bank's online banking services, along with increases in information technology expenses related to software licensing and depreciation.  The increase in other non-interest expense was due mainly to an increase in other real estate owned ("OREO") operations expense.

The Company's efficiency ratio was 41.47% for the current year six month period compared to 40.61% for the prior year six month period.  The change in the efficiency ratio was due primarily to higher non-interest expense in the current year six month period compared to the prior year six month period. 

Income Tax Expense

Income tax expense was $9.3 million for the current year six month period compared to $21.5 million for the prior year six month period.  The effective tax rate was 14.4% for the current year six month period compared to 33.8% for the prior year six month period. The decrease in effective tax rate was due mainly to the Tax Act being signed into law in December 2017.

Financial Condition as of March 31, 2018 

Total assets were $9.12 billion at March 31, 2018 compared to $9.19 billion at September 30, 2017.  The $76.5 million decrease was due primarily to a $211.1 million decrease in cash and cash equivalents, partially offset by an increase in FHLB stock.  At March 31, 2018, the Bank was not required by the FHLB to redeem the FHLB stock associated with the leverage strategy.  At September 30, 2017, this stock was redeemed.

The loans receivable portfolio, net, totaled $7.20 billion at March 31, 2018 and at September 30, 2017.  During the current year six month period, the Bank originated and refinanced $261.0 million of loans with a weighted average rate of 3.89% and purchased $210.9 million of one- to four-family loans from correspondent lenders with a weighted average rate of 3.60%.  The Bank also entered into participations of $107.6 million of commercial real estate loans with a weighted average rate of 4.15%, of which $97.8 million had not yet been funded as of March 31, 2018.  During the current year six month period, the Bank funded $52.0 million of new and existing commercial real estate loans.  There are no agricultural loans in the Bank's loan portfolio.

The Bank is continuing to manage the size of its loan portfolio as it manages its liquidity levels to a target level of 15%.  The size of the loan portfolio has been managed by controlling correspondent loan volume primarily through the rates offered to correspondent lenders.  Given the balance of total assets, it is unlikely that loan growth will substantially increase in the current environment.  Generally, over the past few years, cash flows from the securities portfolio have been used primarily to purchase loans and in part to pay down FHLB advances.  By moving cash from lower yielding assets to higher yielding assets and repaying higher cost liabilities, we have been able to maintain our net interest margin.  In addition to the repayment of securities, the Bank has emphasized growth in the deposit portfolio in part to pay down FHLB advances.  The ratio of securities and cash to total assets was 15.5% at March 31, 2018.  In the long run, management considers a 10% ratio of stockholders' equity to total assets at the Bank an appropriate level of capital.  At March 31, 2018, this ratio was 13.3%.

The Bank has continued to utilize a leverage strategy to increase earnings in fiscal year 2018.  The leverage strategy during the current quarter involved borrowing up to $2.10 billion either on the Bank's FHLB line of credit or by entering into short-term FHLB advances, depending on the rates offered by FHLB.  The borrowings were repaid prior to quarter end for regulatory purposes.  The proceeds from the borrowings, net of the required FHLB stock holdings, which yielded 6.7% during the current quarter and 6.6% during the current year six month period, were deposited at the FRB of Kansas City.  Net income attributable to the leverage strategy is largely derived from the dividends received on FHLB stock holdings, plus the net interest rate spread between the yield on the cash at the FRB of Kansas City and the rate paid on the related FHLB borrowings, less applicable federal insurance premiums and estimated taxes.  Net income attributable to the leverage strategy was $713 thousand during the current quarter, compared to $767 thousand during the prior quarter.  The decrease between quarters was due to a decrease in the net interest rate spread between the yield on the cash at the FRB of Kansas City and the rate paid on the related FHLB borrowings, partially offset by an increase in the yield on the related FHLB stock.  Net income attributable to the leverage strategy was $1.5 million for both the current year six month period and the prior year six month period.  Management continues to monitor the net interest rate spread and overall profitability of the strategy.  The net interest rate spread from the leverage strategy is currently negative and, based on current interest rates, it is anticipated that the net interest rate spread will continue to be negative for some time.  If the negative net interest rate spread worsens, management will likely suspend the strategy until it is in a position that generates income.

Total liabilities were $7.75 billion at March 31, 2018 compared to $7.82 billion at September 30, 2017.  The $72.9 million decrease was due mainly to a decrease in repurchase agreements, partially offset by an increase in deposits.  Repurchase agreements decreased due to the maturity of a $100.0 million repurchase agreement during the current year six month period.  Deposits increased $44.3 million, to $5.35 billion at March 31, 2018, due mainly to an increase in checking accounts.

