Item 1B.
Unresolved Staff Comments
None.
We operate from our main office in Cleveland, Ohio, our 39 full-service branch offices located in Ohio and Florida and our eight loan production offices located in Ohio. Our branch offices are located in the Ohio counties of Cuyahoga, Lake, Lorain, Medina and Summit and in the Florida counties of Broward, Collier, Hillsborough, Lee, Palm Beach, Pasco, Pinellas and Sarasota. Our loan production offices are located in the Ohio counties of Franklin, Butler, Delaware and Hamilton. The Company owns the building in which its home office and executive offices are located, and five other office locations. The net book value of our land, premises, equipment and software was $61.2 million at September 30, 2012. Included in the net book value are two commercial buildings located in Canton, Massachusetts, valued at $18.9 million, which are owned by our Hazelmere entity and leased to third parties in net lease transactions.
Item 3.
Item 3.
Legal Proceedings
The Company and its subsidiaries are subject to various legal actions arising in the normal course of business. In the opinion of management, the resolution of these legal actions is not expected to have a material effect on the Company’s financial condition, results of operation, or statement of cash flows.
Item 4.
Item 4.
Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a)Our common stock is listed and traded on the NASDAQ Global Select Market under the symbol “TFSL”. As of November 19, 2012, we had 9,013 shareholders of record, which number does not include persons or entities holding shares in “nominee” or “street” name through brokerage firms. Shares of our common stock began trading on April 23, 2007 following the completion of our initial public offering. Quarterly trading information for the periods indicated is provided by NASDAQ and included in the following table.
Payment of dividends is subject to declaration by our board of directors and is dependent on a number of factors, including:
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our capital requirements and, to the extent that funds for any such dividend are provided by Third Federal Savings and Loan, the regulatory capital requirements imposed on the Association by the Office of Comptroller of the Currency;
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our financial position and results of operations;
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tax considerations;
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our alternative uses of funds;
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statutory and regulatory limitations; and
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general economic conditions.
In June 2010, and as subsequently reaffirmed on February 7, 2011, the Company was directed not to declare or pay any cash dividend, purchase or redeem any common stock or make any other capital distribution without providing 45 days prior written notice to the Central Regional Director of the OTS and receiving the Regional Director’s written non-objection. This restriction continues to apply under the Company’s new regulator, the FRB. Refer to the Monitoring and Limiting Our Credit Risk section which follows in Item 7. of this Part II, for additional information. At this time the Company does not intend to declare or pay a cash dividend until the concerns of its primary regulator and the Association’s primary regulator are resolved. Any future payment of dividends will be decided by the Company’s board of directors, subject to proper FRB notice and non-objection, if required at that time.
Pursuant to Internal Revenue Service regulations, any payment of dividends by the Association to the Company that would be deemed to be drawn from the Association’s bad debt reserves would require a payment of taxes at the then-current tax rate by the Association on the amount of earnings deemed to be removed from the reserves for such distribution. The Association does not intend to make any distribution to the Company that would create such a federal tax liability.
Through September 30, 2010, Third Federal Savings, MHC, waived its right to receive dividends. The waivers complied with regulatory authorizations (in the form of non-objection) obtained by Third Federal Savings, MHC. Requests for future regulatory authorizations to waive receipts of dividends will be submitted to the FRB. Please refer to the preceding discussion of dividend waivers presented in Part I, Item 1. Business, SUPERVISION AND REGULATION, Holding Company Regulation, sections-Dividends and Waivers of Dividends by Third Federal, MHC. Regulatory non-objection is subject to periodic regulatory review and no assurances can be given regarding future regulatory non-objection. In addition, recent interim final rules issued by the FRB require that a majority of the mutual holding company's members eligible to vote must approve a dividend waiver by a mutual holding company within 12 months prior to the declaration of the dividend being waived. As part of its rulemaking process, the FRB is reviewing comments on the interim final rule and there can be no assurance that the final rule will not require such a member vote.
In the table and graph that follow, we have provided summary information regarding the performance of the cumulative total return of our common stock from September 30, 2007 through September 30, 2012, relative to the cumulative total return on stocks included in the (a) SNL Bank and Thrift Index; (b) SNL Thrift Index and (c) NASDAQ Composite, in each case for the same period. The cumulative return data are presented in dollars, based on starting investments of $100 and assuming the reinvestment of dividends.
______________________
(a)
We did not sell any unregistered securities during the fiscal year ended September 30, 2012.
(b)
Not applicable
(c)
The Company did not repurchase any shares of common stock during the quarter ended September 30, 2012.
On March 12, 2009, the Company announced its fourth stock repurchase program, which authorizes the repurchase of up to an additional 3,300,000 shares of the Company’s outstanding common stock. Purchases under the program will be on an ongoing basis, subject to the availability of stock, general market conditions, the trading price of the stock, alternative uses of capital, regulatory restrictions and our financial performance. Repurchased shares will be held as treasury stock and be available for general corporate use. The program has 2,156,250 shares yet to be purchased as of September 30, 2012. Our last repurchases occurred during the quarter ended December 31, 2009.
Because of concerns communicated to us by the OTS, which was merged into the OCC on July 21, 2011, and pending evaluations by our current federal regulators, the OCC and the Federal Reserve, as referred to in the Monitoring and Limiting Our Credit Risk section in the Overview, section of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, the Company does not intend to declare or pay a cash dividend, or to repurchase any of its outstanding common stock until the concerns of our regulators are resolved.
Item 6.
Item 6.
Selected Financial Data
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(1)
Prepaid expenses and other assets include the remaining balance in prepaid FDIC assessments of $12.1 million at September 30, 2012, $23.4 million at September 30, 2011, and $39.5 million at September 30, 2010.
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(1)
Represents the difference between the weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities for the year.
(2)
The net interest margin represents net interest income as a percent of average interest-earning assets for the year.
(3)
The efficiency ratio represents non-interest expense divided by the sum of net interest income and non-interest income.
(4)
Represents dividends paid per share divided by diluted earnings per share. Receipt of dividends on shares owned by Third Federal Savings, MHC has been waived and dividends paid on unallocated shares of the ESOP are used to pay down the loan to the ESOP.
(5)
Ratios in fiscal year 2012 have been impacted by elimination of SVAs and regulatory guidance related to Chapter 7 bankruptcy.
(6)
TFS Financial Corporation capital ratios were not calculated prior to 2012.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operation
Overview
Our business strategy is to operate as a well-capitalized and profitable financial institution dedicated to providing exceptional personal service to our customers. We cannot assure you that we will successfully implement our business strategy.
Since being organized in 1938, we grew to become, at the time of our initial public offering of stock in April 2007, the nation’s largest mutually-owned savings and loan association based on total assets. We credit our success to our continued emphasis on our primary values: “Love, Trust, Respect, and a Commitment to Excellence, along with some Fun.” Our values are reflected in our pricing of loan and deposit products, and historically, in our Home Today program, as described below. Our values are further reflected in the Broadway Redevelopment Initiative (a long-term revitalization program encompassing the three-mile corridor of the Broadway-Slavic Village neighborhood in Cleveland, Ohio where our main office is located) and the education programs we have established and/or supported. We intend to continue to support our customers.
Regionally high unemployment, weak residential real estate values, capital and credit markets that remain at less than robust levels, and a general lack of confidence in the financial service sector of the economy present challenges for us.
Management believes that the following matters are those most critical to our success: (1) controlling our interest rate risk exposure; (2) monitoring and limiting our credit risk; (3) maintaining access to adequate liquidity and alternative funding sources; and (4) monitoring and controlling operating expenses.
Controlling Our Interest Rate Risk Exposure. Although housing and credit quality issues persist in financial headlines and continue to have a negative effect on our operating results and, as described below, are certainly a matter of significant concern for us, historically our greatest risk has been interest rate risk exposure. When we hold long-term, fixed-rate assets, funded by liabilities with shorter re-pricing characteristics, we are exposed to potentially adverse impact from rising interest rates. Generally, and particularly over extended periods of time that encompass full economic cycles, interest rates associated with longer term assets, like fixed rate mortgages, have been higher than interest rates associated with shorter term funding sources, like deposits. This difference has been an important component of our net interest income and is fundamental to our operations. We manage the risk of holding long-term, fixed-rate mortgage assets primarily by moderating the attractiveness of our loan offerings, thereby controlling the level of additions (new originations) to our portfolio, and, prior to September 30, 2010, by periodically selling long-term, fixed-rate mortgage loans in the secondary market to reduce the amount of those assets held in our portfolio. During the fiscal year ended September 30, 2012, we sold $11.4 million of long-term, fixed-rate mortgage loans compared to $33.6 million and $1.03 billion during the fiscal years ended September 30, 2011 and 2010, respectively the low volume of loan sales since September 30, 2010 reflects the impact of changes by Fannie Mae, historically the Association’s primary loan investor, related to requirements for loans that it accepts and a reduced level of fixed-rate loan originations as described below.
