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CFFN > SEC Filings for CFFN > Form 10-Q on 5-May-2014All Recent SEC Filings




Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The Company and its wholly-owned subsidiary may from time to time make written or oral "forward-looking statements," including statements contained in documents filed or furnished by the Company with the SEC. These forward-looking statements may be included in this Quarterly Report on Form 10-Q, in the Company's reports to stockholders, in the Company's press releases, and in other communications by the Company, which are made in good faith by us pursuant to the "safe harbor" provisions 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, which are subject to significant risks and uncertainties, and are subject to change based on various factors, some of which are beyond our control. The words "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause our future results to differ materially from the plans, objectives, goals, expectations, anticipations, estimates, and intentions expressed in the forward-looking statements:

our ability to continue to maintain overhead costs at reasonable levels;

our ability to continue to originate a significant volume of one- to four-family mortgage loans in our market areas or to purchase loans through correspondents;

our ability to invest funds in wholesale or secondary markets at favorable yields as compared to the related funding source;

our ability to access cost-effective funding;

future earnings and capital levels of the Bank and the continued non-objection by our primary federal banking regulators, to the extent required, to distribute capital from the Bank to the Company, which could affect the ability of the Company to pay dividends in accordance with its dividend policy and/or repurchase stock in accordance with its stock repurchase program;

fluctuations in deposit flows, loan demand, and/or real estate values, as well as unemployment levels, which may adversely affect our business;

the credit risks of lending and investing activities, including changes in the level and direction of loan delinquencies and charge-offs, changes in property values, and changes in estimates of the adequacy of the ACL;

results of examinations of the Bank and the Company by their respective primary federal banking regulators, including the possibility that the regulators may, among other things, require us to increase our ACL;

the strength of the U.S. economy in general and the strength of the local economies in which we conduct operations;

the effects of, and changes in, trade, fiscal policies and laws, and monetary and interest rate policies of the Board of Governors of the Federal Reserve System ("FRB");

the effects of, and changes in, foreign and military policies of the United States government;

inflation, interest rate, market and monetary fluctuations;

the timely development and acceptance of our new products and services and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors' products and services;

the willingness of users to substitute competitors' products and services for our products and services;

our success in gaining regulatory approval of our products and services and branching locations, when required;

the impact of changes in laws and regulations and other governmental initiatives affecting the financial services industry;

implementing business initiatives may be more difficult or expensive than anticipated;

technological changes;

acquisitions and dispositions;

changes in consumer spending and saving habits; and

our success at managing the risks involved in our business.

This list of important factors is not all inclusive. We do not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company or the Bank.

As used in this Form 10-Q, unless we specify otherwise, "the Company," "we," "us," and "our" refer to Capitol Federal Financial, Inc., a Maryland corporation. "Capitol Federal Savings," and "the Bank," refer to Capitol Federal Savings Bank, a federal savings bank and the wholly-owned subsidiary of Capitol Federal Financial, Inc.

The following discussion and analysis is intended to assist in understanding the financial condition, results of operations, liquidity, and capital resources of the Company. It should be read in conjunction with the consolidated financial statements and notes presented in this report. The discussion includes comments relating to the Bank, since the Bank is wholly-owned by the Company and comprises the majority of its assets and is the principal source of income for the Company. This discussion and analysis should be read in conjunction with Management's Discussion and Analysis included in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2013, filed with the SEC.

Executive Summary

The following summary should be read in conjunction with our Management's Discussion and Analysis of Financial Condition and Results of Operations in its entirety.