Stockholders' equity was $1.36 billion at March 31, 2018 compared to $1.37 billion at September 30, 2017.  The $3.6 million decrease was due primarily to the payment of $61.8 million in cash dividends, partially offset by net income of $55.2 million.  The cash dividends paid during the current year six month period totaled $0.46 per share and consisted of a $0.29 per share cash true-up dividend related to fiscal year 2017 earnings per the Company's dividend policy, and two regular quarterly cash dividends totaling $0.17 per share.  On April 18, 2018, the Company announced a regular quarterly cash dividend of $0.085 per share, or approximately $11.4 million, payable on May 18, 2018 to stockholders of record as of the close of business on May 4, 2018.

At March 31, 2018, Capitol Federal Financial, Inc., at the holding company level, had $110.8 million on deposit at the Bank.  For fiscal year 2018, it is the intent of the Board of Directors and management to continue the payout of 100% of the Company's earnings to its stockholders.  Dividend payments depend upon a number of factors including the Company's financial condition and results of operations, regulatory capital requirements, regulatory limitations on the Bank's ability to make capital distributions to the Company, and the amount of cash at the holding company.

In October 2015, the Company announced a stock repurchase plan for up to $70.0 million of common stock.  The repurchase plan does not have an expiration date.  The Company has not repurchased any shares under the repurchase plan through the date of this release.

The following table presents the balance of stockholders' equity and related information as of the dates presented.

The following table presents a reconciliation of total to net shares outstanding as of March 31, 2018. 

Consistent with our goal to operate a sound and profitable financial organization, we actively seek to maintain a well-capitalized status for the Bank in accordance with regulatory standards.  As of March 31, 2018, the Bank and Company exceeded all regulatory capital requirements.  The following table presents the Bank's regulatory capital ratios at March 31, 2018.

A reconciliation of the Bank's equity under GAAP to regulatory capital amounts as of March 31, 2018 is as follows (dollars in thousands):

Capitol Federal Financial, Inc. is the holding company for the Bank.  The Bank has 47 branch locations in Kansas and Missouri, and is one of the largest residential lenders in the State of Kansas.  News and other information about the Company can be found at the Bank's website, http://www.capfed.com.

Except for the historical information contained in this press release, the matters discussed may be deemed to be "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements include statements about our beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions.  The words "may," "could," "should," "would," "will," "believe," "anticipate," "estimate," "expect," "intend," "plan," and similar expressions are intended to identify forward-looking statements.  Forward-looking statements that involve risks and uncertainties, including changes in economic conditions in the Company's market area, changes in policies or the application or interpretation of laws and regulations by regulatory agencies and tax authorities, other governmental initiatives affecting the financial services industry, changes in accounting principles, policies or guidelines, fluctuations in interest rates, demand for loans in the Company's market area, the future earnings and capital levels of the Bank, which would affect the ability of the Company to pay dividends in accordance with its dividend policies, competition, and other risks detailed from time to time in documents filed or furnished by the Company with the SEC.  Actual results may differ materially from those currently expected.  These forward-looking statements represent the Company's judgment as of the date of this release.  The Company disclaims, however, any intent or obligation to update these forward-looking statements.

SUPPLEMENTAL FINANCIAL INFORMATION

 

The following is a reconciliation of the basic and diluted earnings per share calculations for the periods indicated.

Loan Portfolio

The following table presents information related to the composition of our loan portfolio in terms of dollar amounts, weighted average rates, and percentages as of the dates indicated.

Loan Activity:  The following table summarizes activity in the loan portfolio, along with weighted average rates where applicable, for the periods indicated, excluding changes in ACL, discounts/unearned loan fees, and premiums/deferred costs.  Loans that were paid-off as a result of refinances and loans that are sold are included in repayments.  Loan endorsements are not included in the activity in the following table because a new loan is not generated at the time of the endorsement.  The endorsed balance and rate are included in the ending loan portfolio balance and rate.  During the six months ended March 31, 2018, the Bank endorsed $12.8 million of one- to four-family loans, reducing the average rate on those loans by 33 basis points.  The amount of originations and refinances was lower in the current quarter than in prior quarters due to seasonality and a reduction in refinance opportunities.

