TFS Financial Corporation — FY2011 Form 10-K
Business context and reporting period. The filing covers the fiscal year ended September 30, 2011, not a calendar-year or standalone Q4 report. TFS Financial is a savings-and-loan holding company whose principal business is residential mortgage lending and retail deposits through Third Federal Savings and Loan, operating mainly in Ohio and Florida. Third Federal Savings, MHC owned 73.52% of the Company’s shares.
Financial performance and position
| Metric | FY2011 / September 30, 2011 | Comparable period |
|---|---|---|
| Net interest income | $247.6 million | $227.5 million in FY2010 |
| Net interest margin | 2.32% | 2.16% in FY2010 |
| Provision for loan losses | $98.5 million | $106.0 million in FY2010 |
| Non-interest income | $31.0 million | $58.6 million in FY2010 |
| Non-interest expense | $168.1 million | $161.9 million in FY2010 |
| Net income / diluted EPS | $9.3 million / $0.03 | $11.3 million / $0.04 in FY2010 |
| Total assets | $10.89 billion | $11.08 billion in FY2010 |
| Loans, net | $9.75 billion | $9.18 billion in FY2010 |
| Deposits / borrowings | $8.72 billion / $139.9 million | $8.85 billion / $70.2 million in FY2010 |
| Shareholders’ equity | $1.77 billion; 16.3% of assets | $1.75 billion in FY2010 |
| Operating cash flow | $135.6 million | $116.5 million in FY2010 |
FY2011 net interest income improved as lower funding costs more than offset weaker asset yields. Net income nevertheless fell 18%: reduced loan-sale gains and servicing fees, plus higher operating costs, outweighed the margin improvement and lower loan-loss provision. Loan-sale gains were $0.5 million versus $25.3 million in FY2010.
Cash and cash equivalents fell $448.9 million to $294.8 million. Investing cash flow was negative $392.4 million and financing cash flow was negative $192.1 million. The Company reported a 6.81% liquidity ratio and additional immediate borrowing capacity of $814.4 million at the FHLB and $293.0 million at the Federal Reserve. These are sources of liquidity, not cash on hand.
Material changes and credit quality
- Residential mortgage loans rose about 13% to $7.38 billion, while home-equity loans and lines declined about $357.5 million to $2.49 billion. Total loans, net, rose 6%.
- Adjustable-rate mortgage production increased to $1.18 billion, including the SmartRate product; fixed-rate production fell to $959.0 million. Loan sales dropped to $33.6 million from $1.03 billion, limiting a traditional means of managing interest-rate risk.
- Non-performing assets declined to $254.4 million, or 2.34% of assets, from $302.5 million, or 2.73%. Loans delinquent 90 days or more fell to $218.8 million from $254.4 million. Despite improvement, management expected elevated delinquencies and charge-offs to persist.
- The allowance for loan losses increased to $157.0 million from $133.2 million. Net charge-offs were $74.8 million, up from $68.0 million. Home-equity lending remained a major loss source; the Company recorded $49.5 million of home-equity charge-offs.
- The Home Today portfolio was $264.0 million; 30.1% was delinquent 30 days or more, compared with 2.1% for non-Home Today loans. The program’s underwriting was tightened in 2009 and originations had effectively stopped.
- Certificates of deposit totaled $6.06 billion; $3.07 billion matured within one year. Deposits declined $136.0 million during FY2011. The Company did not accept brokered deposits.
Outlook, risks, and unusual items
- Interest-rate exposure: Management’s model estimated that an immediate 200-basis-point rate increase would reduce net portfolio value 24.4% and projected 12-month net interest income 14.6%. These model estimates depend on assumptions and are not forecasts of actual results.
- Regulatory oversight and capital returns: The Company and Association were subject to memorandums of understanding following regulator concerns over home-equity risk management. Management said required submissions and the Reduction Plan’s financial targets had been completed, but the New MOU remained in force. Dividends and share repurchases were suspended pending regulatory resolution and required non-objection.
- OCC allowance change: The OCC directed savings institutions to charge off specific valuation allowances by March 31, 2012. TFS expected to adopt the methodology in the December 2011 quarter, charging off approximately $55.5 million of recorded allowances. Management said this would increase reported charge-offs and reduce the allowance and reported delinquent/non-performing balances by the same amount, without affecting the loan-loss provision.
- Other credit and market risks: Weak Ohio and Florida housing markets, unemployment, falling collateral values, second-lien home-equity exposures, and reduced mortgage-insurance recoveries were significant risks. PMIC had been seized by Arizona regulators, with claims payments indicated to be reduced by 50%.
- Business and cost changes: The Association exited commercial construction lending and placed that portfolio in runoff. A defined-benefit pension freeze was scheduled for December 31, 2011; management expected lower pension expense thereafter, partly offset by increased 401(k) contributions.
- Liquidity and funding: About half of certificates of deposit were due within a year, and reduced loan-sale capacity constrained liquidity and interest-rate-risk management. Management stated liquidity was adequate but acknowledged deposits, refinancing activity, rates, and market access could change.
- Regulatory and execution risks: Dodd-Frank implementation, the CFPB’s authority over the Association, changing capital and deposit-assessment rules, and compliance costs could affect expenses and operations. No specific earnings or revenue guidance was provided.
Deloitte issued an unqualified opinion on the financial statements and internal controls; management also concluded internal control over financial reporting was effective. Management said ordinary-course legal matters were not expected to have a material effect.
Important facts for investors to verify
- Progress and any termination or modification of the New MOU, and whether dividends or repurchases can resume.
- The accounting and reporting effects of the planned $55.5 million allowance charge-off, including how credit-quality comparisons are affected.
- Home-equity and Home Today delinquencies, net charge-offs, collateral values, allowance adequacy, and mortgage-insurance recoveries.
- Deposit retention and repricing as $3.07 billion of CDs mature within one year, alongside available borrowing capacity and liquidity needs.
- Whether mortgage-sale eligibility improves and whether SmartRate originations sufficiently mitigate the Company’s interest-rate exposure.
- Quarterly performance: FY2011 included a $7.3 million first-quarter net loss, followed by profits in each of the next three quarters.