We have been, and intend to continue to be, a community-oriented financial institution offering a variety of financial services to meet the needs of the communities we serve. We attract retail deposits from the general public and invest those funds primarily in permanent loans secured by first mortgages on owner-occupied, one- to four-family residences. We also originate consumer loans primarily secured by first mortgages on one- to four-family residences, commercial and multi-family real estate loans, and construction loans secured by residential, multi-family, or commercial real estate. While our primary business is the origination of one- to four-family mortgage loans funded through retail deposits, we also purchase whole one- to four-family mortgage loans from correspondent and nationwide lenders, participate in loans with other lenders that are secured by commercial or multi-family real estate, and invest in certain investment securities and MBS using funding from retail deposits, FHLB borrowings, and repurchase agreements. The Company is significantly affected by prevailing economic conditions, including federal monetary and fiscal policies and federal regulation of financial institutions. Retail deposit balances are influenced by a number of factors, including interest rates paid on competing investment products, the level of personal income, and the personal rate of savings within our market areas. Lending activities are influenced by the demand for housing and other loans, our loan underwriting guidelines compared to those of our competitors, as well as interest rate pricing competition from other lending institutions. The primary sources of funds for lending activities include deposits, loan repayments, investment income, borrowings, and funds provided from operations.

The Company's results of operations are primarily dependent on net interest income, which is the difference between the interest earned on loans, MBS, investment securities, and cash, and the interest paid on deposits and borrowings. On a weekly basis, management reviews deposit flows, loan demand, cash levels, and changes in several market rates to assess all pricing strategies. The Bank's pricing strategy for first mortgage loan products includes setting interest rates based on secondary market prices and local competitor pricing for our local lending markets, and secondary market prices and national competitor pricing for our correspondent lending markets. Generally, deposit pricing is based upon a survey of competitors in the Bank's market areas, and the need to attract funding and retain maturing deposits. The majority of our loans are fixed-rate products with maturities up to 30 years, while the majority of our retail deposits have maturity or repricing dates of less than two years.

The Federal Open Market Committee of the Federal Reserve (the "FOMC") noted in their April 2014 statement that economic activity has picked up recently, after having slowed sharply during the winter months reflecting, in part, adverse weather conditions. Although the unemployment rate remains elevated, labor market conditions have shown further signs of improvement. The FOMC stated that household spending continued to advance, but business fixed investment edged down and recovery in the housing sector remained slow. The FOMC believes fiscal policy is restraining economic growth, although the extent of restraint may be diminishing. Inflation has been running below the FOMC's longer-run objective, but longer-term inflationary expectations have remained stable. Given the cumulative progress made toward the FOMC's statutory mandate of maximum employment, as well as to the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the FOMC decided to further reduce the pace of its asset purchases. The FOMC will continue its existing policy of reinvesting principal payments from its holdings of agency debt and agency MBS in agency MBS and will continue to purchase additional longer-term Treasury securities, but at a pace of $25 billion per month and agency MBS at a pace of $20 billion per month. The FOMC believes that these actions, taken together, should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery. The FOMC stated that it will closely monitor incoming information on economic and financial developments in the coming months and will continue its asset purchases until the outlook for the labor market improves substantially in the context of price stability. If incoming information broadly supports the FOMC's expectation of continued improvement in labor market conditions and inflation approaches its longer-run objective, the pace of asset purchases will likely be further reduced. The FOMC insisted, however, that asset purchases are not on a preset course. The FOMC remarked that it anticipates maintaining the federal funds rate at zero to 0.25% for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the FOMC's 2% longer-run goal and provided that longer-term inflation expectations remain well anchored. Even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the FOMC views as normal in the long run. When the FOMC decides to begin to remove policy accommodation, they stated they will take a balanced approach consistent with their longer-run goals of maximum employment and inflation of 2%.

Economic conditions in the Bank's local market areas have a significant impact on the ability of borrowers to repay loans and the value of the collateral securing these loans. As of March 2014, the unemployment rate was 4.9% for Kansas and 6.7% for Missouri, compared to the national average of 6.7% based on information from the Bureau of Economic Analysis. Our Kansas City market area, which comprises the largest segment of our loan portfolio and deposit base, has an average household income of approximately $80 thousand per annum, based on 2013 estimates from the American Community Survey, which is a statistical survey by the U.S. Census Bureau. The average household income in our combined market areas is approximately $69 thousand per annum, with 91% of the population at or above the poverty level, also based on the 2013 estimates from the American Community Survey. The Federal Housing Finance Agency ("FHFA") price index for Kansas and Missouri has not experienced significant fluctuations during the past 10 years, unlike other market areas of the United States, which indicates relative stability in property values in our local market areas.

