TFS Financial Corporation — Q3 FY2018 10-Q Summary
Business context and reporting period. TFS Financial is a retail consumer banking company focused on residential mortgage lending and deposits, operating primarily through Third Federal Savings and Loan Association. This unaudited report covers the quarter and nine months ended June 30, 2018; comparisons are with the periods ended June 30, 2017 unless otherwise noted. Dollar amounts below are in millions unless stated otherwise.
Key financial metrics
| Metric | Three months ended June 30 | Nine months ended June 30 |
|---|---|---|
| Net interest income | $70.3 in 2018; $70.3 in 2017 | $212.0 in 2018; $208.8 in 2017 |
| Provision (credit) for loan losses | Credit of $2.0; credit of $4.0 in 2017 | Credit of $9.0; credit of $10.0 in 2017 |
| Non-interest income | $7.2; $4.8 in 2017 | $16.7; $14.7 in 2017 |
| Non-interest expense | $51.4; $44.7 in 2017 | $146.9; $135.2 in 2017 |
| Net income | $20.9; $22.8 in 2017 | $63.8; $65.9 in 2017 |
| Diluted earnings per share | $0.07; $0.08 in 2017 | $0.23; $0.23 in 2017 |
| Net interest margin | 2.09%; 2.16% in 2017 | 2.10%; 2.17% in 2017 |
- Revenue and profitability: Quarterly interest and dividend income rose 7% to $111.1 million, but interest expense also rose 22% to $40.8 million, leaving net interest income essentially unchanged. Quarterly net income fell 8%, primarily as the loan-loss credit narrowed and expenses increased. Nine-month net income declined about 3% despite higher net interest income and loan-sale gains.
- Margins and returns: Quarterly net interest margin declined 7 basis points year over year, to 2.09%; the nine-month margin fell 7 basis points, to 2.10%, as funding costs rose faster than asset yields. Annualized return on average assets and equity for the quarter were 0.60% and 4.76%, respectively.
- Balance sheet: At June 30, total assets were $13.94 billion, up 2% from September 30, 2017. Net loans held for investment were $12.67 billion; deposits were $8.41 billion, up 3%; borrowed funds were $3.66 billion, slightly lower than at fiscal year-end. Shareholders’ equity was $1.75 billion.
- Cash flow: For the nine months, operating activities provided $116.3 million, investing activities used $279.1 million, and financing activities provided $153.1 million. Cash and cash equivalents decreased $9.7 million to $258.5 million.
- Credit quality: Non-accrual loans were $71.3 million, down from $79.1 million at September 30, 2017. Non-performing assets were $74.5 million, or 0.53% of assets. The allowance for loan losses was $43.0 million, 0.34% of recorded loans, versus $48.9 million, or 0.39%, at September 30, 2017. Nine-month net recoveries were $3.0 million.
- Capital and liquidity: The Association reported Tier 1 leverage capital of 10.80% and total risk-based capital of 20.44%, above the disclosed well-capitalized thresholds. Management reported an average liquidity ratio of 5.6% for the quarter and stated liquidity was adequate. The Association reported $185.3 million of immediate additional FHLB borrowing capacity and $59.2 million at the Federal Reserve discount window.
Material changes versus comparable periods
- Loan interest income increased with loan growth and higher yields; loan yields rose to 3.36% for the quarter from 3.26% a year earlier. Rising rates also increased deposit and borrowing costs, contributing to margin compression.
- Non-interest expense rose 15% in the quarter and 9% for the nine-month period. Management attributed much of the compensation increase to the company’s 80th-anniversary events and an associate bonus; technology investment and marketing also contributed to higher expenses.
- Loan-sale gains increased, particularly from a May 2018 bulk sale of $277.4 million of long-term fixed-rate loans to a private investor. Total loan sales were $374.0 million for the nine months, versus $221.5 million in 2017.
- Home equity loans and lines of credit grew to $1.75 billion from $1.55 billion at September 30, 2017, while the legacy Home Today portfolio continued to run off. Deposits increased, driven principally by certificates of deposit; brokered CDs were $648.2 million at period-end.
- Other comprehensive income improved shareholders’ equity: nine-month comprehensive income was $90.6 million, including $26.8 million of other comprehensive income, principally reflecting cash-flow hedge changes.
Outlook, commentary, risks and unusual items
- No specific earnings or revenue guidance was provided. Management said it expected to remain well capitalized and considered liquidity adequate, while cautioning that interim results are not necessarily indicative of full-year results.
- Management’s main stated priorities are managing interest-rate risk, limiting credit risk, maintaining liquidity and controlling expenses. It noted that a rapid and substantial rise in interest rates could adversely affect net interest income over time.
- Interest-rate sensitivity modeling estimated that an instantaneous +200-basis-point shock would reduce the Association’s economic value of equity by 19.45%; a ramped +200-basis-point increase was estimated to reduce 12-month earnings at risk by 3.04%. Management said modeled results were within board-approved limits and cautioned that assumptions mean actual results may differ.
- Credit risks include concentrations in Ohio and Florida, higher-risk legacy Home Today loans, subordinated home equity exposures, and payment increases for certain home equity lines nearing the end of interest-only draw periods. The filing reported $205.4 million of lines with no amortizing draw-period payments approaching the end of their draw periods through fiscal 2020.
- Tax legislation lowered the federal corporate rate, but the company recorded $4.9 million of additional nine-month tax expense to revalue deferred tax assets; management said the estimate remained subject to adjustment. The nine-month effective tax rate was 29.7%, versus 33.0% a year earlier.
- The $277.4 million private-investor loan sale and anniversary-related expenses were notable items. The company also received $48.3 million of cash collateral from derivative counterparties during the nine months; the filing describes collateral and margin arrangements related to its swaps.
- Commitments included $612.3 million to originate loans and $1.76 billion of unfunded commitments, principally home equity lines. Management did not expect pending legal matters to have a material adverse effect. The filing reported no material change in risk factors from the prior disclosures, except as described in the December 2017 10-Q.
Most important facts for investors to verify
- Whether deposit and wholesale funding costs continue to rise faster than loan yields, further pressuring net interest margin.
- Whether loan-sale gains recur: the period’s increase included a sizable, apparently non-routine bulk sale to a private investor.
- Whether credit performance and the $43.0 million allowance remain adequate, especially for home equity and legacy Home Today exposures.
- How the $2.49 billion of certificates of deposit due within one year are retained or replaced, and the cost of that funding.
- Whether interest-rate sensitivity, swap effectiveness and liquidity remain within management’s stated limits as rates and funding conditions change.
- The final tax effects of the Tax Cuts and Jobs Act and the outcome of the requested mutual holding company dividend-waiver non-objection, which was not known at filing.