DenisTangneyJr
Earnings of Capitol Federal Financial, Inc. (NASDAQ:CFFN) will likely receive support from improvement in loan growth. However, pressure on the margin will restrict earnings growth. Overall, I’m expecting the company to report earnings of $0.35 per share for FY2024 and $0.45 per share for FY2025. The September 2024 target price suggests a high upside from the current market price. Additionally, the company is offering a very high dividend yield of 6.6%. As a result, I’m maintaining a Buy rating on Capitol Federal Financial.
(Note: Unlike most other banks, CFFN’s financial year ends in September. The company has released the earnings for the first six months of FY2024, ending March 2024).
Margin Likely to Face Pressure After a Good Couple of Quarters
Capitol Federal Financial’s net interest margin surged by 50 basis points in the December-ending quarter and 11 basis points in the March-ending quarter. The margin’s improvement was mostly attributable to a new strategy. Capitol Federal Financial adopted a balance sheet repositioning strategy late last year, whereby it sold off its securities and used part of the proceeds to bring down borrowings. According to the details of a press release, the company sold $1.30 billion of securities, representing 94% of the securities portfolio, in October and reinvested the proceeds in higher-yielding assets during the next few months. It also paid down some of its costly borrowings.
As the repositioning is now complete, the margin will no longer continue to grow at the same pace. Further, the margin will get pressured by upcoming Fed funds rate cuts. I’m expecting the Federal Reserve to cut the Fed funds rate by 25-50 basis points in July-December 2024, and a further 50 basis points in January-September 2025. As CFFN’s loans re-price faster than deposits, the margin will suffer after every rate cut. The results of the management’s rate-sensitivity analysis given in the 10-Q filing show that a 100-basis points rate cut could reduce the net interest income by 5% over twelve months.
2QFY24 10-Q Filing
Considering these factors, I’m expecting the margin to dip by three basis points in the last quarter of this financial year ending September 2024. For FY2025, I’m expecting the margin to dip by six basis points.
Conducive Environment for Residential Mortgages to Drive Loan Growth
Capitol Federal Financial’s loan portfolio declined in both the December and the March-ending quarters. The portfolio will likely stop declining in upcoming quarters and turn around, partly because of upcoming interest rate cuts. CFFN focuses on residential mortgages, which are more sensitive to interest rate changes than commercial loans. This is because commercial borrowers can pass on the impact of higher borrowing costs to their customers, but residential borrowers have to absorb the entire borrowing cost themselves.
As of March 31, 2024, one-to-four-family residential loans made up 81% of total loans. Therefore, anticipated interest rate cuts will have a sizable effect on the total loan portfolio growth. Although the 15-year mortgage rate has trended upwards for most of this year, it is far from the high reached late last year.
Apart from mortgage rates, home prices are also an important indicator of residential mortgage demand. Capitol Federal Financial’s loans are concentrated in Kansas and Missouri. As shown below, home prices in these states aren’t growing as fast as before (2020-2022), which is good news for housing affordability in the region and consequently mortgage demand.
The Mortgage Bankers Association expects one-to-four-family mortgage originations to grow by 10% year-over-year in 2024.
Mortgage Bankers Association
Considering these factors, I’m expecting the loan portfolio to grow by 0.5% in the June-ending quarter and 1.0% in the final, September-ending quarter. For FY2025, I’m expecting a loan growth of 6.1%. Further, I’m expecting deposits to grow in line with loans. The following table shows my balance sheet estimates.
| Financial Position | FY19 | FY20 | FY21 | FY22 | FY23 | FY24E | FY25E |
| Net Loans | 7,417 | 7,203 | 7,081 | 7,464 | 7,971 | 7,996 | 8,487 |
| Growth of Net Loans | (1.3)% | (2.9)% | (1.7)% | 5.4% | 6.8% | 0.3% | 6.1% |
| Other Earning Assets | 1,404 | 1,733 | 2,039 | 1,591 | 1,598 | 1,281 | 1,320 |
| Deposits | 5,582 | 6,191 | 6,597 | 6,195 | 6,051 | 6,234 | 6,617 |
| Borrowings and Sub-Debt | 2,240 | 1,789 | 1,583 | 2,132 | 2,942 | 2,440 | 2,514 |
| Common equity | 1,336 | 1,285 | 1,242 | 1,096 | 1,044 | 1,032 | 1,046 |
| Book Value Per Share ($) | 9.7 | 9.3 | 9.2 | 8.1 | 7.8 | 7.9 | 8.0 |
| Tangible BVPS ($) | 9.7 | 9.3 | 9.2 | 8.1 | 7.8 | 7.9 | 8.0 |
| Source: SEC Filings, Earnings Releases, Author's Estimates (In USD million unless otherwise specified) | |||||||
Expecting Earnings of $0.35 Per Share
While loan growth will drive earnings, margin pressure will likely restrict the earnings growth. Additionally, I’m using the following assumptions.
- I’m expecting the future provision-expense-to-total-loan ratio to be the same as the average for the last five quarters.