Effective July 1, 2010, Fannie Mae, historically the Association’s primary loan investor, implemented certain loan origination requirement changes affecting loan eligibility that, to date, we have not adopted. In reaching our current decision regarding implementation of the changes necessary to comply with Fannie Mae’s revised requirements, we considered that since 1991, the Association, employing only non-commissioned loan originators and utilizing a centralized underwriting process, had sold loans to Fannie Mae under a series of proprietary variances, or contract waivers, that were negotiated between us and Fannie Mae during the term of our relationship. These proprietary concessions related to certain loan file documentation and quality control procedures the lack of which, in our opinion, did not diminish in any way the excellent credit quality of the loans that we delivered to Fannie Mae, but facilitated the efficiency and effectiveness of our operations and the quality and value of the loan products that we were able to offer to our borrowers. The credit quality of the loans that we delivered to Fannie Mae was consistently evidenced by the superior delinquency profile of our portfolio in peer performance comparisons prepared by Fannie Mae throughout the term of our relationship. In response to the tumult of the housing crisis that commenced in 2008, and with the objective of improving the credit profile its loan portfolio, Fannie Mae has enacted many credit tightening measures, culminating in the effective elimination of proprietary variances and waivers, accompanied by the imposition of additional file documentation requirements and expanded quality control procedures. In addition to substantively changing Fannie Mae’s operating environment, effects of the housing crisis spread throughout the secondary residential mortgage market and resulted in a significantly altered operating framework for all secondary market participants. We believe that this dramatically altered operating framework offers opportunities for business process innovators to create new secondary market solutions especially as such opportunities pertain to high credit quality residential loans similar to those that we have traditionally originated. With the current uncertainty as to how the secondary market might be structured in the future, the Association has concluded that it is premature to incur the costs of the infrastructural changes to our operations (file documentation collection and additional quality control procedures) that would be necessary to fully comply with current Fannie Mae loan eligibility standards. In the near term, the Association expects to continue to monitor secondary market
developments and will continue to assess the merits of implementing the changes required to comply with Fannie Mae’s loan eligibility standards.The Association’s ability to significantly reduce interest rate risk via our traditional loan sales of newly originated longer-term fixed rate residential loans has been limited and will remain so until either the Association changes its loan origination processes or Fannie Mae, Freddie Mac or other market participants revise their loan eligibility standards. In the absence of such changes, future sales of fixed-rate mortgage loans will be predominantly limited to those loans that have established payment histories, strong borrower credit profiles and are supported by adequate collateral values. In that regard, in June 2011, we sold, on a servicing retained basis, $20.3 million of fixed-rate mortgage loans to a private investor. During the three months ended March 31, 2012, we reclassified a pool of high credit quality, fixed-rate, first mortgage loans, with a recorded investment of $245.9 million, from “loans held for investment” to “loans held for sale” and engaged an investment banking representative to offer those loans for sale as non-agency, whole loans in the secondary market to private investors. As a condition to any transaction, the Association will retain the mortgage servicing rights associated with any loans sold. During the three months ended September 30, 2012, $104.7 million of the non-agency, "loans held for sale" portfolio were reclassified to "loans held for investment". During the fiscal year ended September 30, 2012, no loan sales to private investors were completed, nor at September 30, 2012, were any loan sale commitments to private investors outstanding. At September 30, 2012, non-agency, whole loans included as "loans held for sale" had a recorded investment of $114.7 million. During the quarter ended June 30, 2012, the Association implemented procedures necessary for participation in Fannie Mae's HARP II (Home Affordable Refinance Program) initiative. Included in the balance of "loans held for sale" at September 30, 2012, were $9.6 million of agency-compliant HARP II loans. HARP II loan sales during the fiscal year ended September 30, 2012, totaled $11.4 million. At September 30, 2012, outstanding HARP II loan sales commitments totaled $2.8 million.
In response to the agencies’ loan eligibility changes, in July 2010 we began marketing an adjustable-rate mortgage loan product that provides us with improved interest rate risk characteristics when compared to a long-term, fixed-rate mortgage. Since its introduction, the “SmartRate” adjustable rate mortgage has offered borrowers an interest rate lower than that of a fixed-rate loan. The rate is locked for three or five years then resets annually after that. It contains a feature to relock the rate an unlimited number of times at our then current rate and fee schedule, for another three or five years (dependent on the original reset period) without having to complete a full refinance transaction. Relock eligibility is subject to satisfactory payment performance history by the borrower (never 60 days late, no 30-day delinquencies during the last twelve months, current at the time of relock, and no foreclosures or bankruptcies since the SmartRate application was taken). In addition to a satisfactory payment history, relock eligibility requires that the property continue to be the borrower’s primary residence. The loan term cannot be extended in connection with a relock nor can new funds be advanced. All interest rate caps and floors remain as originated. During the fiscal year ended September 30, 2012, adjustable-rate mortgage loan production increased $302.1 million to $1.49 billion from $1.18 billion during the fiscal year ended September 30, 2011. During the same time period, fixed-rate mortgage loan production increased $198.5 million to $1.16 billion from $959.0 million. The amount of origination and refinancing volumes along with the portion of that activity that pertains to loans that we previously sold (but for which we maintained the right to provide mortgage servicing so as to maintain our relationship with our customer) when coupled with the level of loan sales, if any, determines the balance of loans held on our balance sheet. The amount of adjustable-rate loan activity described above resulted in $2.95 billion of long-term adjustable-rate loans in our residential mortgage loans held for investment portfolio at September 30, 2012, as compared to $1.83 billion at September 30, 2011, or an increase of $1.13 billion during the fiscal year. In addition, fixed-rate mortgage loan activity described above resulted in $5.20 billion of long-term fixed rate loans in our residential mortgage loans held for investment portfolio at September 30, 2012, as compared to $5.56 billion at September 30, 2011. The September 30, 2012 measurement excludes $124.5 million of agency and non-agency, long-term, fixed-rate loans reported as “held for sale”. At September 30, 2011, we had no loans designated as “held for sale”.
In the past, we have also managed interest rate risk by promoting home equity lines of credit, which have a variable interest rate. As described below, this product carries an incremental credit risk component and has been adversely impacted by the housing market downturn. Effective June 28, 2010, we suspended the acceptance of new home equity credit applications with the exception of bridge loans and, in accordance with a reduction plan that was accepted by our primary regulator in December 2010, we actively pursued strategies to decrease the outstanding balance of our home equity lending portfolio as well as our exposure to undrawn home equity lines of credit. During the quarter ended June 30, 2011, we achieved the balance and exposure reduction targets included in the reduction plan. Beginning in March 2012, we again offered new home equity lines of credit to qualifying existing home equity customers, subject to certain property and credit performance conditions, which include:
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lower combined loan to value ("CLTV") ratios (80% in Ohio/Kentucky and 70% in Florida; prior programs extended to as high as 89.99%);
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limited geographic offering (only Ohio, Kentucky and Florida; prior programs were offered nationwide);
•
borrower income is fully verified (in prior programs income was not always fully verified);
•
the borrower is qualified using a principal and interest payment based on the current prime rate plus 2.00%, amortized for 20 years (prior programs qualified using the current prime rate);
•
the minimum credit score to qualify for the re-introduced home equity line of credit is 720 (our most recent prior home equity line of credit offering required a minimum credit score of 680); and
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the term of the new home equity line of credit is a five year draw period, interest only payment, followed by a 20 year repayment period, principal and interest (prior program terms generally offered a 10 year draw period, interest only payment, followed by a 10 year repayment period, principal and interest).
Notwithstanding achievement of the reduction plan target and recent limited offers to extend new revolving lines of credit to qualifying, existing home equity line of credit customers, promotion of this product is not a current, meaningful strategy used to manage our interest rate risk profile.
Should a rapid and substantial increase occur in general market interest rates, it is probable that, prospectively and particularly over a multi-year time horizon, the level of our net interest income would be adversely impacted.
Monitoring and Limiting Our Credit Risk. While, historically, we had been successful in limiting our credit risk exposure by generally imposing high credit standards with respect to lending, the confluence of unfavorable regional and macro-economic events since 2008, coupled with our pre-2010 expanded participation in the second lien mortgage lending markets, has significantly refocused our attention with respect to credit risk. In response to the evolving economic landscape, we have continuously revised and updated our quarterly analysis and evaluation procedures, as needed, for each category of our lending with the objective of identifying and recognizing all appropriate credit impairments. At September 30, 2012, 90% of our assets consisted of residential real estate loans (both “held for sale” and “held for investment”) and home equity loans and lines of credit, the overwhelming majority of which were originated to borrowers in the states of Ohio and Florida. Our analytic procedures and evaluations include specific reviews of all home equity loans and lines of credit that become 90 or more days past due, as well as specific reviews of all first mortgage loans that become 180 or more days past due. We also expanded our analysis of current performing home equity lines of credit to better mitigate future risk of loss. In accordance with regulatory guidance issued in January 2012, performing home equity lines of credit subordinate to first mortgages delinquent greater than 90 days are transferred to non-accrual status. At September 30, 2012, the recorded investment of such performing home equity lines of credit classified as non-accrual was $8.8 million. Also, the OCC issued guidance in July 2012 which requires loans, where at least one borrower has been discharged of their obligation in Chapter 7 bankruptcy, to be classified as troubled debt restructurings. Also required is the charge off of performing loans to collateral value and non-accrual classification when all borrowers have had their obligations discharged in Chapter 7 bankruptcy, regardless of how long the loans have been performing. At September 30, 2012, troubled debt restructurings increased by $70.9 million of loans in Chapter 7 bankruptcy status. At September 30, 2012, the recorded investment in non-accrual status loans includes $30.6 of performing loans in Chapter 7 bankruptcy status where at least one borrower has been discharged of their obligation. Based on the OCC interpretive guidance, net charge-offs related to those loans increased $15.8 million for the fiscal year ended September 30, 2012.
In response to market conditions, and in an effort to limit our credit risk exposure and improve the credit performance of new customers, we have tightened our credit criteria in evaluating a borrower’s ability to successfully fulfill his or her repayment obligation and we have revised the design of many of our loan products to require higher borrower down-payments, limited the products available for condominiums, and eliminated certain product features (such as interest-only adjustable-rate loans, loans above certain loan-to-value ratios, and prior to March 2012, home equity lending products with the exception of bridge loans).
