TFS Financial Corporation — Form 10-Q Summary
Business context and reporting period
Retail consumer banking company focused on mortgage lending, deposit gathering and related financial services. This unaudited filing covers the quarter ended December 31, 2011, the first quarter of fiscal 2012; income and cash flows are compared with the quarter ended December 31, 2010. Balance-sheet comparisons are to September 30, 2011. Amounts below are in U.S. dollars.
Key financial metrics
| Metric | Quarter ended Dec. 31, 2011 | Comparable period / prior balance-sheet date |
|---|---|---|
| Interest income | $105.5 million | $107.4 million, prior-year quarter |
| Net interest income | $64.3 million | $59.7 million, prior-year quarter |
| Net interest margin | 2.40% | 2.21%, prior-year quarter |
| Provision for loan losses | $15.0 million | $34.5 million, prior-year quarter |
| Non-interest income / expense | $5.7 million / $42.5 million | $6.8 million / $42.9 million, prior-year quarter |
| Net income (loss) / diluted EPS | $8.5 million / $0.03 | $(7.3) million / $(0.02), prior-year quarter |
| Total assets | $11.06 billion | $10.89 billion at Sept. 30, 2011 |
| Loans held for investment, net | $10.01 billion | $9.75 billion at Sept. 30, 2011 |
| Deposits / borrowed funds | $8.66 billion / $264.5 million | $8.72 billion / $139.9 million at Sept. 30, 2011 |
| Cash and cash equivalents | $254.1 million | $294.8 million at Sept. 30, 2011 |
| Shareholders’ equity | $1.80 billion | $1.77 billion at Sept. 30, 2011 |
Operating cash flow was $91.4 million, investing cash flow was $(236.6) million, and financing cash flow was $104.5 million. Cash and cash equivalents decreased $40.7 million during the quarter. The company reported a 5.54% average liquidity ratio for the quarter and said it considers liquidity adequate. The Association’s regulatory capital ratios exceeded applicable “well-capitalized” thresholds: core capital to adjusted tangible assets was 13.78%, versus a 5.00% requirement.
Material changes versus comparable periods
- Net income improved by $15.8 million year over year, turning from a loss to a profit. The main contributors were lower loan-loss provision and lower deposit interest expense; lower investment-security income and non-interest income partly offset the improvement.
- Net interest income rose 8% year over year as funding costs declined more than asset yields. Net interest margin increased 19 basis points to 2.40%.
- Loan-loss provision fell to $15.0 million from $34.5 million. However, net charge-offs were $75.1 million, compared with $19.5 million a year earlier.
- The allowance for loan losses declined to $96.9 million from $157.0 million at September 30, 2011. A regulatory accounting change drove much of the decrease: the company early-adopted an OCC directive requiring specific valuation allowances on collateral-dependent loans to be charged off. The $55.5 million of such allowances at September 30 was charged off in the quarter; management said this one-time charge-off did not affect the quarter’s provision.
- Total non-accrual loans fell to $174.1 million from $235.3 million at September 30, and non-performing assets fell to $192.3 million from $254.4 million. The company cautioned that these reported declines were materially affected by the specific-allowance charge-offs.
- Loans held for investment, net, increased $261.9 million from September 30; deposits declined $57.4 million, while borrowed funds rose $124.6 million, including $125.0 million of short-term FHLB advances used to augment liquidity.
Outlook, management commentary, risks and unusual items
- Management cited persistently weak housing values, unemployment and uncertain economic conditions as ongoing credit risks, particularly in Ohio and Florida. It expects elevated delinquencies and continued high charge-offs as troubled loans are resolved.
- Home Today loans, a small portion of the portfolio, have disproportionately high delinquencies; loans originated before March 27, 2009 had less stringent underwriting. Private mortgage insurer PMIC was seized by Arizona regulators, with claims payments indicated to be reduced by 50%; the company adjusted affected reserves and loss assumptions.
- Home equity lending is in runoff: the company stopped accepting new applications, except bridge loans, and reported that its regulatory reduction-plan targets had been met and exceeded. It also decided to exit commercial construction lending and is running off that portfolio.
- Interest-rate risk remains significant. The company’s model estimated that an instantaneous 200-basis-point rate increase would reduce net portfolio value by 28% and 12-month net interest income by 16.2%. Management warned that a rapid, substantial increase in rates could adversely affect future net interest income. The internal interest-rate model was being replaced and had not yet been sufficiently tested and validated for this filing.
- Reduced ability to sell newly originated fixed-rate loans to Fannie Mae limits a traditional interest-rate-risk-management tool. The company reported no loan sales in the quarter and was emphasizing adjustable-rate “SmartRate” originations.
- A supervisory memorandum of understanding remains in effect. The company said it had completed the specified actions, but it does not intend to pay cash dividends or repurchase shares until regulators’ concerns are resolved.
- The company froze future benefit accruals under its defined-benefit pension plan effective December 31, 2011. The freeze reduced the recorded projected benefit obligation by $16.1 million; management expects pension expense to decline, partly offset by additional 401(k) contributions.
- Other disclosed risks include interest-rate and real-estate market volatility, competition, regulation and potential changes to funding costs. Management said ordinary-course legal proceedings were not expected to have a material adverse effect. No material changes to the risk factors in the latest Form 10-K were reported.
Most important facts for investors to verify
- Whether asset-quality improvement persists after separating underlying loan performance from the one-time $55.5 million specific-allowance charge-off; track non-accrual loans, delinquencies, charge-offs and the allowance.
- Whether the $15.0 million quarterly provision and $96.9 million ending allowance remain adequate given $75.1 million of net charge-offs and continued regional housing and employment risks.
- Whether deposit outflows, certificate maturities and increased FHLB borrowing affect funding costs and liquidity; review management’s reported funding capacity and liquidity assumptions.
- Whether the new interest-rate-risk model is validated and whether actual rate sensitivity aligns with the disclosed modeled declines in net interest income and net portfolio value.
- Whether regulators modify or terminate the supervisory memorandum, and when restrictions on dividends and share repurchases may change.