TFS Financial Corporation — Form 10-Q Summary
Reporting period: Fiscal first quarter ended December 31, 2013. Comparisons are generally with the three months ended December 31, 2012; balance-sheet comparisons are with September 30, 2013. Amounts are in U.S. dollars.
Business context
TFS Financial conducts retail consumer banking through its thrift subsidiary, Third Federal Savings and Loan Association of Cleveland. Its principal activities are residential mortgage lending and deposit gathering. About 74% of TFS Financial’s outstanding shares were held by its mutual holding company at quarter-end.
Financial performance and position
| Metric | Quarter / period-end result | Comparable result or change |
|---|---|---|
| Interest and dividend income | $93.0 million | Down 7% from $100.4 million |
| Net interest income | $67.8 million | Down slightly from $68.4 million |
| Net interest margin | 2.47% | Unchanged year over year; interest-rate spread increased to 2.29% from 2.24% |
| Provision for loan losses | $6.0 million | Down from $18.0 million |
| Net income | $16.0 million; $0.05 per diluted share | Up from $11.2 million; $0.04 per diluted share |
| Non-interest income | $5.1 million | Down 38% from $8.2 million, principally due to lower loan-sale gains |
| Non-interest expense | $42.9 million | Up slightly from $42.5 million |
| Operating cash flow | $80.6 million | Down from $92.2 million |
| Total assets | $11.38 billion | Up $112.1 million, or 1%, from September 30 |
| Loans held for investment, net | $10.16 billion | Up $73.8 million from September 30 |
| Deposits | $8.31 billion | Down $150.3 million, or 2%, from September 30 |
| Borrowed funds | $986.0 million | Up $240.9 million from September 30 |
| Cash and cash equivalents | $316.9 million | Up $30.9 million from September 30 |
| Shareholders’ equity | $1.86 billion | Down $9.0 million from September 30 |
Lower loan yields and a smaller average loan balance reduced interest income, while lower deposit costs reduced interest expense. Return on average assets was 0.57% versus 0.39%; return on average equity was 3.43% versus 2.46%.
Net cash increased $30.9 million during the quarter: operating activities provided $80.6 million, investing activities used $96.0 million, and financing activities provided $46.3 million. Investing cash use reflected loan originations and securities purchases; financing included increased borrowings, partly offset by deposit outflows and $26.1 million of stock repurchases.
Credit quality, capital and liquidity
- The allowance for loan losses was $85.3 million, or 0.83% of recorded loans, down from $92.5 million at September 30. Net charge-offs were $13.3 million, broadly unchanged year over year; the quarter’s provision was below charge-offs.
- Non-accrual loans were $147.9 million, down from $155.8 million at September 30. Non-performing assets were $169.8 million, or 1.49% of assets, compared with $178.5 million, or 1.58%, at September 30.
- Total troubled debt restructurings were approximately $195.0 million, down from $201.7 million at September 30. Home Today loans were $168.8 million and remained a higher-risk portfolio: they represented 1.7% of held-for-investment loans but a disproportionate share of delinquencies.
- Residential real-estate lending remains geographically concentrated, particularly in Ohio and Florida. Management identified Florida housing conditions and home-equity lending, much of it in subordinate lien positions, as credit risks.
- Management reported an average quarterly liquidity ratio of 6.36% against a 5% minimum target and said liquidity was adequate. At quarter-end, the Association had $9.0 million of immediately available additional FHLB borrowing capacity and $168.9 million available at the Federal Reserve Discount Window; further FHLB capacity was subject to additional stock requirements.
- The Association reported a 13.45% core capital-to-adjusted-tangible-assets ratio and stated that it exceeded regulatory “well-capitalized” requirements. TFS Financial’s total risk-based capital ratio was 27.82%.
Material changes, outlook and risks
- Earnings improved mainly because the loan-loss provision fell by $12.0 million year over year. This was partly offset by lower loan interest income and a $2.7 million decrease in net gains on loan sales.
- The company resumed sales of eligible long-term fixed-rate loans to Fannie Mae after reinstatement as an approved seller on November 15, 2013. It sold $20.9 million of loans during the quarter, including $11.1 million of newly eligible loans and $9.8 million of HARP II loans.
- A new policy resulted in $5.3 million of residential loans delinquent for more than 1,500 days being fully charged off after stalled foreclosure proceedings. Future foreclosure proceeds, if any, would be recoveries of prior charge-offs.
- Management expected moderate charge-offs to continue as delinquent loans are resolved. It noted that improving regional employment and real-estate conditions had supported better credit metrics, but warned that economic recovery remained uncertain and Florida housing values and unemployment could continue to pressure borrowers.
- Interest-rate risk is significant. A modeled instantaneous 200-basis-point rate increase was estimated to reduce the Association’s economic value of equity by 17.0%; the 12-month earnings-at-risk estimate showed a 1.5% decrease under that scenario. Management said modeled exposures remained within board limits; these are estimates based on assumptions, not forecasts.
- The Federal Reserve MOU still requires prior written non-objection for company debt, dividends, and capital distributions. The quarter’s 2,156,250-share repurchase program was completed, but additional repurchases and dividends remained subject to regulatory non-objection.
- On January 8, 2014, after quarter-end, the company entered a mortgage-insurance commutation agreement that reduced maximum remaining exposure by $6.385 million in exchange for a $1.0 million payment. Separately, a November 2013 Fannie Mae resolution agreement involved a $3.1 million payment funded by existing accruals and withdrew specified outstanding repurchase and make-whole demands.
- The filing provides no formal earnings or revenue guidance. Management cautioned that interim results are not necessarily indicative of full-year results.
Other disclosed risks include competition, interest-rate and securities-market volatility, regulatory changes, dependence on third parties, and the effects of real-estate and credit conditions. Management said ordinary-course legal proceedings were not expected to have a material adverse effect. No material change to the risk factors in the prior Form 10-K was reported.
Most important facts for investors to verify
- Whether lower loan-loss provisions are sustainable given charge-offs, delinquency trends, Home Today performance, and the concentrated Ohio and Florida exposure.
- How deposit outflows and higher FHLB borrowings affect funding costs, liquidity, and net interest margin in subsequent quarters.
- Whether Fannie Mae loan-sale eligibility translates into sustained sale volumes and supports interest-rate-risk management.
- The assumptions underlying the allowance for loan losses and the modeled effects of rising rates on economic value of equity and earnings.
- Whether the Federal Reserve resolves the outstanding MOU concerns and permits future dividends or stock repurchases.
- The final financial and risk effects of the January 2014 mortgage-insurance commutation and the continuing adequacy of related reserves.