Capitol Federal Financial, Inc.® Reports Third Quarter Fiscal Year 2020 Results

TOPEKA, Kan.–(BUSINESS WIRE)–Capitol Federal Financial, Inc.^® (NASDAQ: CFFN) (the “Company”), the parent company of Capitol Federal Savings Bank (the “Bank”), announced results today for the quarter ended June 30, 2020. Detailed results will be available in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, which will be filed with the Securities and Exchange Commission (“SEC”) on or about August 7, 2020 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 $19.5 million;

• basic and diluted earnings per share of $0.14;

• net interest margin of 2.07%;

• annualized deposit growth of 20.4%;

• paid dividends of $11.7 million, or $0.085 per share; and

• on July 23, 2020, announced a cash dividend of $0.085 per share, payable on August 21, 2020 to stockholders of record as of the close of business on August 7, 2020.

Impact of the Coronavirus Disease 2019 (“COVID-19”) Pandemic During the Current Quarter

During the current quarter, the COVID-19 pandemic continued to have an impact on our customers, employees, and business operations. Management’s actions related to COVID-19 and the impact of COVID-19 on certain aspects of the Company’s business are summarized below.

Bank operations – In mid-March 2020, preventative health measures were put in place including elimination of business-related travel, implementing mandatory work from home for all employees able to do so, social distancing precautions for all employees in Bank offices, and preventative cleaning at offices and branches. Lobby services were limited to appointment only while drive-through, mobile, and online banking became the Bank’s primary channels of serving customers. Retail loan closings have been conducted with customers coming to our drive-through facilities and commercial loans have been closed in person only when necessary. All employees continue to be paid their regular salary and receive full benefits. In mid-May 2020, lobbies reopened with limitations on the number of customers in a branch at one time. We also implemented operational measures to promote social distancing when customers visit branches and installed sneeze guards. There are several other precautions being taken at our locations such as extra cleaning in high traffic/touch areas and providing locations with additional cleaning supplies, hand sanitizer and masks. In early June 2020, back-office employees started to return to the office in phases. Due to the increase in COVID-19 cases in late June into July 2020, management rolled back the changes to the lobbies that occurred mid-May and adjusted the return to office phases, where necessary, for back-office employees. Our lobby services are now again by appointment only. Management continues to monitor COVID-19 cases and will reopen lobbies when we believe it is appropriate to do so.

Loan modification programs – In late March 2020, the Bank announced loan modification programs to support and provide relief for its borrowers during the COVID-19 pandemic. Generally, loan modifications under these programs (“COVID-19 loan modifications”) for one- to four-family loans and consumer loans consist of a three-month payment forbearance of principal, interest and, in some cases, escrow. COVID-19 loan modifications of commercial loans mainly consist of a six-month interest-only payment period. The Bank’s COVID-19 loan modifications have not been deemed troubled debt restructurings per current accounting principles generally accepted in the United States of America (“GAAP”).

As of June 30, 2020, the Bank had processed COVID-19 loan modifications for 896 one- to four-family loans totaling $233.4 million, for which the borrowers had a weighted average credit score of 733, and 94 consumer loans totaling $2.6 million. Included in these one- to four-family and consumer loan totals are 135 loans with a combined balance of $32.2 million for which the borrowers have requested additional assistance, generally another three-month payment forbearance, and the Bank either completed or was in the process of completing a second modification as of July 20, 2020. During the month of July 2020, the Bank completed or was in the process of completing a first modification for an additional $4.8 million of one- to four-family and consumer loans.

As of June 30, 2020, the Bank had processed COVID-19 loan modifications for 229 commercial loans with a combined gross loan amount of $392.8 million, which includes undisbursed amounts. Included in these totals are six loans with a combined gross loan amount, including undisbursed funds, of $30.6 million for which the borrowers have requested an additional three months of payment deferrals and the Bank was in the process of completing the second modification as of July 20, 2020. The Bank is currently in the process of completing a first modification for one additional commercial loan for $19.2 million.

