TFS Financial Corporation — Q3 FY2019 Form 10-Q
Reporting period: Three and nine months ended June 30, 2019; balance-sheet comparisons are with September 30, 2018. Amounts below are in millions unless otherwise noted.
Business context
TFS Financial is a retail consumer banking and mortgage lender operating principally through Third Federal Savings and Loan Association of Cleveland. Its core activities are residential mortgage lending, home-equity lending, and deposit gathering. Approximately 81% of TFS shares were held by its mutual holding company.
Financial results and position
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Interest and dividend income | $121.0 | $111.1 | $359.8 | $328.5 |
| Net interest income | $65.5 | $70.3 | $201.1 | $212.0 |
| Net income | $18.3 | $20.9 | $58.7 | $63.8 |
| Diluted EPS | $0.06 | $0.07 | $0.21 | $0.23 |
| Net interest margin | 1.90% | 2.09% | 1.95% | 2.10% |
- For the quarter, the net interest margin was 1.90% and return on average assets was 0.51%. Net interest income after the $2.0 million loan-loss credit was $67.5 million.
- For the nine months, operating cash flow was $72.6 million, investing cash outflow was $185.5 million, financing cash inflow was $114.5 million, and cash increased $1.6 million to $271.3 million.
- At June 30, total assets were $14.37 billion, deposits $8.71 billion, FHLB borrowings $3.83 billion, and shareholders’ equity $1.71 billion. Net loans were $13.03 billion; the allowance for loan losses was $39.3 million, or 0.30% of recorded loans.
- Liquidity included $271.3 million of cash and $564.9 million of available-for-sale securities. The average liquidity ratio for the quarter was 5.61%, above management’s 5% minimum target. Management stated liquidity was adequate.
- The Association’s Tier 1 leverage capital ratio was 10.54%; its total risk-based capital ratio was 19.55%. Both exceeded well-capitalized thresholds. The Company’s Tier 1 leverage ratio was 12.18%.
Changes versus prior comparable periods
- Quarterly net income declined 12%; nine-month net income fell about 8%. Net interest income decreased 7% for the quarter and 5% for the nine months.
- Funding costs rose faster than asset yields: nine-month interest expense increased 36%, while interest income rose 10%. The nine-month interest-rate spread narrowed to 1.76% from 1.95%, and margin to 1.95% from 2.10%.
- Loan yields benefited from higher rates and portfolio growth, but higher deposit and borrowing costs more than offset the increase. Deposit and borrowing costs also reflected competitive pricing and use of longer-duration funding.
- Non-interest income declined 29% in the quarter and 12% for the nine months, principally because loan-sale gains were lower than in the prior year, which included a $277.4 million bulk loan sale.
- The loan portfolio grew modestly, driven by home-equity loans and lines of credit; net loans increased $157.2 million from September 2018. Deposits grew $222.9 million and FHLB borrowings increased $111.9 million.
- Non-performing assets were $76.0 million, down from $80.5 million at September 30, 2018. Non-accrual loans were 0.57% of total loans. Net recoveries for the nine months were $4.9 million, versus $3.0 million a year earlier.
- Shareholders’ equity declined $47.9 million, mainly reflecting $69.2 million of other comprehensive loss—primarily changes in cash-flow hedge values—along with $37.1 million of dividends and $7.9 million of repurchases, partly offset by net income.
Outlook, risks and notable items
- No specific earnings or revenue guidance was provided. Management said results for interim periods are not necessarily indicative of full-year results and expects to continue dividends, support asset growth, and repurchase shares, subject to conditions and available capital.
- Interest-rate risk is a central concern. Management noted that a rapid, substantial rate increase or a prolonged flat yield curve could adversely affect net interest income. A modeled instantaneous +200 basis-point shock reduced estimated economic value of equity by 14.96%; modeled 12-month earnings at risk fell 0.88% under a ramped +200 basis-point scenario and 4.53% under an instantaneous shock. These are model estimates, not forecasts.
- Credit risk is concentrated in residential real estate lending: about 91% of assets were residential mortgage and home-equity loans, with significant exposure to Ohio and Florida. Home-equity lending generally carries higher credit risk; legacy Home Today loans have weaker credit profiles and were 0.6% of held-for-investment loans but a disproportionate share of delinquencies.
- Potential funding needs include $3.30 billion of certificates of deposit due within one year, $607.9 million of loan-origination commitments, and approximately $2.11 billion of unfunded home-equity lines. These commitments may not all be drawn. Management expects a significant portion of maturing CDs to remain but notes replacement funding could cost more.
- The Association used $2.40 billion of interest-rate swaps to extend the effective duration of FHLB funding. Nine-month collateral settlements paid to derivative counterparties were $116.4 million; market-value changes contributed to the large OCI loss. Management said its interest-rate-risk profile remained within internal limits.
- A July 2019 member vote approved a proposed mutual-holding-company dividend waiver of up to $1.10 per share over the following 12 months. Federal Reserve non-objection and its timing were still unknown at filing. The Association’s December 2018 $85 million dividend to the parent reduced the Association’s capital ratio but did not affect consolidated capital.
- Management said ordinary-course legal matters were not expected to have a material adverse effect. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether deposit pricing and wholesale funding costs continue to outpace loan-yield improvement, and the resulting trend in net interest margin.
- Deposit retention and refinancing costs as $3.30 billion of CDs mature within one year, alongside the availability and cost of FHLB and other funding.
- Credit quality, charge-offs, recoveries, and allowance adequacy—especially in home-equity and legacy Home Today portfolios and in Ohio and Florida.
- Actual draws on unfunded credit commitments and end-of-draw repayment performance for home-equity lines.
- Subsequent movements in swap collateral, accumulated other comprehensive income, and the Federal Reserve’s response to the proposed dividend waiver.