TFS Financial Corporation — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended March 31, 2011. Financial statements are unaudited. Unless otherwise noted, amounts below are in U.S. dollars.
Business context
TFS Financial is a retail consumer banking company focused on residential mortgage lending and deposit gathering, operating principally through Third Federal Savings and Loan Association of Cleveland. Its lending is concentrated in Ohio and Florida. Approximately 74% of the company’s outstanding shares were held by its mutual holding company at March 31, 2011.
Key financial results
| Metric | Three months ended March 31 | Six months ended March 31 |
|---|---|---|
| Interest and dividend income | $105.7 million, down from $110.4 million | $213.2 million, down from $223.2 million |
| Net interest income | $60.9 million, up from $57.6 million | $120.6 million, up from $114.9 million |
| Provision for loan losses | $22.5 million, down from $25.0 million | $57.0 million, up from $41.0 million |
| Non-interest income | $8.3 million, down from $11.6 million | $15.1 million, down from $23.3 million |
| Non-interest expense | $44.0 million, up from $39.3 million | $86.9 million, up from $79.4 million |
| Net income (loss) | $2.2 million, compared with $2.9 million | $(5.1) million, compared with $11.8 million |
| Basic and diluted earnings (loss) per share | $0.01, compared with $0.01 | $(0.02), compared with $0.04 |
- Margins: Net interest margin was 2.29% for the quarter, up from 2.22%; for the six months it was 2.25%, up from 2.21%. The six-month interest-rate spread was 1.88%, compared with 1.80%.
- Balance sheet at March 31: Total assets were $10.89 billion, down from $11.08 billion at September 30, 2010. Net loans were $9.74 billion, up from $9.18 billion; deposits were $8.76 billion, down from $8.85 billion.
- Credit quality: Allowance for loan losses was $150.7 million, or 1.52% of recorded loans, versus $133.2 million, or 1.43%, at September 30. Six-month net charge-offs were $39.5 million versus $31.9 million. Non-accrual loans declined to $257.9 million from $286.6 million, and non-performing assets were $276.5 million, or 2.54% of assets.
- Cash flow and liquidity: For the six months, operating cash flow was $51.6 million, investing cash flow was $(425.0) million, and financing cash flow was $(181.4) million. Cash and cash equivalents fell by $554.7 million to $189.0 million. The average quarterly liquidity ratio was 7.43%, above the company’s stated 2% minimum.
- Borrowings and capital: Borrowed funds totaled $168.1 million, up from $70.2 million at September 30. The Association reported regulatory capital ratios of 21.58% total capital to risk-weighted assets and 13.72% core capital to adjusted tangible assets, exceeding the stated well-capitalized thresholds.
Material changes and management commentary
- Quarterly net interest income improved as lower deposit costs more than offset reduced yields on loans and securities. For the six-month period, higher credit-loss provisions, lower non-interest income, and higher operating expenses drove the swing to a net loss despite improved net interest income.
- Residential mortgage loans grew, including $802.7 million of adjustable-rate “SmartRate” originations in the six months. Loan sales were only $5.3 million, compared with $400.1 million in the prior-year six-month period, after Fannie Mae eligibility changes effective July 2010 restricted the company’s traditional sales channel.
- Home equity loans and lines declined by $205.4 million from September 30. The company suspended acceptance of new home equity applications, except bridge loans, and is reducing existing exposure. It reported $916.4 million of progress toward a $1 billion commitment-reduction target and $252.6 million toward a $300 million balance-reduction target under its regulatory plan.
- Management cited elevated unemployment, weak housing values and excess housing inventory, especially in Florida, as continuing credit concerns. Home Today loans were only 2.7% of loan balances but accounted for a disproportionate share of delinquencies; 30.4% of that portfolio was delinquent 30 days or more.
- The company reported $152.7 million of troubled debt restructurings at March 31, up from $90.2 million at September 30. Management said restructuring can help obtain repayment, while noting that performance remains subject to uncertainty.
Outlook, risks and contingencies
- Regulatory oversight: The original OTS memorandum of understanding was replaced in February 2011 by new memorandums covering the Association, mutual holding company and TFS Financial. Requirements include independent risk and compensation reviews, succession plans, policy revisions, and advance OTS non-objection for certain debt, dividend or repurchase plans. Management expected to meet remaining deadlines; compliance costs could increase expenses.
- The company stated it would not declare or pay a cash dividend or repurchase shares until OTS concerns are resolved. No shares were repurchased during the quarter.
- Interest-rate exposure: Internal modeling estimated that an immediate 200-basis-point rate increase would reduce the Association’s net portfolio value by 31% and 12-month net interest income by 16.2%. Management cautioned that these models rely on assumptions and are not precise forecasts.
- Funding: Management considered liquidity adequate. Available borrowing capacity was reported as $812.0 million immediately from the FHLB and $317.5 million from the Federal Reserve Discount Window; additional FHLB capacity was subject to collateral and stock requirements. Certificates of deposit totaling $2.73 billion were due within one year.
- Commitments included $175.1 million to originate loans and $1.61 billion of unfunded commitments, principally home equity lines. Mortgage reinsurance contracts had maximum potential losses of $15.5 million; $4.4 million was provided for estimated remaining losses.
- Management cited risks from economic and real estate conditions, concentrated geographic lending, changing interest rates, competition, regulation (including Dodd-Frank), and Fannie Mae and Freddie Mac developments. It issued no specific earnings guidance in the supplied filing text.
- The company reported that disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter. Management did not expect the identified legal proceedings to have a material adverse effect.
Important facts for investors to verify
- Whether the allowance for loan losses adequately reflects credit risk, particularly in home equity, Florida and legacy Home Today loans, and whether charge-offs or delinquencies worsen.
- Progress toward OTS requirements and the home equity reduction targets, including the effect of compliance costs and restrictions on dividends and share repurchases.
- Whether limited mortgage loan-sale capacity and continued growth in adjustable-rate and fixed-rate loan balances materially change interest-rate sensitivity.
- Deposit retention and refinancing outcomes for the $2.73 billion of certificates due within a year, alongside the decline in cash balances and use of borrowings.
- Whether troubled debt restructurings perform as modified and whether reported non-accrual improvements persist; compare these trends with charge-offs and real estate owned balances.