- I’m expecting non-interest income to return to the pre-3QFY23 level. To recall, the company started its balance sheet repositioning strategy during 3Q, which hurt non-interest income.
- I’m expecting non-interest expense growth to continue to remain range-bound, like the last two quarters.
Overall, I’m expecting Capitol Federal Financial to report earnings of $0.35 per share for FY2024 and $0.45 per share for FY2025. In my last report, I estimated earnings of $0.36 per share for this year. I haven’t changed my earnings estimate much because the earnings so far have been in line with my expectations. Besides, my outlook hasn’t changed much.
The following table shows my income statement estimates.
| Income Statement | FY19 | FY20 | FY21 | FY22 | FY23 | FY24E | FY25E |
| Net interest income | 206 | 189 | 175 | 193 | 153 | 164 | 167 |
| Provision for loan losses | 1 | 22 | (9) | (5) | 7 | 2 | 4 |
| Non-interest income | 22 | 20 | 28 | 23 | (171) | 9 | 26 |
| Non-interest expense | 107 | 106 | 116 | 113 | 114 | 114 | 116 |
| Net income - Common Sh. | 94 | 65 | 76 | 84 | (102) | 46 | 58 |
| EPS - Diluted ($) | 0.68 | 0.47 | 0.56 | 0.62 | -0.76 | 0.35 | 0.45 |
| Source: SEC Filings, Earnings Releases, Author's Estimates (In USD million unless otherwise specified) | |||||||
Risks are Low
Capitol Federal Financial has a very low risk level. Firstly, non-accrual loans made up just 0.11% of total loans at the end of March 2024, which shows that the portfolio’s credit risk is very low. Further, uninsured deposits made up just 7% of total deposits, as mentioned in the 10-Q filing.
Moreover, unlike most other banks, CFFN’s securities portfolio had a net gain at the end of the March-ending quarter. This is because the company sold off most of its loss-making securities last year as part of the balance-sheet repositioning strategy.
Dividend Yield is Over 6%
At the current dividend level of $0.085 per quarter and the May 22 closing price, Capitol Federal is offering a very high dividend yield of 6.6%. Capital Federal usually distributes 100% of its earnings as cash dividends. It pays a quarterly dividend of $0.085 per share and then pays the remainder through a special dividend in a cash true-up. A full-year dividend of $0.35 per share (100% of estimated earnings) suggests a dividend yield of 6.8%.
Maintaining a Buy Rating
I’m using the peer average price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Capitol Federal Financial. Peers are trading at an average P/TB ratio of 1.11 and an average P/E ratio of 10.5, as shown below.
| CFFN | TMP | OSBC | UVSP | CFB | HFWA | Average | |
| P/E GAAP ("ttm") | NM | 101.61 | 7.49 | 9.43 | 9.74 | 14.27 | 28.51 |
| P/E GAAP ("fwd") | 15.22 | 11.61 | 7.74 | 10.25 | 9.27 | 13.69 | 10.51 |
| P/TB ("ttm") | 0.66 | 1.20 | 1.32 | 0.99 | 0.95 | 1.08 | 1.11 |
| P/B ("ttm") | 0.67 | 1.04 | 1.11 | 0.78 | 0.92 | 0.78 | 0.93 |
| Source: Seeking Alpha | |||||||
Multiplying the average P/TB multiple with the forecast tangible book value per share of $7.90 gives a target price of $8.80 for the end of September 2024. This price target implies a 69.2% upside from the May 22 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
| P/TB Multiple | 0.91x | 1.01x | 1.11x | 1.21x | 1.31x |
| TBVPS - Sep 2024 ($) | 7.9 | 7.9 | 7.9 | 7.9 | 7.9 |
| Target Price ($) | 7.2 | 8.0 | 8.8 | 9.6 | 10.3 |
| Market Price ($) | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 |
| Upside/(Downside) | 38.6% | 53.9% | 69.2% | 84.4% | 99.7% |
| Source: Author's Estimates |
Multiplying the average P/E multiple with the forecast earnings per share of $0.35 gives a target price of $3.70 for the end of September 2024. This price target implies a 28.5% downside from the May 22 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
| P/E Multiple | 8.5x | 9.5x | 10.5x | 11.5x | 12.5x |
| EPS FY2024 ($) | 0.35 | 0.35 | 0.35 | 0.35 | 0.35 |
| Target Price ($) | 3.0 | 3.4 | 3.7 | 4.1 | 4.4 |
| Market Price ($) | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 |
| Upside/(Downside) | (42.1)% | (35.3)% | (28.5)% | (21.7)% | (14.9)% |
| Source: Author's Estimates |
Equally weighting the target prices from the two valuation methods gives a combined target price of $6.20, which implies a 20.3% upside from the current market price. Adding the forward dividend yield gives a total expected return of 26.9%.
In my last report, I determined a target price of $6.40 and adopted a buy rating. Since then, the market price has dropped. As there is still a high price upside and attractive dividend yield, I’m maintaining the buy rating on Capitol Federal Financial.