Prior to its July 21, 2011 merger into the Office of the Comptroller of the Currency (“OCC”), the Office of Thrift Supervision (“OTS”) expressed concerns with the risk concentration and other aspects of the Association’s home equity loans and lines of credit portfolio and the administration of that portfolio. Under the terms of an August 13, 2010 memorandum of understanding (the “MOU”) between the Association and the OTS, management prepared, or obtained, and submitted to the OTS: (1) a third party report on our home equity lending portfolio; (2) a home equity lending reduction plan (the “Reduction Plan”); (3) enhanced home equity lending and credit risk management policies and procedures; and (4) an updated business plan. On December 27, 2010, notice was received from the OTS that it did not object to the Reduction Plan. The Reduction Plan spanned the period from June 30, 2010 through December 31, 2011. As of December 31, 2011, the Reduction Plan’s targets (a $1 billion reduction in home equity lending commitments, including a $300 million reduction in outstanding balances) had been met and exceeded as home equity lending commitments had been reduced by $1.31 billion from June 30, 2010 levels, including $506.1 million in outstanding balances, to $3.83 billion. Further reductions occurred during the nine months ended September 30, 2012, and as a result, through September 30, 2012 home equity lending commitments had been reduced by $1.66 billion, including $749.5 million in outstanding balances, to $3.48 billion. Other elements of the Reduction Plan included: a $150 million capital infusion from the Company to the Association, which was completed in October, 2010,
and implementation of expanded line management, account management and collection processes regarding home equity lending. These process changes are all now substantially complete. Further, the ratio of the Association’s home equity loans and lines of credit portfolio and open commitments relative to Tier 1 Capital, plus the allowance for loan losses, was reduced to 214% at September 30, 2012 from 237% at December 31, 2011. The December 31, 2011 targeted ratio as contained in the Reduction Plan was 261%.
Effective February 7, 2011, the MOU was terminated and replaced by new memorandums of understanding (the “New MOU”) covering the Association, Third Federal Savings, MHC and the Company. The New MOU addressed the ongoing monitoring of issues raised in the original MOU. In addition, the New MOU required the following actions, all of which we have performed: (1) an independent assessment of the Association’s interest rate risk management policy and a plan to address any deficiencies (the assessment was submitted to the OTS on February 14, 2011); (2) an independent review of management compensation (the review was submitted to the OTS on June 30, 2011); (3) the submittal of an independent enterprise risk management study and a plan to address any deficiencies (the study and plan to address deficiencies were submitted to the OTS on February 11, 2011); (4) the submittal for OTS non-objection 45 days in advance of any plans for new debt, dividends or stock repurchases; (5) formal management and director succession plans (these plans were submitted to the OTS on March 30, 2011 and April 29, 2011, respectively); and (6) revisions to various operational policies (each of which has been completed). In a self-initiated effort, and prior to receipt of the New MOU, in September 2010, we engaged a third party to conduct an independent assessment of our interest rate risk management policy and our enterprise risk management approach. As indicated above, just days after receipt of the New MOU, the assessments were submitted to the OTS. Pursuant to recommendations of the assessments, we installed a new interest rate risk model that provides more customized analysis and we have established new board and management level committees to govern and oversee risk management and compliance. As indicated above, we believe that to date, we have complied with all of the stipulations of the MOU and New MOU. The requirements of the MOU and New MOU carry costs to complete that will continue to increase our non-interest expense in amounts that are not expected to, but may, be material to our results of operations. The Company does not intend to declare or pay a cash dividend, or to repurchase any of its outstanding common stock until the concerns of our regulators are resolved. The requirements of the New MOU will remain in effect until our primary regulator decides to terminate, suspend or modify them.
One aspect of our credit risk concern relates to the high percentage of our loans that are secured by residential real estate in the states of Ohio and Florida, particularly in light of the difficulties that have arisen with respect to the real estate markets in those states. At September 30, 2012, approximately 76.8% and 17.4% of the combined total of our residential, non-Home Today and construction loans held for investment were secured by properties in Ohio and Florida, respectively. Our 30 or more days delinquency ratios on those loans in Ohio and Florida at September 30, 2012 were 1.0% and 2.6%, respectively. Our 30 or more days delinquency ratio for the non-Home Today portfolio as a whole was 1.3%. Also, at September 30, 2012, approximately 38.9% and 29.2% of our home equity loans and lines of credit were secured by properties in Ohio and Florida, respectively. Our 30 days or more delinquency ratios on those loans in Ohio and Florida at September 30, 2012 were 1.3% and 1.6%, respectively. Our 30 or more days delinquency ratio for the home equity loans and lines of credit portfolio as a whole was 1.3%. While we focus our attention on, and are concerned with respect to the resolution of, all loan delinquencies, as these ratios illustrate, our highest concern is centered on loans that are secured by properties in Florida. The “Allowance for Loan Losses” portion of the preceding PART I, Item 1, Business section provides extensive details regarding our loan portfolio composition, delinquency statistics, our methodology in evaluating our loan loss provisions and the adequacy of our allowance for loan losses. As long as unemployment levels remain high, particularly in Ohio and Florida, and housing values remain depressed, due to prior overbuilding and speculation which has resulted in considerable inventory on the market, we expect that we will continue to experience elevated levels of delinquencies and risk of loss.
Our residential Home Today loans are another area of credit risk concern. Although the recorded investment in these loans totaled $204.9 million at September 30, 2012, and constituted only 2.0% of our total “held for investment” loan portfolio balance, these loans comprised 23.1% and 25.0% of our 90 days or greater delinquencies and our total delinquencies, respectively. At September 30, 2012, approximately 95.7% and 4.1% of our residential, Home Today loans were secured by properties in Ohio and Florida, respectively. At September 30, 2012, the percentages of those loans delinquent 30 days or more in Ohio and Florida were 21.2% and 17.2%, respectively. The disparity between the portfolio composition ratio and delinquency composition ratio reflects the nature of the Home Today loans. We do not offer, and have not offered, loan products frequently considered to be designed to target sub-prime borrowers containing features such as higher fees or higher rates, negative amortization, or low initial payment features with adjustable interest rates. Our Home Today loan products, which prior to March 27, 2009 were made to borrowers with credit profiles who would not have otherwise qualified for our loan products and might have been described as sub-prime borrowers, generally contained the same features as loans offered to our non-Home Today borrowers. The overriding objective of our Home Today lending, just as it is with our non-Home Today lending, was to create successful homeowners. We have attempted to manage our Home Today credit risk by requiring that borrowers attend pre- and post-borrowing financial management education and counseling and that the borrowers be referred to us by a sponsoring organization with which we have partnered. Further, to manage the credit aspect of these loans, inasmuch as
the majority of these buyers do not have sufficient funds for required down payments, many loans include private mortgage insurance. At September 30, 2012, 54.2% of Home Today loans included private mortgage insurance coverage. From a peak recorded investment of $306.6 million at December 31, 2007, the total recorded investment of the Home Today portfolio has declined to $204.9 million at September 30, 2012. This trend generally reflects the evolving conditions in the mortgage real estate market and the tightening of standards imposed by issuers of private mortgage insurance. As part of our effort to manage credit risk, effective March 27, 2009, the Home Today underwriting guidelines were revised to be substantially the same as our traditional mortgage product. At September 30, 2012, the recorded investment in Home Today loans originated subsequent to March 27, 2009 was $2.2 million. Unless and until lending standards and private mortgage insurance requirements loosen, we expect the Home Today portfolio to continue to decline in balance.
Maintaining Access to Adequate Liquidity and Alternative Funding Sources. For most insured depositories, customer and community confidence are critical to their ability to maintain access to adequate liquidity and to conduct business in an orderly fashion. The Company believes that maintaining high levels of capital is one of the most important factors in nurturing customer and community confidence. Accordingly, we have managed the pace of our growth in a manner that reflects our emphasis on high capital levels. At September 30, 2012, the Association’s ratio of core capital to adjusted tangible assets (a basic industry measure under which 5.00% is deemed to represent a “well capitalized” status) was 13.31%. We expect to continue to maintain high capital ratios.
In managing its level of liquidity, the Company monitors available funding sources, which include attracting new deposits, borrowing from others, the conversion of assets to cash and the generation of funds through profitable operations. The Company has traditionally relied on retail deposits as its primary means in meeting its funding needs. At September 30, 2012, deposits totaled $8.98 billion, while borrowings totaled $488.2 million and borrowers’ advances and servicing escrows totaled $195.4 million, combined. In evaluating funding sources, we consider many factors, including cost, duration, current availability, expected sustainability, impact on operations and capital levels.
To attract deposits, we offer our customers attractive rates of return on our deposit products. Our deposit products typically offer rates that are highly competitive with the rates on similar products offered by other financial institutions. We intend to continue this practice.
We preserve the availability of alternative funding sources through various mechanisms. First, by maintaining high capital levels, we retain the flexibility to increase our balance sheet size without jeopardizing our capital adequacy. Effectively, this permits us to increase the rates that we offer on our deposit products thereby attracting more potential customers. Second, we pledge available real estate mortgage loans and investment securities with the Federal Home Loan Bank of Cincinnati (“FHLB”) and the Federal Reserve Bank of Cleveland (“Federal Reserve”). At September 30, 2012, these collateral pledge support arrangements provide for additional borrowing capacity of up to $4.22 billion with the FHLB (provided an additional investment in FHLB capital stock of up to $75.0 million is made) and up to $233.3 million at the Federal Reserve. Third, we invest in high quality marketable securities that exhibit limited market price variability, and to the extent that they are not needed as collateral for borrowings, can be sold in the institutional market and converted to cash. At September 30, 2012, our investment securities portfolio totaled $421.4 million. Finally, cash flows from operating activities have been a regular source of funds. During the fiscal years ended September 30, 2012, 2011 and 2010, cash flows from operations totaled $155.6 million, $135.6 million and $116.5 million, respectively. Cash flow from operations during the fiscal year ended September 30, 2010 was adversely affected by the $51.9 million prepayment of Federal Deposit Insurance Corporation (FDIC) deposit insurance assessments made in December 2009, which has a remaining balance of $12.1 million at September 30, 2012.
