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CFFN > SEC Filings for CFFN > Form 10-Q on 1-Aug-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 one- to four-family mortgage loans through correspondent lenders;

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 real estate 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, 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 structure of the Bank's retail branches is undergoing a transformation as more customers utilize electronic and other remote channels to conduct business. The physical footprint of the branch is being reduced. The last branch opened by the Bank occupies approximately 2,100 square feet and we anticipate that future retail branches will be even smaller, operating with three to five retail staff members. The interior layout of the branch also will transform, with future or remodeled branches designed without a teller counter and designed for more consultative interactions with less emphasis on transaction processing. To support this operating concept, the Bank has fully implemented a new branch staffing model that eliminates our traditional teller role, blending transaction processing and account servicing functions under Customer Service Associates and Customer Service Representatives. The expanded skill set of branch staff provides branch managers greater flexibility to manage customer flows within the branches. Also, the branch management ranks have been pared, with 32 of our 47 branches now operating under a manager responsible for either two or three offices. Future branch manager reductions will occur based upon retirements and attrition. Since 2010, the Bank has reduced retail branch staff by 24 full-time equivalent positions while adding four new branch locations. Additionally, lending staff have been deployed from regionally centralized locations to the branch network. By utilizing paperless electronic document technology, the Bank can better utilize staff resources regardless of their physical location. This promotes a more efficient loan process which benefits the customer and the loan operation. Having loan staff located in the branch network also provides them with more frequent opportunities to interact with customers.

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 July 2014 statement that economic activity rebounded in recent months. Labor market conditions have improved, with the unemployment rate declining further. However, a range of labor market indicators suggests that there remains significant underutilization of labor resources. The FOMC stated that household spending continued to advance and business fixed investment is advancing, but recovery in the housing sector remains slow. The FOMC believes fiscal policy is restraining economic growth, although the extent of restraint may be diminishing. Inflation moved somewhat closer to the FOMC's longer-run objective and 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 $15 billion per month and agency MBS at a pace of $10 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 June 2014, the unemployment rate was 4.9% for Kansas and 6.5% for Missouri, compared to the national average of 6.1% based on information from the Bureau of Labor Statistics. Our Kansas City market area, which comprises the largest segment of our loan portfolio and deposit base, had 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 was 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, indicating stability in property values in our local market areas.

Total assets were $9.03 billion at June 30, 2014 compared to $9.19 billion at September 30, 2013. The $155.4 million decrease was due primarily to a $293.6 million decrease in the securities portfolio, partially offset by a $173.7 million increase in the loan portfolio. The cash flows from the securities portfolio were used to fund loan growth, pay dividends, and repurchase stock. During the current year nine month period, the Bank originated and refinanced $403.5 million of loans with a weighted average rate of 3.95%, purchased $357.8 million of loans from correspondent lenders with a weighted average rate of 3.74%, and participated in $43.8 million of commercial real estate loans with a weighted average rate of 4.16%. As of June 30, 2014, the Bank had 26 active correspondent lending relationships operating in 26 states.

Loans 30 to 89 days delinquent decreased $4.4 million, or 15.7%, from $27.6 million at September 30, 2013 to $23.2 million at June 30, 2014. Of the $23.2 million of 30 to 89 day delinquent loans at June 30, 2014, 81% were 59 days or less delinquent. The ratio of loans 30 to 89 days delinquent to total loans receivable, net, decreased eight basis points, from 0.46% at September 30, 2013, to 0.38% at June 30, 2014. Non-performing loans decreased $104 thousand, or 0.4%, from $26.4 million at September 30, 2013 to $26.3 million at June 30, 2014. Of the $26.3 million of non-performing loans at June 30, 2014, $9.2 million, or approximately 35%, were 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, decreased one basis point, from 0.44% at September 30, 2013, to 0.43% at June 30, 2014.

Total liabilities were $7.53 billion at June 30, 2014 compared to $7.55 billion at September 30, 2013. The $22.2 million decrease was due primarily to a decrease in advance payments by borrowers for taxes and insurance. FHLB borrowings decreased $45.1 million, which was primarily offset by a $43.4 million increase in deposits. The increase in deposits was comprised of a $42.6 million increase in the checking portfolio, an $11.9 million increase in the savings portfolio, and a $4.2 million increase in the money market portfolio, partially offset by a $15.3 million decrease in the certificate of deposit portfolio.

Stockholders' equity was $1.50 billion at June 30, 2014 compared to $1.63 billion at September 30, 2013. The $133.2 million decrease was due primarily to the payment of $127.9 million in dividends and the repurchase of $66.3 million of stock, partially offset by net income of $57.5 million. During the current nine month period, the Company repurchased 5,533,465 shares of common stock.

Net income for the quarter ended June 30, 2014 was $20.0 million, compared to $18.0 million for the quarter ended June 30, 2013. The $2.0 million, or 11.0%, increase in net income was due primarily to a $1.8 million increase in net interest income and a $1.2 million decrease in salaries and employee benefits due primarily to a reduction in ESOP related expenses, partially offset by a $1.1 million increase in provision for credit losses. The net interest margin increased 13 basis points, from 1.96% for the prior year quarter to 2.09% for the current quarter. The Company's efficiency ratio was 43.19% for the current quarter compared to 46.99% for the prior year quarter.

