TFS Financial Corporation — Form 10-Q Summary
Reporting period: Fiscal first quarter ended December 31, 2010; comparisons are primarily with the three months ended December 31, 2009. Balance-sheet comparisons are with September 30, 2010. Amounts below are in millions unless stated otherwise. The interim financial statements are unaudited.
Business context
TFS Financial is a retail consumer banking and mortgage-lending company operating principally through Third Federal Savings and Loan Association of Cleveland. Its core activities are residential mortgage lending and deposit gathering. Approximately 74% of the parent’s shares were held by its mutual holding company at quarter-end.
Financial results and position
| Metric | Quarter ended Dec. 31, 2010 | Comparable / prior-period value |
|---|---|---|
| Interest income | $107.4 | $112.8 year-ago quarter |
| Net interest income | $59.7 | $57.3 year-ago quarter |
| Net interest margin | 2.21% | 2.20% year-ago quarter |
| Provision for loan losses | $34.5 | $16.0 year-ago quarter |
| Non-interest income | $6.8 | $11.6 year-ago quarter |
| Non-interest expense | $42.9 | $40.1 year-ago quarter |
| Net income (loss) | $(7.3); $(0.02) per diluted share | $8.9; $0.03 per diluted share |
- The net interest spread was 1.82%, up from 1.77%. Annualized return on average assets was -0.26%, and return on average equity was -1.68%, versus 0.33% and 2.03%, respectively, a year earlier.
- Total assets were $11.06 billion, broadly unchanged from September 30. Net loans held for investment rose to $9.70 billion from $9.18 billion; deposits declined to $8.79 billion from $8.85 billion.
- Cash and cash equivalents fell to $342.5 million from $743.7 million. Shareholders’ equity was $1.75 billion. Borrowed funds were $64.2 million, down from $70.2 million.
- Operating cash flow was $85.7 million, compared with cash used of $1.9 million a year earlier. Investing activities used $434.0 million and financing activities used $53.0 million; cash decreased $401.2 million during the quarter.
- The allowance for loan losses increased to $148.2 million, or 1.50% of recorded loans, from $133.2 million at September 30. Net charge-offs were $19.5 million, versus $14.0 million a year earlier.
- Liquidity averaged 9.29% under the company’s stated measure, above its 2% minimum target. The Association reported regulatory capital ratios of 21.32% total risk-based capital and 13.45% core capital to adjusted tangible assets; it exceeded applicable “well capitalized” requirements.
Material changes and management commentary
- Net interest income rose 4% as lower deposit costs more than offset reduced asset yields. Interest income declined 5%, while interest expense fell 14%.
- The company reported a quarterly loss, principally reflecting the higher loan-loss provision, lower fee income and no loan-sale gains, along with increased non-interest expense. Salaries and benefits fell 17%, but federal insurance premiums and other operating expenses increased.
- Mortgage originations increased materially, including production of $582.0 million in adjustable-rate loans, compared with $6.1 million a year earlier. No long-term fixed-rate mortgage loans were sold in the quarter, versus $170.8 million a year earlier. Management said Fannie Mae eligibility changes limited its traditional loan-sale channel and increased its exposure to longer-term mortgage assets.
- Management cited high unemployment, weak housing values and economic uncertainty as continuing credit risks, particularly in Ohio and Florida. Nonperforming assets were $292.0 million, or 2.64% of assets, at December 31. Troubled debt restructurings totaled $143.7 million.
Outlook, risks and contingencies
- Management expected elevated delinquencies and charge-offs to continue as troubled loans are resolved. It stated that future loan-loss provisions may be required if credit quality or economic conditions worsen.
- The portfolio is geographically concentrated: approximately 80% of residential non-Home Today and construction loans were in Ohio and 18% in Florida. Home Today loans were about 2.8% of recorded loans but represented a disproportionately high share of delinquencies; pre-March 2009 originations had less stringent underwriting.
- The Association had suspended new home-equity and equity-line applications, except bridge loans, and was reducing existing exposure. Under an OTS-accepted plan, by December 31, 2010 commitments had been reduced $738.2 million and outstanding balances $158.7 million against targets of $1 billion and $300 million, respectively, by December 31, 2011. A $150 million capital contribution to the Association was completed in October 2010.
- A new OTS memorandum of understanding dated February 7, 2011 replaced the prior MOU and requires, among other items, independent risk-management and interest-rate-risk assessments, a compensation review, succession planning and advance OTS non-objection for certain debt, dividend or repurchase plans. The company said it did not intend to pay cash dividends or repurchase shares until OTS concerns were resolved; no shares were repurchased in the quarter.
- Management reported available additional borrowing capacity, including $916.0 million immediately available from the FHLB and $332.3 million from the Federal Reserve Discount Window. Certificates of deposit totaling $2.72 billion matured within one year, creating potential funding and repricing risk if they did not renew.
- Internal rate-risk modeling estimated that a 200-basis-point rate increase would reduce the Association’s net portfolio value by 32% and projected net interest income over the following 12 months to decline 13.8%. Management cautioned that these models rely on assumptions and are not precise forecasts.
- Management estimated a 38.3% federal effective tax rate for fiscal 2011. It also noted continuing risk from FDIC assessments and costs associated with OTS-required actions. The filing states that results for the interim period are not necessarily indicative of full-year results.
- Commitments included $310.3 million to originate loans and $1.70 billion in unfunded equity-line, construction-loan and private-equity commitments. Mortgage-insurance reinsurance exposure had a contractual maximum of $15.5 million; the company recorded a $4.8 million liability for estimated remaining losses.
Most important facts for investors to verify
- Whether higher provisions and charge-offs persist, and how the allowance compares with subsequent credit losses and delinquency trends.
- Progress against the OTS home-equity reduction plan and the new MOU requirements, including whether restrictions on dividends and repurchases are lifted.
- Whether Fannie Mae or other market participants change eligibility standards, and the resulting effect on loan sales, asset growth and interest-rate exposure.
- Renewal rates and pricing for the $2.72 billion of certificates of deposit maturing within one year, alongside the company’s actual liquidity and borrowing capacity.
- Performance of Home Today loans, second-lien home-equity exposures and loans concentrated in Florida, where housing weakness and delinquency risks were emphasized.