Finally, historically, a portion of the residential first mortgage loans that we originated were considered to be highly liquid as they were eligible for sale/delivery to Fannie Mae. However, due to delivery requirement changes imposed by Fannie Mae, effective July 1, 2010, this channel of available liquidity has been significantly reduced. Refer to the Residential Real Estate Mortgage Loans section in PART I, Item 1, Business for additional details. At September 30, 2012, $124.5 million of agency and non-agency eligible, long-term, fixed-rate loans were reported as “held for sale”. During the fiscal year ended September 30, 2012, $11.4 million of agency-compliant HARP II loans were sold. Although negotiations were conducted with several potential buyers, no loan sales to private investors were completed during the current fiscal year. We continue to evaluate and consider adopting the various process changes which we would be required to make in order to conform our newly originated mortgage loans with Fannie Mae's requirements. To date, we have not elected to incorporate those process changes into our core operations, should we elect to do so, we believe that we have the ability, after implementing appropriate process changes, to originate mortgages that would conform to the Fannie Mae Selling Guide requirements and would be eligible for delivery to Fannie Mae.
Overall, while customer and community confidence can never be assured, the Company believes that our liquidity is adequate and that we have adequate access to alternative funding sources.
Monitoring and Controlling Operating Expenses. We continue to focus on managing operating expenses. Our ratio of non-interest expense to average assets was 1.52% for the fiscal year ended September 30, 2012 and 1.54% for the fiscal year ended September 30, 2011. As of September 30, 2012, our average assets per full-time employee and our average deposits per full-time employee were $11.7 million and $9.2 million, respectively. Based on industry statistics published by the Office of Comptroller of the Currency as of December 31, 2011, we believe that each of these measures compares favorably with the averages for our peer group. Our average deposits held at our branch offices ($230.3 million per branch office as of September 30, 2012) contribute to our expense management efforts by limiting the overhead costs of serving our deposit customers. We will continue our efforts to control operating expenses as we grow our business.
While we devote a great deal of our attention to managing our operating expenses, certain costs are largely outside of our control. One expense that increased dramatically beginning in fiscal 2009 is our FDIC deposit insurance premiums and assessments. In November 2009, the FDIC amended its assessment regulations to require insured institutions to pay, on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of calendar 2009 and to also prepay their estimated risk-based assessments for all of the calendar years 2010, 2011 and 2012. Our required $51.9 million prepayment was determined based upon our assessment rate in effect on September 30, 2009 and reflected a presumed 5% annualized growth factor applied to the institution’s assessment base as well as an assumed assessment rate increase of three cents per $100 of deposits effective January 1, 2011. In recognition of the industry’s weakened condition and the significant losses experienced by the FDIC, the prepayment was intended to preclude additional special assessments for the foreseeable future; however, the prepayment does not preclude the FDIC from changing assessment rates or from revising the risk-based assessment system, pursuant to the existing notice and comment rulemaking framework. As more fully described in PART I Item 1. Business-SUPERVISION AND REGULATION Federal Banking Regulation-Insurance of Deposit Accounts the Dodd-Frank Act required the FDIC to revise its assessment system to base it on each institution’s total assets less tangible capital instead of deposits. While the assessment base increased for all institutions, including the Association, changes pursuant to the Dodd-Frank requirement resulted in a 5% increase in the Association's assessment base which was more than offset by a 35% reduction in the Association’s assessment rate during the quarter immediately prior to the change when compared to the quarter immediately following the change, which was effective April 1, 2011.
Critical Accounting Policies
Critical accounting policies are defined as those that involve significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that the most critical accounting policies upon which our financial condition and results of operations depend, and which involve the most complex subjective decisions or assessments, are our policies with respect to our allowance for loan losses, mortgage servicing rights, income taxes, pension benefits and stock-based compensation.
Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. The amount of the allowance is based on significant estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. The methodology for determining the allowance for loan losses is considered a critical accounting policy by management due to the high degree of judgment involved, the subjectivity of the assumptions used and the potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses. At September 30, 2012, the allowance for loan losses was $100.5 million or 0.97% of total loans. An increase or decrease of 10% in the allowance would result in a $10.0 million charge or credit, respectively, to income before income taxes.
As a substantial percentage of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans are critical in determining the amount of the allowance required for specific loans. Assumptions are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly affect the valuation of a property securing a loan and the related allowance determined. Management carefully reviews the assumptions supporting such appraisals to determine that the resulting values reasonably reflect amounts realizable on the related loans.
Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. We consider a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates by management that may be susceptible to significant change based on changes in economic and real estate market conditions.
Historically, the evaluation has been comprised of a specific component and a general component. The specific component relates to loans that are delinquent or otherwise identified as a problem loan through the application of our loan
review process and our loan grading system. All such loans are evaluated individually, with principal consideration given to the value of the collateral securing the loan. Through September 30, 2011, specific valuation allowances were established as required by this analysis and charge-offs, when necessary, were recorded when the loan was resolved through deed in lieu, foreclosure or short sales. Beginning in September 2011, a portion of the SVA was reclassified as IVA. This portion represents the allowance on individually reviewed loans dependent on cash flows, such as performing TDRs, and a portion of the allowance on loans that represents further deterioration in the fair value not supported by an appraisal. Refer to the Allowance for Loan Losses section in PART I, Item 1, Business-THIRD FEDERAL SAVINGS AND LOAN ASSOCIATION OF CLEVELAND-Lending Activities, for additional details. The general component of the evaluation is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We also analyze historical loss experience, delinquency trends, general economic conditions and geographic concentrations. Effective March 31, 2009, loss factors used in determining an appropriate allowance level are supplemented by a market valuation allowance that addresses more qualitative factors that impact potential losses. The conditions evaluated include a combination of various market conditions, mainly a decrease in home values and an increase in unemployment rates, which have caused higher delinquencies and charge-offs in the loan portfolio, and increased foreclosure rates. This analysis establishes factors that are applied to the loan groups to determine the amount of the general component of the allowance for loan losses.
During the quarter ended December 31, 2011, a one-time charge-off of SVAs, which was $55.5 million at September 30, 2011, was recorded by the Company in connection with the adoption of the OCC's prescribed methodology regarding loan impairments. Refer to the Allowance for Loan Losses section in PART I, Item 1, Business-THIRD FEDERAL SAVINGS AND LOAN ASSOCIATION OF CLEVELAND-Lending Activities, for additional details. Additionally, effective September 30, 2012, pursuant to OCC issued guidance, $15.8 million of performing loans, where all borrowers have been discharged of their obligation through Chapter 7 bankruptcy procedures, were charged-off.
Actual loan losses may be significantly more than the allowances we have established, which could have a material negative effect on our financial results.
Mortgage Servicing Rights. Mortgage servicing rights represent the present value of the estimated future servicing fees expected to be received pursuant to the right to service loans in our loan servicing portfolio. Mortgage servicing rights are recognized as assets for both purchased rights and for the allocated value of retained servicing rights on loans sold. The most critical accounting policy associated with mortgage servicing is the methodology used to determine the fair value of capitalized mortgage servicing rights. A number of estimates affect the capitalized value and include: (1) the mortgage loan prepayment speed assumption; (2) the estimated prospective cost expected to be incurred in connection with servicing the mortgage loans; and (3) the discount factor used to compute the present value of the mortgage servicing right. The mortgage loan prepayment speed assumption is significantly affected by interest rates. In general, during periods of falling interest rates, mortgage loans prepay faster and the value of our mortgage servicing assets decreases. Conversely, during periods of rising rates, the value of mortgage servicing rights generally increases due to slower rates of prepayments. The estimated prospective cost expected to be incurred in connection with servicing the mortgage loans is deducted from the retained servicing fee (gross mortgage loan interest rate less amounts remitted to third parties-investor pass-thru rate, guarantee fee, mortgage insurance fee, etc.) to determine the net servicing fee for purposes of capitalization computations. To the extent that prospective actual costs incurred to service the mortgage loans differ from the estimate, our future results will be adversely (or favorably) impacted. The discount factor selected to compute the present value of the servicing right reflects expected marketplace yield requirements.
The amount and timing of mortgage servicing rights amortization is adjusted monthly based on actual results. In addition, on a quarterly basis, we perform a valuation review of mortgage servicing rights for potential decreases in value. This quarterly valuation review entails applying current assumptions to the portfolio classified by interest rates and, secondarily, by prepayment characteristics. At September 30, 2012, the capitalized value of our right to service $3.81 billion of loans for others was $19.6 million, or 0.51% of the serviced loan portfolio and was based on an estimated weighted-average life of 2.8 years. Activity in the balance of mortgage servicing rights is summarized as follows:
At September 30, 2012, substantially all of the approximately 37.4 thousand loans serviced for Fannie Mae and others were performing in accordance with their contractual terms and management believes that it has no material repurchase obligations associated with these loans. The following tables summarize our repurchases and loss reimbursements to investors, charges related to default servicing non-compliance and compensatory fees incurred during the indicated periods. All transactions were related to loans serviced for Fannie Mae. There were no material repurchase or loss reimbursement requests outstanding at September 30, 2012. An accrual for $2.4 million has been established for probable losses.
(1) Repurchases of non-recourse, non-performing loans were generally attributed to underwriting (primarily debt-to-income ratio) non-compliance.