Small Business Administration (“SBA”) Payroll Protection Program (“PPP”) loans – As of June 30, 2020, the Bank had originated and funded 700 PPP loans totaling $42.6 million, with a median loan amount of $21 thousand, and received origination fees totaling $1.8 million associated with these loans. These loans are fully guaranteed by the SBA. The program ended June 30, 2020, but was extended on July 6, 2020 through August 8, 2020. Through July 20, 2020, the Bank had originated an additional $520 thousand in PPP loans. The Bank continues to accept applications for PPP loans.

Correspondent loan activity – In an effort to manage the influx of refinance requests from current customers in our local markets during the initial days of the COVID-19 pandemic, the Bank suspended accepting new applications for correspondent one- to four-family loans in mid-March 2020. Correspondent applications and commitments in the pipeline at the time of the suspension continued to progress through the approval and funding process. In mid-June 2020, the Bank resumed accepting new applications for correspondent one- to four-family loans.

Capital, liquidity, and dividends – Management performed stress test scenarios during April 2020. Based on the Company’s existing capital levels, deposit inflows, loan underwriting policies, loan concentration, and geographical diversification, no liquidity or capital concerns were identified as a result of the stress tests. Management anticipates being able to manage the economic risks and uncertainties associated with the COVID-19 pandemic and remain well capitalized with sufficient liquidity to serve our customers.

Deposit balances have increased due primarily to the economic stimulus payments and PPP loans. As a result, management is currently faced with the challenge of excess liquidity. Due to the nature of deposit cash flows, management does not know how long the excess liquidity will be retained. As such, management has elected, for the time being, to reduce the Bank’s level of borrowings using the excess liquidity from the deposit portfolio.

With earnings of $0.34 per share, year-to-date, and a cash balance at the holding company level of $89.0 million, the Company has the resources to continue to pay its regular quarterly dividend of $0.085 per share for the foreseeable future. Given the state of economic uncertainty and how that may play out with the credit risk exposure in the Bank’s loan portfolio, the Company elected to defer the annual True Blue dividend in June 2020 and did not ask for a regulatory non-objection to move capital from the Bank to the Company to pay that dividend. It is management’s intent to ask for a regulatory non-objection at some point in the future and to pay this dividend when economic conditions are more certain. It remains the Company’s intent to pay out 100% of its earnings.

Comparison of Operating Results for the Three Months Ended June 30, 2020 and March 31, 2020

For the quarter ended June 30, 2020, the Company recognized net income of $19.5 million, or $0.14 per share, compared to net income of $4.3 million, or $0.03 per share, for the quarter ended March 31, 2020. The increase was due primarily to recording a $22.1 million provision for credit losses during the prior quarter, and no provision for credit losses in the current quarter. This was partially offset by an increase in income tax expense and a decrease in net interest income compared to the prior quarter. The net interest margin decreased 12 basis points, from 2.19% for the prior quarter to 2.07% for the current quarter. The decrease in the net interest margin was due mainly to a decrease in the loan portfolio yield, specifically the yield on the correspondent one- to four-family loan portfolio due to an increase in premium amortization as result of an increase in payoff activity.

Markets responded to the COVID-19 pandemic in many ways, with a dramatic lowering of interest rates in a short period of time having the most impact on the operations and performance of the Bank. With the pandemic impacting the United States later in the March 2020 quarter, the opportunity to fully respond in that quarter was somewhat limited. Since the onset of the pandemic, the Bank lowered its offered rates on deposits and restructured its borrowings. We have lowered offered rates on all retail deposit products except checking and savings accounts. Changes in the rates paid on money market accounts have an immediate impact on the cost of our deposits, while the impact of reducing rates offered on our certificate of deposit products lower the cost of deposits only as higher-costing certificates of deposit reprice lower when they mature. During the prior quarter, the Bank was able to restructure the cost of $350.0 million of its Federal Home Loan Bank Topeka (“FHLB”) advances by lowering their cost 72 basis points. During the current quarter, we realized the full benefit of that restructuring. As the Bank further monitors rates offered and the cost of borrowings, we anticipate that the average cost of our interest-bearing liabilities will continue to decrease.

