TFS Financial Corporation — Form 10-Q Summary
Business context and reporting period
Retail consumer banking company focused on residential mortgage lending and deposit gathering, operating primarily through Third Federal Savings and Loan Association of Cleveland. The report covers the quarter and nine months ended June 30, 2011; the balance-sheet comparison is with September 30, 2010. Financial statements are unaudited. Amounts below are in U.S. dollars; financial statement amounts are generally shown in millions.
Financial performance and condition
| Metric | Three months ended June 30, 2011 | Three months ended June 30, 2010 | Nine months ended June 30, 2011 | Nine months ended June 30, 2010 |
|---|---|---|---|---|
| Net interest income | $63.0 | $57.5 | $183.6 | $172.4 |
| Provision for loan losses | $22.5 | $30.0 | $79.5 | $71.0 |
| Non-interest income | $8.8 | $28.5 | $23.8 | $51.8 |
| Non-interest expense | $39.6 | $40.7 | $126.5 | $120.1 |
| Net income | $6.0 | $10.2 | $0.9 | $22.1 |
| Basic and diluted earnings per share | $0.02 | $0.03 | $0.00 | $0.07 |
| Net interest margin | 2.37% | 2.17% | 2.29% | 2.20% |
- Balance sheet at June 30: Total assets were $10.88 billion, loans held for investment net were $9.70 billion, deposits were $8.70 billion, borrowed funds were $185.1 million, and shareholders’ equity was $1.77 billion. Compared with September 30, 2010, assets declined 2%, loans net grew 6%, deposits declined 2%, borrowings rose from $70.2 million, and equity increased 1%.
- Cash and cash flow: Cash and cash equivalents were $277.6 million, down from $743.7 million at September 30, 2010. Nine-month operating cash flow was $156.8 million; investing cash flow was negative $370.3 million and financing cash flow negative $252.7 million. Cash declined $466.2 million during the period.
- Credit quality: The allowance for loan losses was $153.3 million, or 1.56% of recorded loans, compared with $133.2 million, or 1.43%, at fiscal year-end. Nine-month net charge-offs were $59.4 million versus $47.8 million in 2010. Non-accrual loans fell to $240.1 million from $286.6 million, and total non-performing assets were $260.2 million, or 2.39% of assets. Troubled debt restructurings totaled $160.8 million, including $23.1 million past due 90 days or more.
- Capital and liquidity: The Association reported a 13.82% core capital-to-adjusted tangible assets ratio and 22.02% total capital-to-risk-weighted assets ratio, above stated well-capitalized thresholds. The quarterly average liquidity ratio was 7.09%, against a company minimum target of 2%. Management reported additional borrowing capacity of $769.2 million immediately available from the FHLB and $311.5 million from the Federal Reserve Discount Window; total collateral-supported FHLB capacity was higher, subject to additional stock requirements.
Material changes versus comparable periods
- Quarterly net income declined 42%; nine-month net income declined 96%. Higher net interest income and lower quarterly loan-loss provision did not offset the steep reduction in loan-sale gains. Nine-month results also reflected higher credit provisions and operating expenses.
- Loan-sale gains fell to $0.2 million for the quarter and $0.5 million year to date, from $19.7 million and $25.5 million, respectively. Sales volume declined substantially after Fannie Mae changed loan eligibility requirements, which TFS had not adopted.
- Lower deposit costs supported margin expansion: quarterly net interest margin rose 20 basis points and the nine-month margin rose 9 basis points year over year. Interest expense declined as certificate-of-deposit rates and balances fell.
- Residential mortgage loans grew while home equity loans and lines declined. The company originated $956.1 million of adjustable-rate “SmartRate” mortgages in the first nine months, versus $28.7 million in the prior-year period; fixed-rate originations fell to $785.3 million from $1.15 billion.
- Delinquent loans 90 days or more totaled $221.3 million, down from $254.4 million at September 30, 2010. However, nine-month net charge-offs increased, and the allowance increased to reflect management’s assessment of current risks.
Outlook, management commentary, risks and unusual items
- No specific earnings or revenue guidance was provided. Management expected elevated delinquencies to persist, citing unemployment, weak housing values and excess housing inventory, particularly in Florida. It expected the Home Today portfolio to continue declining as tighter underwriting and limited mortgage insurance constrain new lending.
- Interest-rate risk remains material. The company’s internal model estimated that an immediate 200-basis-point rate increase would reduce the Association’s net portfolio value by 28% and reduce projected 12-month net interest income by 14.5%. Management cautioned that model results depend on assumptions and are not forecasts.
- The Association’s home equity lending concentration and risk management were subject to regulatory oversight. The original OTS memorandum of understanding was replaced in February 2011 by new memoranda covering the Association, mutual holding company and TFS Financial. Required submissions and actions through June 30 were reported completed; the new requirements remained in effect. OTS supervision transferred to the OCC on July 21, 2011.
- The home-equity reduction plan had met and exceeded June 30 targets: commitments were reduced by $1.05 billion and outstanding balances by $335.7 million. The portfolio and open commitments relative to Tier 1 capital plus allowance fell to 256%, versus 350% at September 30, 2010; the plan’s December 2011 target was 261%.
- The company stated it did not intend to pay cash dividends or repurchase shares until regulatory concerns were resolved. No shares were repurchased during the quarter.
- Liquidity considerations include $2.84 billion of certificates of deposit due within one year and $1.77 billion of unused home-equity lines, of which $203.6 million was suspended and unavailable. Management said commitments were expected to be funded through normal operations and believed liquidity was adequate.
- Management estimated a 17.0% federal effective tax rate for fiscal 2011, including a $0.4 million unfavorable deferred-tax-asset reserve adjustment. The nine-month income tax provision was $0.6 million; the filing notes the effective rate is affected by bank-owned life insurance.
Most important facts for investors to verify
- Whether loan-sale eligibility changes or alternative investors allow TFS to resume meaningful fixed-rate mortgage sales and restore associated gains and interest-rate risk capacity.
- Trends in loan-loss provisions, charge-offs, non-accrual loans, restructurings and collateral values, especially for Home Today and second-lien home-equity exposures in Ohio and Florida.
- Progress on regulatory requirements and whether the OCC and Federal Reserve resolve their concerns; confirm any resulting constraints on dividends, repurchases, funding or operations.
- Deposit retention and repricing as the $2.84 billion of certificates mature, and the company’s ability to maintain liquidity and funding costs.
- Actual sensitivity of earnings and capital to interest-rate changes compared with management’s model estimates and assumptions.