(2) At September 30, 2012 the Association serviced 178 loans with a principal balance of $6.3 million for Fannie Mae that were subject to recourse. Of these, 12 loans with principal balances that totaled $439 thousand were delinquent 30 days or more. All other loans serviced for others were sold without recourse.
(3) Repurchases of non-recourse, performing loans during prior periods were the result of post-sales file reviews that identified underwriting (primarily debt-to-income ratio) non-compliance.
(4) Post-disposition file reviews resulted in losses or charges when loans which had been sold to Fannie Mae failed to perform; the underlying collateral was sold; a loss was incurred; and a post-disposition file review identified underwriting (primarily debt-to-income ratio) non-compliance.
(5) Compensatory fees related to default servicing represented instances in which the Association's default servicing procedures did not comply with Fannie Mae's servicing requirements.
Income Taxes. We consider accounting for income taxes a critical accounting policy due to the subjective nature of certain estimates that are involved in the calculation. We use the asset/liability method of accounting for income taxes in which deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. We must assess the realization of the deferred tax asset and, to the extent that we believe that recovery is not likely, a valuation allowance is established. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to income tax expense. The carry forward portion of our $55.0 million charitable contribution expense incurred in April 2007 in conjunction with the formation of the Third Federal Foundation expired on September 30, 2012, with a $6.0 million valuation allowance representing the portion of the carryforward that is expiring unused. Although we have determined a valuation allowance is not required for deferred tax assets at September 30, 2012, there is no guarantee that those assets will be recognizable in the future.
Pension Benefits. The determination of our obligations and expense for pension benefits is dependent upon certain assumptions used in calculating such amounts. Key assumptions used in the actuarial valuations include the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation. Actual results could differ from the assumptions and market driven rates may fluctuate. Significant differences in actual experience or significant changes in the assumptions could materially affect future pension obligations and expense.
Stock-based Compensation. We recognize the cost of associate and director services received in exchange for awards of equity instruments based on the grant date fair value of those awards in accordance with FASB ASC 718, “Compensation-Stock Compensation."
We estimate the per share value of option grants using the Black-Scholes option pricing model using assumptions for expected dividend yield, expected stock price volatility, risk-free interest rate and expected option term. These assumptions are subjective in nature and involve uncertainties, and therefore, cannot be determined with precision.
The per share value of options is highly sensitive to changes in assumptions. In general, the per share fair value of options will move in the same direction as changes in the expected stock price volatility, risk-free interest rate and expected option term, and in the opposite direction from changes in expected dividend yield. For example, the per share fair value of options will generally increase as expected stock volatility increases, risk-free interest rate increases, expected option term increases and expected dividend yield decreases. The use of different assumptions or different option pricing models could result in materially different per share fair values of options.
Comparison of Financial Condition at September 30, 2012 and 2011
Total assets increased $625.2 million, or 6%, to $11.52 billion at September 30, 2012 from $10.89 billion at September 30, 2011. This change was the result of increases in our mortgage loans held for sale and our mortgage loan portfolio combined with increases in cash and cash equivalents and investment securities.
Cash and cash equivalents increased $13.5 million, or 5%, to $308.3 million at September 30, 2012 from $294.8 million at September 30, 2011. The net increase can be attributed to maintaining liquidity on the balance sheet in the current interest rate environment.
Investment securities increased $13.0 million, or 3%, to $421.4 million at September 30, 2012 from $408.4 million at September 30, 2011. During the quarter ended June 30, 2012, all of our investment securities in the held to maturity portfolio were transferred to the available for sale portfolio to ensure that the securities would be eligible for inclusion in the computation of regulatory liquidity. There were no sales of investment securities during the fiscal year ended September 30, 2012 as $228.0 million in purchases of investment securities were substantially offset by $214.1 million in principal paydowns and $4.7 million of net acquisition premium amortization which occurred in the mortgage-backed securities portfolio . Differences between cost and fair value for investment securities held in the available for sale portfolio also affected the change in the balance during the fiscal year.
Mortgage loans held for sale increased to $124.5 million at September 30, 2012 from none at September 30, 2011. During the quarter ended March 31, 2012, a pool of long-term, fixed-rate loans were reclassified from the portfolio of loans held for investment and an investment banking representative was engaged to offer those loans for sale, on a servicing retained basis, as non-agency, whole loans in the secondary market. No sales of such loans were completed or committed during the fiscal year ended September 30, 2012. Mortgage loans held for sale at September 30, 2012 also included $9.6 million of agency-compliant HARP II loans.
Loans held for investment, net, increased $474.1 million, or 5%, to $10.22 billion at September 30, 2012 from $9.75 billion at September 30, 2011. Supported by consistent loan growth, residential mortgage loans increased $766.7 million, or 10%, to $8.15 billion during the year ended September 30, 2012. The increase in residential mortgage loans includes the negative impact of $97.6 million in net charge-offs from both Home Today and non-Home Today loans during the year ended September 30, 2012. The total allowance for loan losses decreased $56.5 million, or 36%, to $100.5 million from $157.0 million at September 30, 2011. As previously reported, the Association’s primary federal banking regulator, the OCC, required all SVAs maintained by savings institutions to be charged off by March 31, 2012. As permitted, the Company elected to early-adopt this methodology effective December 31, 2011. As a result, reported loan charge-offs for the year ended September 30, 2012 were impacted by the $55.5 million balance of the SVA that was recorded at September 30, 2011. During the year ended September 30, 2012, $1.49 billion of three and five year “SmartRate” loans were originated while $1.16 billion of 10, 15, and 30 year fixed-rate first mortgage loans were originated. These originations were partially offset by paydowns. Historically, the preponderance of our new loan originations was comprised of fixed-rate loans which were frequently offset by fixed-rate loan sales. Loan sales of $11.4 million were recorded during the year ended September 30, 2012. This limited amount of loan sales activity reflects the impact of the changes that were made by Fannie Mae, the Association’s primary loan investor, related to requirements for loans that it accepts, as well as the strategy of originating adjustable rate loans to be held for investment on our balance sheet. Refer to the Controlling Our Interest Rate Risk Exposure section of the Overview for additional discussion regarding our management of interest rate risk. The increase in residential mortgage loans was partially offset by a $335.7 million decrease in home equity loans and lines of credit. Effective June 28, 2010 through February 2012, we suspended the acceptance of new home equity loan and line of credit applications with the exception of bridge loans. Beginning in March 2012, we again offered new home equity lines of credit to qualifying existing home equity customers, subject to certain property and credit performance conditions. At September 30, 2012, pending commitments to extend new home equity lines of
credit to our existing customers totaled $3.5 million. Refer to the Controlling Our Interest Rate Risk Exposure section of the Overview for additional information.
Mortgage loan servicing assets, net, decreased $9.3 million, or 32%, to $19.6 million at September 30, 2012 from $28.9 million at September 30, 2011. This net change reflects the significant reduction in loan sales, and accompanying creation of new mortgage loan servicing assets, that resulted from the delivery requirement changes imposed by Fannie Mae and as described above. For the fiscal year ended September 30, 2012 mortgage loan servicing asset amortization totaled $9.3 million while asset generation from new sales totaled $43 thousand. The majority of the amortization is linked to the cyclically low level of mortgage interest rates that prompted accelerated refinance activity by borrowers. The principal balance of loans serviced decreased $1.63 billion, or 30%, during the year ended September 30, 2012 to $3.81 billion from $5.43 billion at September 30, 2011.
Deposits increased $265.5 million, or 3%, to $8.98 billion at September 30, 2012 from $8.72 billion at September 30, 2011. The increase in deposits was the result of a $139.5 million increase in our certificates of deposit combined with a $97.3 million increase in our high-yield savings accounts (a subcategory of our savings accounts) and a $31.0 million increase in our high-yield checking accounts (a subcategory of our negotiable order of withdrawal accounts) during the fiscal year ended September 30, 2012. We believe that our high-yield savings accounts as well as our high-yield checking accounts provide a stable source of funds. In addition, our high yield savings accounts are expected to reprice in a manner similar to our equity loan products, and, therefore, assist us in managing interest rate risk.
Borrowed funds increased $348.3 million, or 249%, to $488.2 million at September 30, 2012 from $139.9 million at September 30, 2011. The largest component of the increase is $320.0 million of lower cost, short-term (overnight) borrowings from the Federal Home Loan Bank of Cincinnati, the proceeds of which are held in interest bearing cash equivalents and augment our liquidity.
Principal, interest, and related escrow owed on loans serviced decreased $24.4 million, or 16%, to $127.5 million at September 30, 2012 from $151.9 million at September 30, 2011. Principal and interest collected decreased $11.9 million along with a $12.5 million decrease in retained tax payments collected from borrowers in the current period. Principal and interest will fluctuate based on normal curtailments and paydowns, but historically low mortgage interest rates increased the amount of refinancing activity in the preceding periods. As a result of the aforementioned activity and the low volume of loan sales in the current fiscal year, the principal balance of loans serviced decreased $1.62 billion, or 30%, to $3.81 billion from $5.43 billion at September 30, 2011.
Accrued expenses and other liabilities decreased $6.9 million to $46.3 million at September 30, 2012 from $53.2 million at September 30, 2011. This change primarily reflects a $16.0 million decrease in the accruals related to our retirement and pension plans as a result of a plan amendment to freeze future pension benefit accruals as of December 31, 2011. This decrease was partially offset by the in-transit status of $5.3 million of real estate tax payments that have been collected from borrowers and are being remitted to various taxing agencies, and a $2.4 million increase in loss reimbursement accruals related to serviced loans.