Net income for the nine months ended June 30, 2014 was $57.5 million, compared to $53.3 million for the nine months June 30, 2013. The $4.2 million, or 7.9%, increase in net income was due primarily to a $4.1 million decrease in salaries and employee benefits due primarily to a reduction in ESOP related expenses. The net interest margin increased six basis points, from 1.98% for the prior year nine month period to 2.04% for the current year nine month period. The Company's efficiency ratio was 43.78% for the current year nine month period compared to 47.11% for the prior year nine month period.

The Bank intends to implement a leverage strategy during the fourth quarter of fiscal year 2014. The leverage strategy involves borrowing from the FHLB up to $2.10 billion on the Bank's line of credit, subject to the pre-approval of the FHLB President. The borrowing will consist of two leverage tiers. The first $800.0 million is intended to remain borrowed on the line of credit for an extended period of time while the additional $1.30 billion will be borrowed in the first days of each quarter and paid off prior to the end of each quarter. Per FHLB policy, the Bank is required to purchase 4.5% of the amount borrowed in FHLB stock. The proceeds of the borrowings, net of FHLB stock purchased, will be deposited at the Federal Reserve Bank of Kansas City. Under current conditions, this leverage strategy will increase pre-tax income approximately $4.5 million annually, the average balance of borrowings approximately $2.10 billion, the average balance of cash approximately $2.00 billion, and FHLB stock approximately $100.0 million each quarter and reduce the net interest margin by approximately 35 basis points. The $800.0 million of leverage not paid off at quarter end will reduce the Bank's Tier 1 equity ratio to about 13.0%. This transaction is expected to have minimal impact on the Bank's ability to manage its interest rate risk and liquidity.

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

                            June 30,        March 31,       December 31,     September 30,       June 30,
                              2014             2014             2013             2013              2013
                                                       (Dollars in thousands)
Total assets             $ 9,031,039      $ 9,115,417      $ 9,111,054      $  9,186,449      $ 9,239,764
Cash and cash
equivalents                   88,424          114,835           88,665           113,886          131,287
AFS securities               857,372          895,623          993,593         1,069,967        1,167,043
HTM securities             1,637,043        1,720,283        1,668,484         1,718,023        1,819,895
Loans receivable, net      6,132,520        6,053,897        6,024,589         5,958,868        5,792,620
FHLB stock                   112,876          125,829          129,095           128,530          134,222
Deposits                   4,654,862        4,693,762        4,620,908         4,611,446        4,628,436
FHLB borrowings            2,468,420        2,467,169        2,515,618         2,513,538        2,611,480
Repurchase agreements        320,000          320,000          320,000           320,000          290,000
Stockholders' equity       1,498,907        1,530,005        1,569,463         1,632,126        1,624,502
Equity to total assets
at end of period                16.6  %          16.8  %          17.2  %           17.8  %          17.6  %

Loans Receivable. The loans receivable portfolio, net, increased $173.7 million, or 2.9%, to $6.13 billion at June 30, 2014, from $5.96 billion at September 30, 2013. Loan growth during the current nine month period was primarily funded with cash flows from the securities portfolio.

Included in the loan portfolio at June 30, 2014 were $100.0 million, or 1.6% of the total loan portfolio, of adjustable-rate mortgage ("ARM") loans that were originated as interest-only. Of these interest-only loans, $84.6 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 $84.6 million of bulk purchased interest-only ARM loans held as of June 30, 2014, had a weighted average credit score of 726 and a weighted average LTV ratio of 70% at June 30, 2014. At June 30, 2014, $54.3 million, or 54%, of the interest-only loans were still in their interest-only payment term and $3.7 million, or 14% of non-performing loans, were interest-only ARMs.

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 June 30, 2014, 67% of the loans had a balance at origination of less than $417 thousand.

                                  June 30, 2014          September 30, 2013
                                            Average                   Average
                                Amount        Rate        Amount        Rate
                                           (Dollars in thousands)
Real estate loans:
One- to four-family          $ 5,890,819     3.74  %   $ 5,743,047     3.77  %
Multi-family and commercial       62,038     4.66           50,358     5.22
One- to four-family               73,975     3.70           63,208     3.51
Multi-family and commercial       34,677     4.01           14,535     4.17
Total real estate loans        6,061,509     3.75        5,871,148     3.78

Consumer loans:
Home equity                      130,645     5.18          135,028     5.26
Other                              4,960     4.21            5,623     4.41
Total consumer loans             135,605     5.14          140,651     5.23

Total loans receivable         6,197,114     3.78        6,011,799     3.82

Undisbursed loan funds            58,067                    42,807
ACL                                9,082                     8,822
Discounts/unearned loan fees      23,812                    23,057
Premiums/deferred costs          (26,367)                  (21,755)
Total loans receivable, net  $ 6,132,520               $ 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, if available. In most cases, the most recent appraisal was obtained at the time of origination.

                                            June 30, 2014                                          September 30, 2013
                                         % of      Credit             Average                     % of      Credit             Average
                          Balance        Total     Score     LTV      Balance      Balance        Total     Score     LTV      Balance
                                                                    (Dollars in thousands)
Originated              $ 3,987,912     67.7  %      765    64  %    $    127    $ 4,054,436     70.6  %      763    65  %    $    127
Correspondent purchased   1,321,527     22.4         764    67            332      1,044,127     18.2         761    67            341
Bulk purchased              581,380      9.9         749    67            311        644,484     11.2         747    67            316
                        $ 5,890,819    100.0  %      763    65            158    $ 5,743,047    100.0  %      761    65            155

The following table presents annualized prepayment speeds of our one- to four-family loan portfolio for the monthly and quarterly periods ended June 30, 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.

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