During late February and through much of March, rates offered on our one- to four-family loan products increased in order to control the volume of loans the Bank could process. During the current quarter, the offered rates on our one- to four-family loans decreased along with local market rates, but our ability to process the loan volumes was maintained. Given current rates offered on new loans and the recent volume of one- to four-family refinances and endorsements of terms to lower current market rates, the yield on the total loan portfolio is likely to continue to decrease. Additionally, with significant cash inflows realized due to securities being called and prepayments on mortgage-backed securities (“MBS”) increasing, the yields on reinvested funds into new securities are lower than the portfolio yield.

Considering the drastic changes in market rates and the ongoing economic uncertainty, even with the changes the Bank has made to its cost of funding, with the lower rates on new mortgage loans, refinances, endorsements and new securities also at lower rates, our net interest margin could continue to decrease with further downside risk as a result of high levels of prepayments and premium amortization on correspondent loans, as was experienced during the current quarter.

Interest and Dividend Income

The weighted average yield on total interest-earning assets decreased 23 basis points, from 3.55% for the prior quarter to 3.32% for the current quarter, while the average balance of interest-earning assets increased $78.0 million between the two periods. 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 weighted average yield on the loans receivable portfolio decreased 17 basis points, from 3.72% for the prior quarter to 3.55% for the current quarter, due mainly to a $2.1 million increase in premium amortization related to correspondent loans as a result of an increase in payoff activity. The decrease in interest income on the MBS portfolio and the investment securities portfolio was due primarily to the purchase of securities at market rates lower than the existing portfolios. The decrease in dividend income on FHLB stock was due mainly to a reduction in the dividend rate paid by FHLB compared to the prior quarter. The decrease in interest income on cash and cash equivalents was due mainly to a decrease in the yield earned on cash held at the Federal Reserve Bank of Kansas City (“FRB of Kansas City”).

Interest Expense

The weighted average rate paid on total interest-bearing liabilities decreased 14 basis points, from 1.55% for the prior quarter to 1.41% for the current quarter, while the average balance of interest-bearing liabilities increased $121.2 million between the two periods. The following table presents the components of interest expense for the time periods presented, along with the change measured in dollars and percent.

The decrease in interest expense on deposits was due to a decrease in the weighted average rate paid on money market accounts, wholesale certificates of deposit, and retail/business certificates of deposit, partially offset by an increase in the average balance of deposits. Management generally reduced deposit offer rates throughout the quarter as discussed above.

The decrease in interest expense on borrowings was due primarily to a full quarter impact of the replacement of certain FHLB advances at lower market rates. During the prior quarter, the Bank prepaid fixed-rate FHLB advances totaling $350.0 million with a weighted average rate of 2.42%, and replaced these advances with $350.0 million of fixed-rate FHLB advances with a weighted average term of 4.7 years and a weighted average effective rate of 1.70%, which includes the impact of deferred prepayment penalties being recognized over the life of the new advances. Additionally, the Bank reduced the usage of its FHLB line of credit compared to the prior quarter, and did not replace a $100 million FHLB advance, at a rate of 1.61%, that matured during the current quarter.

Provision for Credit Losses

The Bank did not record a provision for credit losses during the current quarter, compared to a provision for credit losses during the prior quarter of $22.1 million. The $22.1 million provision for credit losses in the prior quarter was in recognition of the deterioration of economic conditions as a result of the COVID-19 pandemic. There was significant deterioration of economic conditions at March 31, 2020 due to the COVID-19 pandemic which carried into the June 30, 2020 quarter. There was no deterioration in credit quality indicators, such as loan delinquencies, asset classification and credit scores, during the current quarter. Loans 30 to 89 days delinquent were 0.20% of total loans at June 30, 2020 and 0.24% of total loans at March 31, 2020. Loans 90 days or more delinquent or in foreclosure were 0.12% of total loans at June 30, 2020 and 0.10% of total loans at March 31, 2020. The allowance for credit losses (“ACL”) to loans receivable ratio was 0.42% at both June 30, 2020 and March 31, 2020. See additional discussion regarding management’s evaluation of the adequacy of the Bank’s ACL at June 30, 2020 in the Financial Condition section below.