Total assets were $9.12 billion at March 31, 2014 compared to $9.19 billion at September 30, 2013. The $71.0 million decrease was due primarily to a $172.1 million decrease in the securities portfolio, partially offset by a $95.0 million increase in the loan portfolio. Loan growth during the current year six month period was primarily funded with cash flows from the securities portfolio. During the current year six month period, the Bank originated and refinanced $256.8 million of loans with a weighted average rate of 3.93%, purchased $219.4 million of loans from correspondent lenders with a weighted average rate of 3.73%, and participated in $19.4 million of commercial real estate loans with a weighted average rate of 4.25%.

Loans 30 to 89 days delinquent decreased $5.4 million, or 19.7%, from $27.6 million at September 30, 2013 to $22.1 million at March 31, 2014. Of the $22.1 million of 30 to 89 day delinquent loans at March 31, 2014, 77% were 59 days or less delinquent. The ratio of loans 30 to 89 days delinquent to total loans receivable, net, decreased nine basis points, from 0.46% at September 30, 2013, to 0.37% at March 31, 2014. Non-performing loans increased $2.3 million, or 8.5%, from $26.4 million at September 30, 2013 to $28.7 million at March 31, 2014. Of the $28.7 million of non-performing loans at March 31, 2014, $8.1 million are less than 90 days delinquent but are required to be reported as nonaccrual pursuant to OCC reporting requirements. The ratio of non-performing loans to total loans receivable, net, increased three basis points, from 0.44% at September 30, 2013, to 0.47% at March 31, 2014.

Total liabilities were $7.59 billion at March 31, 2014 compared to $7.55 billion at September 30, 2013. The $31.1 million increase was due primarily to an $82.3 million increase in deposits, partially offset by a $46.4 million decrease in FHLB borrowings. The increase in deposits was comprised of a $60.2 million increase in the checking portfolio, a $15.2 million increase in the savings portfolio, and an $11.2 million increase in the money market portfolio, partially offset by a $4.3 million decrease in the certificate of deposit portfolio.

Stockholders' equity was $1.53 billion at March 31, 2014 compared to $1.63 billion at September 30, 2013. The $102.1 million decrease was due primarily to the payment of $82.8 million in dividends and the repurchase of $57.2 million of stock, partially offset by net income of $37.5 million. During the current six month period, the Company repurchased 4,770,075 shares of common stock.

Net income for the quarter ended March 31, 2014 was $19.7 million, compared to $17.7 million for the quarter ended March 31, 2013. The $2.0 million, or 11.1%, increase in net income was largely due to a $1.4 million increase in net interest income and $1.4 million decrease in non-interest expense, partially offset by a $446 thousand increase in income tax expense. The net interest margin increased 10 basis points, from 1.97% for the prior year quarter to 2.07% for the current quarter. The Company's efficiency ratio was 42.42% for the current quarter compared to 46.19% for the prior year quarter.

Net income for the six months ended March 31, 2014 was $37.5 million, compared to $35.3 million for the six months March 31, 2013. The $2.2 million, or 6.3%, increase in net income was largely due to a $3.3 million decrease in non-interest expense, partially offset by a $485 thousand decrease in non-interest income and $442 thousand increase in provision for credit losses. The net interest margin increased three basis points, from 1.99% for the prior year six month period to 2.02% for the current year six month period. The Company's efficiency ratio was 44.09% for the current year six month period compared to 47.17% for the prior year six month period.

