TFS Financial Corporation — Form 10-Q Summary
Business context and reporting period. TFS Financial is a retail consumer banking company focused on residential mortgage lending and deposit gathering, operating principally through Third Federal Savings and Loan Association of Cleveland. This unaudited Form 10-Q covers the fiscal quarter and six months ended March 31, 2013; balance-sheet comparisons are to September 30, 2012.
Key financial metrics
| Metric | Three months ended March 31, 2013 | Six months ended March 31, 2013 |
|---|---|---|
| Net interest income | $67.9 million | $136.3 million |
| Provision for loan losses | $10.0 million | $28.0 million |
| Non-interest income | $6.1 million | $14.4 million |
| Non-interest expense | $45.2 million | $87.8 million |
| Net income | $12.8 million | $23.9 million |
| Diluted earnings per share | $0.04 | $0.08 |
| Net interest margin | 2.48% | 2.48% |
- Balance sheet at March 31: total assets were $11.12 billion, down 3% from September 30; net loans held for investment were $9.85 billion; available-for-sale securities were $456.9 million; and cash and cash equivalents were $284.1 million.
- Funding and equity: deposits were $8.76 billion, down $224.1 million from September 30; borrowed funds were $315.9 million, down $172.3 million. Shareholders’ equity was $1.84 billion.
- Cash flow, six months: operating activities provided $66.4 million; investing activities provided $325.7 million; financing activities used $416.2 million. Cash and cash equivalents declined $24.1 million to $284.1 million.
- Credit reserves and problem assets: the allowance for loan losses was $101.2 million, or 1.02% of recorded loans. Six-month net charge-offs were $27.2 million. Non-accrual loans were $166.0 million, and total non-performing assets were $185.9 million, or 1.67% of assets.
- Capital and liquidity: the Association reported a 14.05% core-capital-to-adjusted-tangible-assets ratio and a 23.52% total risk-based capital ratio, above stated well-capitalized requirements. Its average liquidity ratio for the quarter was 6.23%, versus a 5% minimum target.
Material changes versus comparable periods
- Quarterly net income rose from $1.0 million to $12.8 million year over year; six-month net income increased from $9.5 million to $23.9 million.
- Net interest income increased 3% for the quarter and 5% for the six months. Lower deposit costs more than offset lower yields on loans and mortgage-backed securities; the six-month net interest margin rose from 2.41% to 2.48%.
- Loan-loss provision declined from $27.0 million to $10.0 million for the quarter and from $42.0 million to $28.0 million for the six months. Six-month net charge-offs fell sharply from $97.7 million to $27.2 million, but the prior-year amount included a $55.5 million one-time charge-off of specific valuation allowances under an OCC directive. Accordingly, the comparison does not represent solely underlying credit improvement.
- Non-interest expense increased 4% for the quarter and 2% for the six months. Loan-sale gains contributed to higher six-month non-interest income.
- Loans held for investment and deposits contracted. The company sold $222.2 million of loans during the six months, while mortgage loans held for sale declined to $96.9 million.
- Credit indicators improved from prior-year levels: loans 90 days or more delinquent were 1.1% of net loans, compared with 1.5% a year earlier. Home Today loans remained a disproportionate credit concern, representing about 2% of held-for-investment loans but 22% of loans 90 days or more delinquent.
Outlook, commentary, and risks
- Management provided no specific earnings or revenue guidance. It reported improved regional employment, more stable housing values, and better credit metrics, but expects delinquencies and charge-offs to remain elevated amid economic uncertainty and depressed housing values, particularly in Florida.
- The portfolio is concentrated in residential real estate, especially Ohio and Florida. Home equity loans and lines of credit are generally higher risk because many are subordinate liens; management identified this portfolio as a continuing source of most credit losses. Current mean combined loan-to-value for the home-equity portfolio was 79%; Florida draw-period lines had a reported current mean of 99%.
- Mortgage-insurance recoveries are uncertain. PMIC advised that claims would be paid at 55%, with the balance deferred; management adjusted affected loss estimates. MGIC’s debt rating was below investment grade, although it continued paying claims under its contracts.
- Fannie Mae eligibility changes have constrained the company’s traditional loan-sale channel. TFS was developing compliant origination processes and targeted Fannie Mae review and approval for late summer 2013; timing and approval remained uncertain. Private whole-loan sales and HARP II sales provided alternative outlets.
- Interest-rate exposure remains material. The Association’s modeled economic value of equity fell 25.0% under an immediate 200-basis-point rate increase; modeled 12-month earnings at risk declined 0.4% under that scenario. These are model-based estimates, dependent on assumptions, not forecasts.
- A Federal Reserve-administered memorandum of understanding remained in effect for the company and its mutual holding company. It requires advance regulatory non-objection for specified debt, dividends, and share repurchases. TFS said it would not pay cash dividends or repurchase shares until regulatory concerns are resolved. The Association’s separate MOU was terminated in December 2012.
- At March 31, certificates of deposit totaling $2.38 billion were due within one year. Management considered liquidity adequate and cited borrowing capacity and other funding sources, but deposit retention and replacement funding costs remain relevant.
- Unfunded commitments included $1.24 billion of home-equity lines (excluding suspended accounts) and $635.9 million of loan-origination commitments. Management stated that commitment totals do not necessarily represent future cash requirements.
- Management reported no material expected adverse effect from ordinary-course legal proceedings, no material risk-factor changes from the prior Form 10-K, and effective disclosure controls.
Important facts for investors to verify
- Whether subsequent delinquency, charge-off, and allowance trends support management’s view that credit quality is improving, especially for Florida and Home Today exposures.
- How much of the reduction in loan-loss expense reflects sustainable credit improvement versus the prior-period OCC-mandated charge-off comparison.
- Progress and costs of Fannie Mae-compliant origination processes, actual agency approval, and the availability and pricing of private loan-sale channels.
- Deposit retention and funding costs as certificates mature, together with the availability and terms of contingent borrowing capacity.
- Any change in the remaining MOU, including restrictions on dividends and repurchases, and the eventual effect of Basel III capital rules.
- The assumptions underlying interest-rate sensitivity estimates and any changes in model results or portfolio positioning.
- Potential mortgage-insurance recoveries, loan repurchase exposure, and the adequacy of the related reserves.