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 deposit service fees was due mainly to a decrease in service charge income as a result of a decrease in consumer activity stemming primarily from the COVID-19 pandemic. The increase in insurance commissions was due primarily to the receipt of annual contingent insurance commissions and adjustments to the related accruals during the prior quarter, and no such adjustments during the current quarter. Contingent insurance commissions are performance-based incentives based on certain criteria established by the insurance carriers. These commissions are accrued based on management’s expectations and are adjusted when the funds are received. The decrease in other non-interest income was due primarily to a decrease in income associated with interest rate swap collateral, a decrease in commercial loan late fees, and a decrease in income from bank-owned life insurance (“BOLI”) resulting from a decrease in yield on the Bank’s BOLI 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 regulatory and outside services was due primarily to the timing of external audit services. The decrease in advertising and promotional expenses was due mainly to adjustments in advertising schedules and postponements of campaigns that were currently in-progress as a result of the COVID-19 pandemic. The increase in the federal insurance premium was due mainly to the Bank recognizing a federal insurance premium accrual as the remaining assessment credit from the Federal Deposit Insurance Corporation (“FDIC”) was utilized during the current quarter. We anticipate the federal insurance premium for the fourth quarter of fiscal year 2020 will be approximately $620 thousand, or $333 thousand higher than the current quarter.

The Company’s efficiency ratio was 51.58% for the current quarter compared to 49.05% for the prior quarter. The change in the efficiency ratio was due primarily to lower net interest income 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 higher value indicates that the financial institution is generating revenue with a proportionally higher level of expense.

Income Tax Expense

Income tax expense was $5.1 million for the current quarter, compared to $824 thousand for the prior quarter. The effective tax rate was 20.7% for the current quarter compared to 16.2% for the prior quarter. The effective tax rate was higher in the current quarter due primarily to the Company’s permanent differences, which generally lower our income tax expense, having a proportionately smaller impact given the higher pretax income in the current quarter compared to the prior quarter. Management anticipates the effective income tax rate for the fourth quarter of fiscal year 2020 will be approximately 21%, resulting in an effective tax rate of approximately 20% for fiscal year 2020.

Comparison of Operating Results for the Nine Months Ended June 30, 2020 and 2019

The Company recognized net income of $46.3 million, or $0.34 per share, for the nine-month period ended June 30, 2020 compared to net income of $71.8 million, or $0.52 per share, for the nine-month period ended June 30, 2019. The decrease in net income was due primarily to a $21.9 million increase in provision for credit losses and a decrease in net interest income, partially offset by a decrease in income tax expense.

Net interest income decreased $12.9 million, or 8.3%, from the prior year period to $143.7 million for the current year period. The net interest margin decreased 15 basis points, from 2.30% for the prior year period to 2.15% for the current year period. The leverage strategy was suspended at certain times during the prior year period and during all of the current year period due to the negative interest rate spreads between the related FHLB borrowings and cash held at the FRB of Kansas City, making the transaction unprofitable. See additional discussion regarding the leverage strategy in the Financial Condition section below. When the leverage strategy is in place, it increases our net interest income but reduces the net interest margin due to the amount of earnings from the transaction in comparison to the size of the transaction. Excluding the effects of the leverage strategy, the net interest margin would have decreased 17 basis points, from 2.32% for the prior year period to 2.15% for the current year period. The decrease in the net interest margin, excluding the effects of the leverage strategy, was due mainly to an increase in the cost of retail/business certificates of deposit, as well as a decrease in the loan portfolio yield, specifically the yield on the correspondent one- to four-family loan portfolio.

Interest and Dividend Income

The weighted average yield on total interest-earning assets decreased 13 basis points, from 3.61% for the prior year period to 3.48% for the current year period, and the average balance of interest-earning assets decreased $165.9 million. Absent the impact of the leverage strategy, the weighted average yield on total interest-earning assets would have decreased 14 basis points, from 3.62% for the prior year period to 3.48% for the current year period, and the average balance of interest-earning assets would have decreased $89.0 million. The decrease in the weighted average yield between periods was due primarily to a decrease in the loan portfolio yield. 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.

Contacts

Kent Townsend

Executive Vice President,

Chief Financial Officer and Treasurer

(785) 231-6360

ktownsend@capfed.com

Investor Relations

(785) 270-6055

investorrelations@capfed.com

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