Shareholders’ equity increased $32.9 million, or 2%, to $1.81 billion at September 30, 2012 from $1.77 billion at September 30, 2011. Activity reflects $11.5 million of net income in the 2012 fiscal year combined with $11.1 million of adjustments related to the allocation of shares of our common stock related to awards under the stock-based compensation plan and the ESOP, a $7.8 million reduction in the actuarially determined balance of our pension obligation and a $2.5 million increase in gains on investment securities as a result of the transfer of securities from held to maturity to available for sale.
Analysis of Net Interest Income
Net interest income represents the difference between the income we earn on our interest-earning assets and the expense we pay on our interest-bearing liabilities. Net interest income depends on the volume of interest-earning assets and interest-bearing liabilities and the rates earned on such assets and the rates paid on such liabilities.
Average balances and yields. The following table sets forth average balances, average yields and costs, and certain other information at and for the fiscal years indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. Average balances are derived from daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or interest expense.
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(1)
Interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(2)
Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(3)
Net interest margin represents net interest income divided by total interest-earning assets.
Rate/Volume Analysis. The following table presents the effects of changing rates and volumes on our net interest income for the fiscal years indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.
Comparison of Operating Results for the Fiscal Years Ended September 30, 2012 and 2011
General. Net income increased $2.2 million, or 24%, to $11.5 million for the fiscal year ended September 30, 2012 compared to $9.3 million for the fiscal year ended September 30, 2011. This change was attributed to an increase in net interest income partially offset by a decrease in non-interest income, and increases in the provision for loan losses and non-interest expense.
Interest Income. Interest income decreased $9.6 million or 2%, to $417.9 million for the fiscal year ended September 30, 2012 compared to $427.5 million for the prior fiscal year. The decrease in interest income resulted primarily from decreases in interest income from loans and mortgage-backed securities.
Interest income on mortgage-backed securities decreased $5.4 million, or 47%, to $6.2 million from $11.6 million during the prior fiscal year. The average yield on mortgage-backed securities decreased 64 basis points to 1.65% compared to 2.29% in the prior fiscal year as interest rates on adjustable rate securities reset to lower current rates and higher, fixed-rate securities continue to experience accelerated paydowns. The average balance of mortgage-backed securities decreased $131.5 million to $375.5 million compared to $507.0 million during the prior fiscal year. The $214.1 million in principal paydowns and maturities which occurred in the current fiscal year were more than offset by $228.0 million in purchases. There were no sales of mortgage-backed securities during the current fiscal year.
Interest income on loans decreased $4.1 million, or less than 1%, to $409.4 million compared to $413.5 million in the prior fiscal year. This change was attributed to a 22 basis point decrease in the yield to 3.99% from 4.21% as historically low interest rates have increased the amount of refinance activity. Additionally, the increase in our “SmartRate” adjustable-rate first mortgage loan originations during the fiscal year at interest rates below rates offered on fixed-rate products contributed to the lower average yield. The decrease in interest income on loans during the current fiscal year was partially offset by the $435.5 million increase in the average balance of loans to $10.26 billion in the current fiscal year compared to $9.83 billion in the prior fiscal year as new loan production exceeded repayments and loan sales.
Interest Expense. Interest expense decreased $24.2 million, or 13%, to $155.6 million during the 2012 fiscal year from $179.8 million during the 2011 fiscal year. The change resulted primarily from a decrease in interest expense on certificates of deposit combined with modest decreases in interest expense on NOW accounts and savings accounts.
Interest expense on certificates of deposit decreased $21.6 million, or 13%, to $142.7 million compared to $164.3 million during the prior fiscal year. The change was attributed to a 33 basis point decrease in the average rate we paid on certificates of deposit to 2.35% from 2.68% combined with a $80.0 million, or 1%, decrease in the average balance to $6.06 billion from $6.14 billion. Rates were adjusted on deposits in response to changes in general market rates as well as to changes in the rates paid by our competition on short-term certificates of deposit.
Interest expense on savings accounts decreased $2.5 million, or 25%, to $7.5 million compared to $10.0 million the prior fiscal year. The change was attributed to an 18 basis point decrease in the average rate we paid on savings accounts to 0.43% from 0.61%, partially offset by a $125.1 million, or an 8%, increase in the average balance to $1.76 billion from $1.63 billion the prior fiscal year, reflecting customer preference for savings accounts when rates are comparable to our short-term certificates of deposit.
Net Interest Income. Net interest income increased $14.6 million, or 6%, to $262.2 million compared to $247.6 million during the prior fiscal year. As net interest income increased during the current fiscal year, we experienced an improvement of our interest rate spread which increased 14 basis points to 2.11% compared to 1.97% during the prior fiscal year. Our net interest margin increased 7 basis points to 2.39% compared to 2.32% in the prior fiscal year. This increase can be partially attributed to the higher average loan balance in the current fiscal year. Our average net interest-earning assets decreased $11.3 million, to $1.80 billion during the current fiscal year compared to $1.81 billion during the prior fiscal year.
Provision for Loan Losses. We establish provisions for loan losses, which are charged to operations, in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of non-performing and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses on a quarterly basis and make provisions for loan losses in order to maintain the allowance. Continuing economic issues, including high levels of unemployment, are challenging our borrowers’ ability to repay their loans at a time when housing prices are weak, in part as a consequence of the collapse of the sub-prime mortgage market, and make it difficult to sell their homes. This limits the ability of many borrowers to self-cure a delinquency.
Based on our evaluation of the above factors, we recorded a provision for loan losses of $102.0 million during the fiscal year ended September 30, 2012 and a provision of $98.5 million during the fiscal year ended September 30, 2011. The increase in the provision is due to the impact of $15.8 million of charge-offs related to Chapter 7 Bankruptcy status loans, as described below, which was partially offset by improved credit quality. The increased level of net charge-offs (non-SVA and Chapter 7 related) during the current fiscal year, $87.2 million as compared to $74.8 million during the fiscal year ended September 30, 2011, resulted from increases in both the residential non-Home Today and the residential Home Today portfolios and was partially offset by decreased charge-offs (non-SVA related) in the home equity lending portfolio. The increased charge-off activity (non-SVA related) occurred despite continued improvement in delinquencies and was attributed partially to the OCC Bank Accounting Advisory Series (BAAS) interpretive guidance issued in July 2012 related to loans in Chapter 7 bankruptcy, which resulted in charge-offs totaling $15.8 million. Also, more delinquent loans moving into foreclosure and increased losses recognized based on declining sheriff sale appraisal amounts contributed to the increased charge-offs for the year. The current provision reflects our net charge-off experience, lower home values and the uncertain economic times, which continue to challenge many of our loan customers. As delinquencies in the portfolio have been resolved through pay-off, short sale or foreclosure, or management determines the collateral is not sufficient to satisfy the loan, uncollected balances have been charged against the allowance for loan losses previously provided. The net charge-offs (non-SVA related, but inclusive of the Chapter 7 bankruptcy charge-offs) of $103.0 million during the fiscal year ended September 30, 2012 were approximately the same as the $102.0 million loan loss provision recorded for the current fiscal year. The loan loss provision of $98.5 million recorded for the fiscal year ended September 30, 2011 exceeded net charge-offs of $74.8 million plus the increase in specific valuation allowances during that same fiscal year of $14.6 million; note that changes in SVAs are considered to be the equivalent of a partial charge-off. The allowance for loan losses was $100.5 million, or 0.97% of the total recorded investment in loans receivable, at September 30, 2012, compared to $157.0 million, or 1.56% of the total recorded investment in loans receivable at September 30, 2011. The $56.5 million decrease in the allowance for loan losses primarily reflects the impact of the adoption, effective December 31, 2011, of an OCC directive to discontinue the use of SVAs as discussed earlier. The SVA balance at September 30, 2011 was $55.5 million.
Of the $52.7 million decrease in the recorded investment of non-accrual loans from September 2011 to September 2012, the largest decrease was in our residential Home Today portfolio, which decreased $28.5 million, or 41% to $41.1 million. The decrease in the balance of the residential Home Today loans during the fiscal year ended September 30, 2012 included $22.6 million, related to the charge-off of SVAs that was recorded effective December 31, 2011. As of September 30, 2012, the recorded investment in our Home Today portfolio was $204.9 million, compared to $262.9 million at September 30, 2011. The $41.1 million balance in Home Today non-accrual loans includes $11.2 million in troubled debt restructurings which are current but included with non-accrual loans for a minimum period of six months from their restructuring date.
The recorded investment in non-accruing home equity loans and lines of credit decreased $1.6 million, or 4%, during the current fiscal year ended September 30, 2012. During the current fiscal year, net charge-offs of $43.2 million of uncollected balances have been charged against the allowance for loan losses. As of September 30, 2012, the recorded investment in our home equity loans and lines of credit portfolio was $2.16 billion, compared to $2.5 billion at September 30, 2011. We believe that non-performing home equity loans and lines of credit are, on a relative basis, of greater concern than non-Home Today loans as these home equity loans and lines of credits generally hold subordinated positions and accordingly, represent a higher level of risk. The non-performing balances of home equity loans and lines of credit were $16.6 million or 1% of the home equity loans and lines of credit portfolio at September 30, 2012 compared to $36.5 million or 1% at September 30, 2011. In light of the depressed housing market in our primary geographic markets and the continued high level of delinquencies in our portfolio, we will continue to closely monitor the loss performance of this category.
The recorded investment in non-accrual loans in our residential, non-Home Today portfolio decreased $19.2 million or 15% to $105.8 million at September 30, 2012. During the current fiscal year, net charge-offs of $55.4 million of uncollected balances were charged against the allowance for loan losses. The $105.8 million balance includes $28.3 million in troubled debt restructurings which are current but included with non-accrual loans for a minimum period of six months from their restructuring date.
We believe we have recorded all losses that are both probable and reasonable to estimate for fiscal years ended September 30, 2012 and 2011.
