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, deposits and related services, principally through Third Federal Savings and Loan Association of Cleveland. This unaudited Form 10-Q covers the three months ended December 31, 2012 (fiscal Q1 2013); operating results are compared with the three months ended December 31, 2011. Balance-sheet changes are compared with September 30, 2012. Figures below are in millions unless otherwise noted.
Key financial metrics
| Metric | Quarter ended Dec. 31, 2012 | Prior-year quarter / comparison |
|---|---|---|
| Interest and dividend income | $100.4 | $105.5 |
| Net interest income | $68.4 | $64.3 |
| Net interest margin | 2.47% | 2.40% |
| Provision for loan losses | $18.0 | $15.0 |
| Net income | $11.2 | $8.5 |
| Diluted earnings per share | $0.04 | $0.03 |
| Operating cash flow | $92.2 | $91.4 |
Non-interest income was $8.2 million, up from $5.7 million, largely reflecting $3.0 million of net gains on loan sales. Non-interest expense was nearly unchanged at $42.5 million. Annualized return on average assets was 0.39%, versus 0.31%; return on average equity was 2.46%, versus 1.90%.
At December 31, total assets were $11.38 billion, down from $11.52 billion at September 30. Net loans held for investment were $9.84 billion, down 4%; mortgage loans held for sale rose to $324.3 million from $124.5 million. Deposits were $8.80 billion, down 2%, while borrowed funds were $468.0 million, down from $488.2 million. Cash and cash equivalents were $333.6 million, and available-for-sale securities were $450.9 million. Shareholders’ equity was $1.82 billion.
Credit metrics: the allowance for loan losses was $105.2 million, or 1.06% of recorded loans, versus $100.5 million, or 0.96%, at September 30. Non-accrual loans were $179.6 million; total non-performing assets were $198.2 million, or 1.74% of assets. Loans 90 or more days delinquent were $116.5 million, approximately 1.2% of net loans. Total troubled debt restructurings were $214.0 million.
Liquidity and capital: the quarterly average liquidity ratio was 6.04%, against a stated minimum target of 5%. Management reported $486.9 million of immediately available additional FHLB borrowing capacity and $215.9 million at the Federal Reserve Discount Window. The Association’s core capital to adjusted tangible assets ratio was 13.59%; it exceeded the regulatory “well-capitalized” thresholds presented in the filing.
Material changes versus comparable periods
- Net income rose 32% year over year, supported by higher net interest income and loan-sale gains, partly offset by a larger loan-loss provision.
- Net interest income increased 6%; net interest margin improved 7 basis points. Funding costs fell faster than asset yields: the average cost of interest-bearing liabilities declined to 1.38% from 1.87%, while the yield on earning assets declined to 3.62% from 3.94%.
- Loan-sale activity and transfers of $264.9 million of loans into held-for-sale status contributed to the sharp increase in held-for-sale loans and the decrease in loans held for investment. The company completed $77.2 million of loan sales in the quarter.
- Deposits declined $176.9 million during the quarter, mainly as certificates of deposit fell; growth in high-yield savings and checking partly offset the decline. Operating cash flow was broadly stable year over year.
- Net charge-offs were $13.3 million, compared with $75.1 million in the prior-year quarter. The prior-year figure included a one-time $55.5 million charge-off of specific valuation allowances required under OCC guidance; therefore, the reported comparison is not like-for-like. Excluding that item, prior-year net charge-offs were $19.6 million.
Outlook, management commentary, risks and unusual items
- Management said it believes liquidity is adequate and expects to maintain high capital levels, but provided no specific earnings or financial guidance. It cautioned that interim results are not necessarily indicative of full-year results.
- Management identified interest-rate risk, credit quality, liquidity and expense control as key priorities. The mortgage-heavy balance sheet is exposed to rate movements: the company’s model estimated a 25.3% decrease in economic value of equity under an instantaneous 200-basis-point rate increase. Estimated 12-month net interest income would decline 2.0% under that scenario. These are model estimates, not forecasts.
- Credit risks include geographic concentration in Ohio and Florida, weak housing values, unemployment, second-lien home-equity exposure, and elevated delinquencies in the legacy Home Today portfolio. Management expected elevated delinquency levels to persist. Florida housing conditions and uncertainty over mortgage insurer PMIC’s ability to pay claims were particular concerns; PMIC claims were already subject to a 50% reduction, and the company increased loss estimates for potential further deterioration.
- Loan sales remain constrained by Fannie Mae eligibility changes. The Association was developing processes to meet current standards; management said near-term sales would generally depend on strong payment histories, borrower credit and collateral. Loan sales commitments were zero at quarter-end.
- Following termination of the Association’s New MOU by its primary regulator in December 2012, the New MOU applicable to TFS Financial and Third Federal Savings, MHC remained in effect. Among other requirements, it calls for advance regulatory non-objection to new debt, dividends or repurchases. The company said it would not declare or pay cash dividends or repurchase shares until regulatory concerns are resolved.
- Commitments included $300.1 million to originate loans and $1.28 billion of unfunded home-equity lines, excluding suspended accounts. The company also reported a $2.6 million reserve for remaining estimated losses under mortgage-insurance reinsurance contracts and a $2.4 million accrual for probable Fannie Mae-related servicing or repurchase losses. Management did not expect ordinary-course legal proceedings to materially affect results. Ohio was auditing franchise tax returns for fiscal years 2009–2011.
Most important facts for investors to verify
- Whether the $18.0 million quarterly loan-loss provision and $105.2 million allowance adequately reflect home-equity, Florida, Home Today and mortgage-insurer exposures.
- Subsequent performance of delinquent loans and the $214.0 million troubled-debt-restructuring portfolio, including Chapter 7 bankruptcy-related classifications.
- Progress toward Fannie Mae-compliant origination and the ability to sell held-for-sale loans without materially affecting margins or liquidity.
- Deposit retention and funding costs as $2.42 billion of certificates of deposit were due within one year of December 31, 2012.
- Any changes to the remaining regulatory MOU, including restrictions on dividends, share repurchases and new debt, and the eventual effect of Basel III capital rules.