 

The following table presents loan origination, refinance, and purchase activity for the periods indicated, excluding endorsement activity, along with associated weighted average rates and percent of total.  Loan originations, purchases, and refinances are reported together.  The fixed-rate one- to four-family loans less than or equal to 15 years have an original maturity at origination of less than or equal to 15 years, while fixed-rate one- to four-family loans greater than 15 years have an original maturity at origination of greater than 15 years.  The adjustable-rate one- to four-family loans less than or equal to 36 months have a term to first reset of less than or equal to 36 months at origination, and adjustable-rate one- to four-family loans greater than 36 months have a term to first reset of greater than 36 months at origination.

One- to Four-Family Loans:  The following table presents, for our portfolio of one- to four-family loans, the amount, percent of total, weighted average credit score, weighted average loan-to-value ("LTV") ratio, and average balance per loan as of the dates presented.  Credit scores are updated at least semiannually, with the latest update in March 2018, from a nationally recognized consumer rating agency.  The LTV ratios were based on the current loan balance and either the lesser of the purchase price or original appraisal, or the most recent Bank appraisal, if available.  In most cases, the most recent appraisal was obtained at the time of origination.

One- to Four-Family Loan Commitments - The following table summarizes our one- to four-family loan origination and refinance commitments and one- to four-family correspondent loan purchase commitments as of March 31, 2018, along with associated weighted average rates.  Loan commitments generally have fixed expiration dates or other termination clauses and may require the payment of a rate lock fee.  It is expected that some of the loan commitments will expire unfunded, so the amounts reflected in the table below are not necessarily indicative of future cash needs.

The following table presents originated, refinanced, and correspondent purchased activity in our one- to four-family loan portfolio, excluding endorsement activity, along with associated weighted average LTVs and weighted average credit scores for the periods indicated.  Of the loans originated during the current quarter and current year six month period, $18.1 million and $38.4 million, respectively, were refinanced from another lender.

The following table presents the amount, percent of total, and weighted average rate, by state, of one- to four-family loan originations and correspondent purchases where originations and purchases in the state exceeded five percent of the total amount originated and purchased during the six month period ended March 31, 2018.

Commercial Real Estate Loans:  During the current year six month period, the Bank entered into commercial real estate loan participations of $107.6 million, which included $102.6 million of commercial real estate construction loans.  Substantially all of the $102.6 million of commercial real estate construction loans had not yet been funded as of March 31, 2018.  The Bank intends to continue to grow its commercial real estate loan portfolio through participations with correspondent lenders and other select lead banks.

The following table presents the Bank's commercial real estate loans and loan commitments by industry classification, as defined by the North American Industry Classification System, as of March 31, 2018.  Based on the terms of the construction loans as of March 31, 2018, of the $162.4 million of undisbursed amounts in the table, $26.4 million is projected to be disbursed by June 30, 2018, and an additional $102.0 million is projected to be disbursed by March 31, 2019.  It is possible that not all of the funds will be disbursed due to the nature of the funding of construction projects.  Included in the table are fixed-rate loans totaling $315.7 million at a weighted average rate of 4.09% and adjustable-rate loans totaling $152.6 million at a weighted average rate of 4.61%.  The weighted average rate of fixed-rate loans is lower than that of adjustable-rate loans due to the majority of the fixed-rate loans in the portfolio at March 31, 2018 having shorter terms to maturity.  The credit risk for several of the Bank's borrowing relationships is mitigated due to the amount of equity injected into the projects, strong debt service coverage ratios, and liquidity, personal cash flow and net worth of the guarantors.  Several of these borrowing relationships have a preference for fixed-rate loans and the market interest rates are typically lower for these types of borrowers.

The following table summarizes the Bank's commercial real estate loans and loan commitments by state as of March 31, 2018. 

The following table presents the Bank's commercial real estate loan portfolio and outstanding loan commitments, categorized by gross loan amount (unpaid principal plus undisbursed amounts) or outstanding loan commitment amount, as of March 31, 2018.

Asset Quality

The following tables present loans 30 to 89 days delinquent, non-performing loans, and OREO as of the dates indicated.  Of the loans 30 to 89 days delinquent at March 31, 2018, approximately 67% were 59 days or less delinquent.  Non-performing loans are loans that are 90 or more days delinquent or in foreclosure, and nonaccrual loans that are less than 90 days delinquent but are required to be reported as nonaccrual pursuant to Office of the Comptroller of the Currency ("OCC") reporting requirements even if the loans are current.  Non-performing assets include non-performing loans and OREO.  Over the past 12 months, OREO properties acquired in settlement of loans were owned by the Bank, on average, for approximately seven months before they were sold.