Available Information

Financial and other Company information, including press releases, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports can be obtained free of charge from our investor relations website, SEC filings are available on our website immediately after they are electronically filed with or furnished to the SEC, and are also available on the SEC's website at

Critical Accounting Policies

Our most critical accounting policies are the methodologies used to determine the ACL and fair value measurements. These policies are important to the presentation of our financial condition and results of operations, involve a high degree of complexity, and require management to make difficult and subjective judgments that may require assumptions or estimates about highly uncertain matters. The use of different judgments, assumptions, and estimates could cause reported results to differ materially. These critical accounting policies and their application are reviewed at least annually by the audit committee of our Board of Directors. For a full discussion of our critical accounting policies, see Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2013.

                              Financial Condition

The following table presents selected balance sheet information as of the dates

                           March 31,       December 31,     September 30,       June 30,        March 31,
                              2014             2013             2013              2013             2013
                                                       (Dollars in thousands)
Total assets             $ 9,115,417      $ 9,111,054      $  9,186,449      $ 9,239,764      $ 9,393,718
Cash and cash
equivalents                  114,835           88,665           113,886          131,287           48,574
AFS securities               895,623          993,593         1,069,967        1,167,043        1,245,443
HTM securities             1,720,283        1,668,484         1,718,023        1,819,895        1,953,779
Loans receivable, net      6,053,897        6,024,589         5,958,868        5,792,620        5,715,273
Capital stock of FHLB        125,829          129,095           128,530          134,222          130,680
Deposits                   4,693,762        4,620,908         4,611,446        4,628,436        4,693,573
FHLB borrowings            2,467,169        2,515,618         2,513,538        2,611,480        2,634,465
Repurchase agreements        320,000          320,000           320,000          290,000          315,000
Stockholders' equity       1,530,005        1,569,463         1,632,126        1,624,502        1,643,007
Equity to total assets
at end of period                16.8  %          17.2  %           17.8  %          17.6  %          17.5  %

Loans Receivable. The loans receivable portfolio, net, increased $95.0 million, or 1.6%, to $6.05 billion at March 31, 2014, from $5.96 billion at September 30, 2013. Loan growth during the current six month period was primarily funded with cash flows from the securities portfolio.

Our portfolio of correspondent purchased loans increased $173.4 million, or 16.6%, from September 30, 2013 to $1.22 billion at March 31, 2014, of which $873.9 million are serviced by the Bank and $343.6 million are serviced by our mortgage sub-servicer. The mortgage sub-servicer has experience servicing loans in the market areas in which we purchase loans and services the loans according to the Bank's servicing standards, which is intended to allow the Bank greater control over servicing and help maintain a standard of loan performance. As of March 31, 2014, the Bank had 27 active correspondent lending relationships operating in 24 states.

Included in the loan portfolio at March 31, 2014 were $103.7 million, or 1.7% of the total loan portfolio, of adjustable-rate mortgage ("ARM") loans that were originated as interest-only. Of these interest-only loans, $87.7 million were purchased in bulk loan packages from nationwide lenders, primarily during fiscal year 2005. Interest-only ARM loans do not typically require principal payments during their initial term, and have initial interest-only terms of either 5 or 10 years. The $87.7 million of bulk purchased interest-only ARM loans held as of March 31, 2014, had a weighted average credit score of 726 and a weighted average LTV ratio of 71% at March 31, 2014. At March 31, 2014, $56.3 million, or 54%, of the interest-only loans were still in their interest-only payment term and $4.3 million, or 15% of non-performing loans, were interest-only ARMs.

As a portfolio lender focused on delivering outstanding customer service while acquiring quality assets, the ability of our borrowers to repay has always been paramount in our business model. Our implementation of the "ability to repay" and "qualified mortgage" rules on January 10, 2014, as issued by the Consumer Financial Protection Bureau, is not anticipated to have a significant impact to our overall book of business.

The following table presents information related to the composition of our loan portfolio at the dates presented. Within the one- to four-family loan portfolio at March 31, 2014, 68% of the loans had a balance at origination of less than $417 thousand.

