TFS Financial Corporation — Form 10-Q Summary
Business context and period. TFS Financial is a retail consumer banking company focused primarily on residential mortgage lending and deposits, operating through Third Federal Savings and Loan Association. This fiscal third-quarter report covers the quarter and nine months ended June 30, 2012; comparisons are to the corresponding 2011 periods unless otherwise stated. Figures below are U.S. dollars.
Financial performance and position
- Quarter: Net interest income rose 4% to $65.9 million, but net income fell 85% to $0.9 million. The main drag was provision for loan losses, which increased to $31.0 million from $22.5 million. Earnings per share were reported as $0.00, rounded.
- Nine months: Net interest income increased 7% to $195.9 million; net income was $10.4 million versus $0.9 million. The improvement primarily reflected lower loan-loss provisions and higher net interest income, partly offset by lower non-interest income. Diluted EPS was $0.03 versus $0.00.
- Interest margins: Net interest margin was 2.38% for the quarter (2.37% prior year) and 2.40% year to date (2.29% prior year). Lower deposit and borrowing costs more than offset reduced yields on earning assets. Quarter return on average assets was 0.03%; year-to-date it was 0.12%.
- Credit costs and asset quality: The nine-month provision was $73.0 million, down from $79.5 million. Non-accrual loans were $154.0 million, down from $235.3 million at September 30, 2011; non-performing assets were $173.7 million, or 1.51% of assets. The allowance was $107.4 million, 1.05% of recorded loans, compared with $157.0 million at September 30, 2011.
- Balance sheet: Assets increased 6% to $11.49 billion. Net loans held for investment were $10.12 billion; deposits were $8.96 billion; borrowed funds were $569.7 million, up from $139.9 million at September 30, 2011. Shareholders’ equity was $1.81 billion.
- Cash flow and liquidity: For the nine months, operating cash flow was $105.3 million, investing cash use was $670.2 million, and financing cash flow was $588.4 million; cash and equivalents ended at $318.4 million. The average quarterly liquidity ratio was 5.83%, above the company’s 5% minimum. Management said liquidity and access to alternative funding were adequate.
- Capital: The Association reported a 22.08% total risk-based capital ratio and a 13.32% core-capital-to-adjusted-tangible-assets ratio, above the stated “well-capitalized” requirements of 10.00% and 5.00%, respectively.
Material changes and unusual items
- The allowance for loan losses fell substantially in part because the company adopted an OCC directive to charge off $55.5 million of specific valuation allowances (SVAs) previously included in the allowance. This was a one-time accounting/regulatory change that increased reported charge-offs and reduced reported delinquent and non-accrual balances; it did not affect the nine-month provision. Excluding SVA charge-offs, nine-month net charge-offs were $67.1 million, up from $59.4 million in the comparable 2011 period.
- All held-to-maturity securities, approximately $343.7 million, were transferred to available-for-sale in the June quarter to make them eligible for regulatory liquidity calculations. A $2.3 million net unrealized gain was recorded in accumulated other comprehensive income at transfer.
- The company classified $233.2 million of long-term fixed-rate mortgages as held for sale, but had completed no sales by June 30. It also increased short-term FHLB borrowings, primarily to augment liquidity.
- The defined-benefit pension plan’s future benefit accruals were frozen effective December 31, 2011. This reduced pension expense and liabilities; the company estimated fiscal 2012 combined pension-plan and replacement 401(k) contributions/expense of $1.5 million.
Outlook, management commentary, and risks
No specific earnings or revenue guidance was provided. Management expected elevated delinquencies and credit losses to persist amid high unemployment, weak housing values and lengthy foreclosure timelines, especially in Florida. It expected home-equity lending to remain a significant source of losses. The company’s residential lending is concentrated in Ohio and Florida; Florida represented about 17% of residential loans, and management identified that market as a particular concern.
- Home-equity loans and lines were $2.24 billion; the portfolio’s current mean combined loan-to-value ratio was 79%. For Florida home-equity lines in the draw period, the reported current mean combined loan-to-value ratio was 102%. These loans are often subordinate liens and may be exposed to declining collateral values.
- Home Today loans were $217.9 million and had materially higher delinquency rates than traditional residential mortgages. Mortgage insurer PMIC had been seized by Arizona regulators, with claims payments indicated to be reduced by 50%; the company adjusted its loss estimates accordingly.
- Interest-rate exposure remains material: the company estimated that a 200-basis-point rate increase would reduce economic value of equity by 26.0% and 12-month earnings at risk by 11.4%. Management cautioned that model assumptions limit the precision of these estimates.
- The Association remained subject to memoranda of understanding with regulators. The company said it did not intend to pay cash dividends or repurchase shares until regulatory concerns were resolved. It also expected proposed Basel III capital rules to affect future risk-weighted capital ratios unfavorably, but had not quantified the impact.
- Other exposures include $428.4 million of commitments to originate loans, $1.40 billion of unfunded commitments (primarily home-equity lines), and mortgage-insurance reinsurance exposure with maximum potential losses of $14.4 million. Management considered its recorded reserve adequate, while noting actual losses could differ.
Management reported disclosure controls were effective and stated that ordinary-course legal proceedings were not expected to have a material adverse effect. No material changes to the risk factors in the prior Form 10-K were reported.
Important facts for investors to verify
- Whether the steep quarterly earnings decline and higher provision signal further deterioration in credit costs, notwithstanding improving reported delinquency and non-accrual totals.
- The effect of the $55.5 million SVA charge-off on period-to-period comparisons, allowance coverage, and reported asset-quality measures.
- Future charge-offs and reserve needs in Ohio- and Florida-concentrated residential and home-equity portfolios, including exposure to high current combined loan-to-value ratios and mortgage-insurer recoveries.
- Whether the $233.2 million mortgage-loan sale pool is ultimately sold, and the effects of retaining fixed-rate loans on interest-rate risk and liquidity.
- Deposit retention and refinancing needs, including $2.67 billion of certificates of deposit due within one year, and the cost and availability of additional borrowings.
- Resolution of regulatory concerns and any resulting changes to dividend, repurchase, capital, or interest-rate-risk restrictions.