 

The following tables present ACL activity and related ratios at the dates and for the periods indicated.

 

The distribution of our ACL at the dates indicated is summarized below.

Securities Portfolio

The following table presents the distribution of our securities portfolio, at amortized cost, at the dates indicated.  The majority of our securities are issued by U.S. government-sponsored enterprises ("GSEs").  Overall, fixed-rate securities comprised 74% of our securities portfolio at March 31, 2018.  The weighted average life ("WAL") is the estimated remaining maturity (in years) after three-month historical prepayment speeds and projected call option assumptions have been applied.  Weighted average yields on tax-exempt securities are not calculated on a fully taxable equivalent basis.

MBS:  The following table summarizes the activity in our portfolio of MBS for the periods presented.  The weighted average yields and WALs for purchases are presented as recorded at the time of purchase.  The weighted average yields for the beginning balances are as of the last day of the period previous to the period presented and the weighted average yields for the ending balances are as of the last day of the period presented and are generally derived from recent prepayment activity on the securities in the portfolio as of the dates presented.  The beginning and ending WAL is the estimated remaining principal repayment term (in years) after three-month historical prepayment speeds have been applied.

 

Investment Securities:  The following table summarizes the activity of investment securities for the periods presented.  The weighted average yields and WALs for purchases are presented as recorded at the time of purchase.  The weighted average yields for the beginning balances are as of the last day of the period previous to the period presented and the weighted average yields for the ending balances are as of the last day of the period presented.  The beginning and ending WALs represent the estimated remaining principal repayment terms (in years) of the securities after projected call dates have been considered, based upon market rates at each date presented.

 

Deposit Portfolio

The following table presents the amount, weighted average rate, and percent of total for the components of our deposit portfolio at the dates presented.

The following table presents scheduled maturities of our certificates of deposit, including public units, along with associated weighted average rates, as of March 31, 2018: 

Borrowings

The following table presents the maturity of term borrowings (including FHLB advances, at par, and repurchase agreements), along with associated weighted average contractual and effective rates as of March 31, 2018.

The following table presents the maturity and weighted average repricing rate, which is also the weighted average effective rate, of certificates of deposit, split between retail and public unit amounts, and term borrowings for the next four quarters as of March 31, 2018.

The following tables present borrowing activity for the periods shown.  The borrowings presented in the table have original contractual terms of one year or longer.  FHLB advances are presented at par.  The weighted average effective rate includes the impact of interest rate swaps and the amortization of deferred prepayment penalties resulting from FHLB advances previously prepaid.  The weighted average maturity ("WAM") is the remaining weighted average contractual term in years.  The beginning and ending WAMs represent the remaining maturity at each date presented.  For new borrowings, the WAMs presented are as of the date of issue.

 

Average Rates and Lives

At March 31, 2018, the Bank's gap between the amount of interest-earning assets and interest-bearing liabilities projected to reprice within one year was $65.6 million, or 0.72% of total assets, compared to $185.2 million, or 2.06% of total assets, at December 31, 2017.  The decrease in the one-year gap amount was due primarily to a decrease in the amount of mortgage-related assets projected to reprice due to higher interest rates.  As interest rates rise, borrowers have less economic incentive to refinance their mortgages and agency debt issuers have less economic incentive or opportunity to exercise their call options in order to issue new debt at lower interest rates.  This increase in interest rates resulted in lower projected cash flows on these assets over the next year compared to December 31, 2017.  The decrease in the projected cash flows on mortgage-related assets was partially offset by an increase in the amount of cash held at March 31, 2018.

The majority of interest-earning assets anticipated to reprice in the coming year are repayments and prepayments on mortgage loans and MBS, both of which include the option to prepay without a fee being paid by the contract holder.  The amount of interest-bearing liabilities expected to reprice in a given period is not typically impacted significantly by changes in interest rates because the Bank's borrowings and certificate of deposit portfolios have contractual maturities and generally cannot be terminated early without a prepayment penalty.  If interest rates were to increase 200 basis points, as of March 31, 2018, the Bank's one-year gap is projected to be $(327.0) million, or (3.59)% of total assets.  This compares to a one-year gap of $(305.9) million, or (3.40)% of total assets, if interest rates were to have increased 200 basis points as of December 31, 2017.