                                 March 31, 2014          September 30, 2013
                                            Average                   Average
                                Amount        Rate        Amount        Rate
                                           (Dollars in thousands)
Real estate loans:
One- to four-family          $ 5,840,337     3.75  %   $ 5,743,047     3.77  %
Multi-family and commercial       47,505     4.83           50,358     5.22
Construction                      94,286     3.79           77,743     3.63
Total real estate loans        5,982,128     3.75        5,871,148     3.78

Consumer loans:
Home equity                      130,321     5.22          135,028     5.26
Other                              4,991     4.29            5,623     4.41
Total consumer loans             135,312     5.18          140,651     5.23

Total loans receivable         6,117,440     3.79        6,011,799     3.82

Undisbursed loan funds            55,505                    42,807
ACL                                8,967                     8,822
Discounts/unearned loan fees      23,653                    23,057
Premiums/deferred costs          (24,582)                  (21,755)
Total loans receivable, net  $ 6,053,897               $ 5,958,868

The following table presents, for our portfolio of one- to four-family loans, the balance, percentage of total, weighted average credit score, weighted average LTV ratio, and the average balance per loan at the dates presented. Credit scores are updated at least semiannually, with the last update in March 2014, 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. In most cases, the most recent appraisal was obtained at the time of origination.

                                           March 31, 2014                                       September 30, 2013
                                         % of     Credit            Average                     % of     Credit            Average
                          Balance       Total     Score     LTV     Balance      Balance       Total     Score     LTV     Balance
                                                                  (Dollars in thousands)
Originated              $ 4,017,833     68.8  %     765    64  %   $    127    $ 4,054,436     70.6  %     763    65  %   $    127
Correspondent purchased   1,217,524     20.8        764    67           334      1,044,127     18.2        761    67           341
Bulk purchased              604,980     10.4        748    67           312        644,484     11.2        747    67           316
                        $ 5,840,337    100.0  %     763    65           157    $ 5,743,047    100.0  %     761    65           155

The following table presents the annualized prepayment speeds of our one- to four-family loan portfolio for the monthly and quarterly periods ended March 31, 2014. The balances represent the unpaid principal balance of one- to four-family loans, and the terms represent the contractual terms for our fixed-rate loans, and current terms to repricing for our adjustable-rate loans. Loan refinances are considered a prepayment and are included in the prepayment speeds presented below. The annualized prepayment speeds are presented with and without endorsements.

                                                                      March 31, 2014
                                              Monthly Prepayment               Quarterly Prepayment             Net Premiums/
                                              Speeds (annualized)               Speeds (annualized)            Deferred Costs
                            Unpaid        Including         Excluding       Including         Excluding         & (Discounts/
         Term             Principal      Endorsements     Endorsements     Endorsements     Endorsements     Unearned Loan Fees)
                                                                  (Dollars in thousands)
Fixed-rate one- to
15 years or less:
Originated               $   902,259           7.5  %            7.5  %          7.8  %            7.8  %    $            (2,909)
purchased                    247,622           7.9               7.9             5.8               5.8                     3,030
Bulk purchased                14,260          25.5              25.5            40.8              40.8                        92
                           1,164,141           7.8               7.8             7.8               7.8                       213
More than 15 years:
Originated                 2,828,104           6.4               5.9             5.8               5.3                   (13,348)
purchased                    722,147           3.1               3.1             3.3               3.3                     8,055
Bulk purchased                33,567          11.4              11.4            10.9              10.9                     1,279
                           3,583,818           5.8               5.4             5.4               5.0                    (4,014)
Total fixed-rate one-
to four-
family loans:              4,747,959           6.3               6.0             6.0               5.7                    (3,801)

Adjustable-rate one-
to four-family:
36 months or less:
Originated                   173,762          16.9              12.1            14.9              13.1                      (281)
purchased                     62,014          37.2              12.8            23.9              14.5                       522
. . .
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