Refer to Item1. Business for additional discussion and disclosure related to our provisions for loan losses.
Non-Interest Income. Non-interest income decreased $6.5 million, or 21%, to $24.5 million during the current fiscal year compared to $31.0 million during the prior fiscal year primarily due lower to loan fees.
Loan fees and service charges decreased $4.1 million, or 26%, to $11.5 million during the current fiscal year compared to $15.6 million during prior fiscal year. This change is attributed to reduced loan servicing fees in the current fiscal year as the balance of our portfolio of sold loans we are servicing for others has decreased 30% from September 30, 2011 resulting in a $4.0 million decrease in loan servicing fees collected in the current period compared to the fiscal year ended September 30, 2011. The decrease in the portfolio of sold loans we are servicing for others can be attributed to the increased paydowns in addition to the significantly lower volume of loan sales.
Non-Interest Expense. Non-interest expense increased $3.0 million, or 2%, to $171.1 million during fiscal year 2012 compared to $168.1 million during fiscal year 2011, primarily from increases in salaries and employee benefits, other operating and marketing expenses partially offset by decreases in Federal insurance premiums and appraisal and other loan review expenses.
Salaries and employee benefits increased $4.1 million, or 5%, to $80.1 million during the current fiscal year compared to$76.0 million during the prior fiscal year. Compensation costs increased $6.2 million, reflecting normal annual salary merit adjustments coupled with full year impacts related to staff additions associated with enhanced risk management and account administration activities. Other variances in comparing our expenses for the fiscal year ended September 30, 2012 to those during the fiscal year ended September 30, 2011 included a $2.9 million reduction in retirement costs as accumulated benefits under the defined benefit pension plan were frozen effective December 31, 2011, and a $0.8 million increase in group health care expense. For additional detail regarding the defined benefit plan, see the Defined Benefit Plan section of Note 13 of the Notes to our Consolidated Financial Statements.
Federal insurance premium and assessments decreased $5.2 million, or 27%, to $14.3 million during the current fiscal year compared to $19.5 million during the prior fiscal year. This change reflects the revision, as required pursuant to the Dodd-Frank Act and as adopted effective April 1, 2011, in the deposit insurance assessment system that reoriented the determination of each institution’s deposit insurance assessment so that it is based on total assets less tangible capital of the institution rather than solely on the balance of deposits. Our high level of tangible capital and minimal use of wholesale borrowings resulted in our reduced level of assessment.
Appraisal and other loan review expenses decreased $2.4 million, or 43%, to $3.2 million during during the current fiscal year compared compared to $5.6 million during the prior fiscal year. These costs decreased in the current fiscal year from an elevated level in the prior fiscal year when additional operating expenses (legal, postage, courier, telephone, etc.) associated with our home equity lending reduction plan were incurred.
Other operating expenses increased $2.8 million, or 11%, to $29.0 million in the current fiscal year compared to $26.2 million in the prior fiscal year. The majority of the increase is related to loss reimbursement expenses for loans serviced for FNMA, which increased $4.4 million in the current fiscal year to $4.8 million, partially offset by decreases in various other expenses. The increase in loss reimbursement expenses included $2.4 million of actual loss reimbursements and the establishment of a reserve of $2.4 million for probable losses.
Income Tax Expense. The provision for income taxes was $2.1 million during the current fiscal year compared to $2.7 million during the prior fiscal year. The provision for the current fiscal year included $2.0 million of federal tax and $98 thousand of state income tax expense. The provision for the fiscal year ended September 30, 2011 included $2.7 million of federal income tax provision and $75 thousand of state income tax provision. The state income tax provision is subtracted from income before income taxes when calculating the federal income tax provision. Our effective federal tax rate was 15.1% in the current fiscal year compared to 22.2% for the prior fiscal year. The primary difference in the effective tax rate of this fiscal year when compared to the prior fiscal year is the adjustment to our deferred tax asset valuation allowance related to our charitable contribution carryforward. The valuation allowance was increased by $600 thousand during the fiscal year ended September 30, 2011 and decreased by $500 thousand during the fiscal year ended September 30, 2012. The charitable contribution carryforward expired September 30, 2012. Our expected effective income tax rate is below the federal statutory rate primarily because of our ownership of bank-owned life insurance.
Comparison of Operating Results for the Fiscal Years Ended September 30, 2011 and 2010
General. Net income decreased $2.0 million, or 18%, to $9.3 million for the fiscal year ended September 30, 2011 compared to $11.3 million for the fiscal year ended September 30, 2010. This change was attributed to a decrease in non-interest income combined with an increase in non-interest expense partially offset by an increase in net interest income and a decrease in the provision for loan losses.
Interest Income. Interest income decreased $10.4 million or 2%, to $427.5 million for the fiscal year ended September 30, 2011 compared to $437.9 million for the prior fiscal year. The decrease in interest income resulted primarily from decreases in interest income from loans and mortgage-backed securities.
Interest income on mortgage-backed securities decreased $7.6 million, or 40%, to $11.6 million from $19.2 million during fiscal 2010. The average yield on mortgage-backed securities decreased 73 basis points to 2.29% compared to 3.02% in fiscal 2010 as interest rates on adjustable rate securities reset to lower current rates and higher, fixed-rate securities continue to experience accelerated paydowns. The average balance of mortgage-backed securities decreased $128.8 million to $507.0 million compared to $635.8 million during the prior fiscal year. The $274.1 million in principal paydowns and maturities which occurred in 2011 were partially offset by $14.7 million in purchases. There were no sales of mortgage-backed securities during the 2011 fiscal year.
Interest income on loans decreased $2.0 million, or less than 1%, to $413.5 million compared to $415.5 million compared to the fiscal 2010. This change was attributed to a 24 basis point decrease in the yield to 4.21% from 4.45% as historically low interest rates have increased the amount of refinance activity. Additionally, the increase in our “SmartRate” adjustable-rate first mortgage loan originations during the fiscal year at interest rates below rates offered on fixed-rate products contributed to the lower average yield. The decrease in interest income on loans during fiscal 2011 was partially offset by the $501.3 million increase in the average balance of loans to $9.83 billion in fiscal 2011 compared to $9.33 billion in fiscal 2010 as new loan production exceeded repayments and loan sales.
Interest Expense. Interest expense decreased $30.5 million, or 15%, to $179.8 million during the 2011 fiscal year from $210.4 million during the 2010 fiscal year. The change resulted primarily from a decrease in interest expense on certificates of deposit combined with modest decreases in NOW accounts and savings accounts.
Interest expense on certificates of deposit decreased $25.5 million, or 13%, to $164.3 million compared to $189.8 million during fiscal 2010. The change was attributed to a 33 basis point decrease in the average rate we paid on certificates of deposit to 2.68% from 3.01% combined with a $164.2 million, or 3%, decrease in the average balance to $6.14 billion from $6.30 billion. Rates were adjusted on deposits in response to changes in general market rates as well as to changes in the rates paid by our competition on short-term certificates of deposit.
Interest expense on savings accounts decreased $3.2 million, or 24%, to $10.0 million compared to $13.2 million in fiscal 2010. The change was attributed to a 30 basis point decrease in the average rate we paid on savings accounts to 0.61% from 0.91%, partially offset by a $189.1 million, or a 13%, increase in the average balance to $1.63 billion from $1.44 billion in fiscal 2010, reflecting customer preference for savings accounts when rates are comparable to our short-term certificates of deposit.
Net Interest Income. Net interest income increased $20.1 million, or 9%, to $247.6 million compared to $227.5 million during fiscal 2010. As net interest income increased during fiscal 2011, we experienced an improvement of our interest rate spread which increased 20 basis points to 1.97% compared to 1.77% during fiscal 2010. Our net interest margin increased 16 basis points to 2.32% compared to 2.16% in fiscal 2010. This increase can be partially attributed to the higher average loan balance in fiscal 2011. Our average net interest-earning assets increased $76.3 million, to $1.81 billion during fiscal 2011 compared to $1.73 billion during fiscal 2010.
Provision for Loan Losses. We established provisions for loan losses, which were charged to operations, in order to maintain the allowance for loan losses at a level we considered necessary to absorb credit losses incurred in the loan portfolio that were both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we considered past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower's ability to repay a loan and the levels of non-performing and other classified loans. The amount of the allowance was based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assessed the allowance for loan losses on a quarterly basis and made provisions for loan losses in order to maintain the allowance. Economic issues, including high levels of unemployment, have challenged our borrowers' ability to repay their loans at times when housing prices are weak, in part as a consequence of the collapse of the sub-prime mortgage market, and have made it difficult to sell their homes. This limits the ability of many borrowers to self-cure a delinquency.
Based on our evaluation of the above factors, we recorded a provision for loan losses of $98.5 million during the fiscal year ended September 30, 2011 and a provision of $106.0 million during the prior fiscal year. The lower provision in fiscal 2011 reflected the overall stabilization of credit quality in our loan portfolio. The provisions recorded exceeded net charge-offs of $74.8 million and $68.0 million for the fiscal years ended September 30, 2011 and 2010, respectively. Our provisions for loan losses in 2011 exceeded the total of charge-offs, adjusted for the net change in specific valuation allowances, and as a result, our combined general and market valuation allowances increased. The provision for fiscal 2011 reflected our net charge-off experience, lower home values and the uncertain economic times, which challenged many of our loan customers. As delinquencies in the portfolio have been resolved through pay-off, short sale or foreclosure, or management determines the collateral is not sufficient to satisfy the loan, uncollected balances have been charged against the allowance for loan losses previously provided. The allowance for loan losses was $157.0 million, or 1.58% of total recorded investment in loans receivable, at September 30, 2011, compared to $133.2 million or 1.43% of total recorded investment in loans receivable at September 30, 2010.