During the current quarter, loan repayments totaled $246.9 million and cash flows from the securities portfolio totaled $115.9 million.  The asset cash flows of $362.8 million were reinvested into new assets at current market interest rates.  Total cash flows from fixed-rate liabilities that matured and repriced into current market interest rates during the current quarter were $337.2 million.  These offsetting cash flows allow the Bank to manage its interest rate risk and gap position more precisely than if the Bank did not have offsetting cash flows due to its mix of assets or maturity structure of liabilities.

Other strategies include managing the Bank's wholesale assets and liabilities.  The Bank primarily uses long-term fixed-rate borrowings with no embedded options to lengthen the average life of the Bank's liabilities.  The fixed-rate characteristics of these borrowings lock-in the cost until maturity and thus decrease the amount of liabilities repricing as interest rates move higher compared to funding with lower-cost short-term borrowings.  These borrowings are laddered in order to prevent large amounts of liabilities repricing in any one period.  The WAL of the Bank's term borrowings as of March 31, 2018 was 2.0 years.  However, including the impact of interest rate swaps related to $200.0 million of adjustable-rate FHLB advances, the WAL of the Bank's term borrowings as of March 31, 2018 was 2.4 years.  The interest rate swaps effectively convert the adjustable-rate borrowings into long-term, fixed-rate liabilities.

The Bank uses the securities portfolio to shorten the average life of the Bank's assets.  Purchases in the securities portfolio over the past few years have primarily been focused on callable agency debentures with maturities no longer than five years, shorter duration MBS, and adjustable-rate MBS.  These securities have a shorter average life and provide a steady source of cash flow that can be reinvested as interest rates rise or used to purchase higher-yielding assets.  The WAL of the Bank's securities portfolio as of March 31, 2018 was 2.7 years.

In addition to the wholesale strategies, the Bank has sought to increase core deposits and long-term certificates of deposit.  Core deposits are expected to reduce the risk of higher interest rates because their interest rates are not expected to increase significantly as market interest rates rise.  Specifically, checking accounts and savings accounts have had minimal interest rate fluctuations throughout historical interest rate cycles, though no assurance can be given that this will be the case in future interest rate cycles.  The balances and rates of these accounts have historically tended to remain very stable over time, giving them the characteristic of long-term liabilities.  The Bank uses historical data pertaining to these accounts to estimate their future balances.  At March 31, 2018 the WAL of the Bank's non-maturity deposits was 12.8 years.

Over the last few years, the Bank has priced long-term certificates of deposit more aggressively than short-term certificates of deposit with the goal of giving customers incentive to move funds into longer-term certificates of deposit when interest rates were lower.  The balance of our retail certificates of deposit with terms of 36 months or longer increased $322.6 million, or 24%, since March 31, 2015.  Long-term certificates of deposit reduce the amount of liabilities repricing as interest rates rise in a given time period.

Because of the on-balance sheet strategies implemented over the past several years, management believes the Bank is well-positioned to move into a market rate environment where interest rates are higher.

The following table presents the weighted average yields/rates and WALs (in years), after applying prepayment, call assumptions, and decay rates for our interest-earning assets and interest-bearing liabilities as of March 31, 2018.  Yields presented for interest-earning assets include the amortization of fees, costs, premiums and discounts, which are considered adjustments to the yield.  The interest rate presented for term borrowings is the effective rate, which includes the impact of interest rate swaps and amortization of deferred prepayment penalties resulting from FHLB advances previously prepaid.  The WAL presented for term borrowings includes the effect of interest rate swaps.  The maturity and repricing terms presented for one- to four-family loans represent the contractual terms of the loan.

Average Balance Sheets

The following table presents the average balances of our assets, liabilities, and stockholders' equity, and the related annualized weighted average yields and rates on our interest-earning assets and interest-bearing liabilities for the periods indicated and the weighted average yield/rate on our interest-earning assets and interest-bearing liabilities at March 31, 2018, as well as selected performance ratios and other information as of the dates and for the periods shown.  At March 31, 2018, the borrowings and cash related to the leverage strategy was not in place, so the yields/rates presented at March 31, 2018 in the tables below do not reflect the full effects of the leverage strategy.  Weighted average yields are derived by dividing annualized income by the average balance of the related assets, and weighted average rates are derived by dividing annualized expense by the average balance of the related liabilities, for the periods shown.  Average outstanding balances are derived from average daily balances.  The weighted average yields and rates include amortization of fees, costs, premiums and discounts, which are considered adjustments to yields/rates.  Weighted average yields on tax-exempt securities are not calculated on a fully taxable equivalent basis.

 

 

 

 

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SOURCE Capitol Federal Financial, Inc.