Of the $51.3 million decrease in the recorded investment of non-accrual loans from September 2010 to September 2011, the largest decrease was in our residential Home Today portfolio, which decreased $22.4 million, or 24.3% to $69.6 million. As of September 30, 2011, the recorded investment in our Home Today portfolio was $262.9 million, compared to $279.2 million at September 30, 2010. The $69.6 million balance in Home Today non-accrual loans included $9.6 million in troubled debt restructurings which are current but included with non-accrual loans for a minimum period of six months from their restructuring date.
The recorded investment in non-accruing home equity loans and lines of credit decreased $17.6 million, or 32%, during the fiscal year ended September 30, 2011, when net charge-offs of $49.5 million of uncollected balances were charged against the allowance for loan losses. As of September 30, 2011, the recorded investment in our home equity loans and lines of credit portfolio was $2.50 billion, compared to $2.87 billion at September 30, 2010. We believed that non-performing home equity loans and lines of credit were, on a relative basis, of greater concern than non-Home Today loans as these home equity loans and lines of credits generally hold subordinated positions and accordingly, represent a higher level of risk. The non-performing balances of home equity loans and lines of credit were $36.9 million or 1.47% of the home equity loans and lines of credit portfolio at September 30, 2011 compared to $54.5 million or 1.90% at September 30, 2010. In light of the depressed housing market in our primary geographic markets and the continued high level of delinquencies in our portfolio, we continued to closely monitor the loss performance of this category.
The recorded investment in non-accrual loans in our residential, non-Home Today portfolio decreased $10.1 million or 7% to $125.0 million at September 30, 2011, when net charge-offs of $17.5 million of uncollected balances were charged against the allowance for loan losses. The $125.0 million balance included $6.5 million in troubled debt restructurings which were current but included with non-accrual loans for a minimum period of six months from their restructuring date. We
believed we had recorded all losses that were both probable and reasonable to estimate for fiscal years ended September 30, 2011 and 2010.
We used the same general methodology in assessing the allowance at the end of each period, except that, beginning September 30, 2010, the individual loan loss review methodology applied to home equity loans and lines of credit was enhanced to include updated individual reviews for all home equity loans and lines of credit that were 90 days or more past due. Previously, updated individual reviews were not performed if the previous review had been performed within the last 12 months.
Refer to Item1. Business for additional discussion and disclosure related to our provisions for loan losses.
Non-Interest Income. Non-interest income decreased $27.7 million, or 47%, to $31.0 million during fiscal 2011 compared to $58.6 million during fiscal 2010.
In the fiscal year ended September 30, 2011 there were $33.6 million in loan sales from which we recorded $490 thousand of net gains compared to net gains of $25.3 million on $942.2 million in loan sales in prior fiscal year. The significantly lower volume of loan sales in fiscal 2011 reflects the impact of changes by Fannie Mae related to requirements for loans that it accepts. Refer to the Controlling Our Interest Rate Risk Exposure section of the Overview for additional discussion.
Loan fees and service charges decreased $5.0 million, or 24%, to $15.6 million during the fiscal year 2011 compared to $20.6 million during fiscal 2010. This change was attributed to reduced loan servicing fees in the fiscal year 2011 as the balance of our portfolio of sold loans we were servicing for others has decreased 23% from September 30, 2010 resulting in a $4.9 million decrease in loan servicing fees collected in the period ended September 30, 2011 compared to the fiscal year ended September 30, 2010. The decrease in the portfolio of sold loans we were servicing for others can be attributed to the increased paydowns in addition to the significantly lower volume of loan sales.
Non-Interest Expense. Non-interest expense increased $6.1 million, or 4%, to $168.1 million during fiscal year 2011 compared to $161.9 million during fiscal year 2010, primarily from increases in appraisal and other loan review expenses, real estate owned expense (associated legal cost and losses on the disposition of properties) and other operating expenses partially offset by a decrease in salaries and employee benefits. Salaries and employee benefits decreased $7.9 million, or 9%, to $76.0 million during the fiscal year 2011 compared to $83.9 million during fiscal 2010. This change was primarily due to a $5.2 million decrease in associate compensation costs (particularly bonus accruals and costs related to employee stock-based incentive programs), and a $3.3 million decrease in defined benefit retirement plan expense (resulting primarily from the correction of an actuarial error).
Appraisal and other loan review expenses increased $4.3 million to $5.6 million during fiscal year 2011 compared to $1.3 million during fiscal 2010. These costs along with other costs included in other operating expenses (legal, postage, courier, telephone etc.) are associated with our home equity lending reduction plan. Additionally, professional consulting fees incurred in connection with the enhancement of our home equity lending account administration and account management activities coupled with similar fees incurred in connection with an independent evaluation of our enterprise risk management processes and procedures also contributed to the cost increase. Finally, because of the higher loan refinance activity during fiscal year 2011, the cost of interest advances that the Company is required to make (and which is included in other operating expenses) when serviced loans are repaid prior to month end increased $1.0 million in fiscal year 2011 when compared to the prior fiscal year.
Income Tax Expense. The provision for income taxes was $2.7 million during fiscal year 2011 compared to $6.9 million during fiscal 2010. The provision for fiscal year 2011 included $2.7 million of federal tax and $75 thousand of state income tax expense. The provision for fiscal year ended 2010 included $6.8 million of federal income tax provision and $47 thousand of state income tax provision. The state income tax provision is subtracted from income before income taxes when calculating the federal income tax provision. Our effective federal tax rate was 22.2% in fiscal year 2011 compared to 37.6% for fiscal 2010. The primary difference in the effective tax rate for fiscal year 2011 when compared to the fiscal 2010 is the result of the $1.9 million adjustment to increase our deferred tax asset valuation allowance related to our charitable contribution carryforward that was recognized during the fiscal year ended September 30, 2010 as compared to an adjustment of $600 thousand recognized during the fiscal year ended September 30, 2011. Our effective federal income tax rate was affected by insurance related permanent tax differences which had a more beneficial impact during fiscal 2011 as compared to fiscal 2010 due to lower pre-tax earnings .
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments, advances from the FHLB of Cincinnati, borrowings from the Federal Reserve Discount Window, maturities and sales of securities and, historically, sales of loans. As described below, since June 2010, the amount of liquidity derived from loan sales has decreased significantly.
To augment the primary sources of funds described above, we have the ability to obtain funds through the use of collateralized borrowings in the wholesale markets. Additionally, access to the equity capital markets via a supplemental first step transaction or a full (second step) transaction remain as other potential source of liquidity, although this channel generally requires six to nine months of lead time.
While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The Association’s Asset/Liability Management Committee is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We seek to maintain a minimum liquidity ratio of 2% or greater (which we compute as the sum of cash and cash equivalents plus unpledged investment securities for which ready markets exist, divided by total assets). For the year ended September 30, 2012, our liquidity ratio averaged 5.80%. We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of September 30, 2012.
We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities and the objectives of our asset/liability management program.
Excess liquid assets are generally invested in interest-earning deposits and short- and intermediate-term securities.
Our most liquid assets are cash and cash equivalents. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At September 30, 2012, cash and cash equivalents totaled $308.3 million, which represented an increase of 5% from September 30, 2011. The increase can be attributed to maintaining liquidity on the balance sheet as total assets have increased.
Effective July 1, 2010, our traditional underwriting procedures no longer comply with Fannie Mae’s standard requirements and accordingly, our ability to manage liquidity via the loan sales channel has been and will continue to be limited until either we change our underwriting standards or Fannie Mae, or other market participants, revise their qualification standards. In the absence of such changes, and except for certain specific circumstances as described below, future sales of fixed rate mortgage loans will be limited to those loans that have established payment histories, strong borrower credit profiles and are supported by adequate collateral values. During the year ended September 30, 2012 sales of long-term, fixed rate loans totaled only $11.4 million and were comprised entirely of loans that qualified under Fannie Mae's HARP II (Home Affordable Refinance Program) initiative. While a total of $124.5 million of loans were reclassified as “held for sale” at September 30, 2012, only $9.6 million represented agency-compliant HARP II loans. The remaining $114.7 million was comprised of high credit quality, long-term, fixed-rate residential first mortgage loans, which were being marketed to private, third-party investors, but which were not Fannie Mae compliant. At September 30, 2012, outstanding HARP II loan sales commitments totaled $2.8 million; no loan sales commitments with third-party investors were outstanding.
Investment securities classified as available-for-sale, which provide additional sources of liquidity, totaled $421.4 million at September 30, 2012. Also, at September 30, 2012 we had borrowed $488.2 million from the FHLB of Cincinnati.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in the Consolidated Financial Statements.
At September 30, 2012, we had $299.8 million in loan commitments outstanding. In addition to commitments to originate loans, we had $1.36 billion in unused lines of credit which were available to borrowers. Certificates of deposit due within one year of September 30, 2012 totaled $2.55 billion, or 28.4% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including loan sales, sales of investment securities, other deposit products, including certificates of deposit, Federal Home Loan Bank advances, borrowings from the Federal Reserve Discount Window or other collateralized borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before September 30, 2013. We believe, however, based on past experience that a significant portion of such deposits will remain with us. Generally, we have the ability to attract and retain deposits by adjusting the interest rates offered.
Our primary investing activities are originating residential mortgage loans and purchasing investments. During the year ended September 30, 2012, we originated $2.64 billion of loans, and during the year ended September 30, 2011, we originated $2.14 billion of loans. We purchased $228.0 million of securities during the year ended September 30, 2012, and $14.7 million during the year ended September 30, 2011.
Financing activities consist primarily of changes in deposit accounts, changes in the balances of principal and interest owed on loans serviced for others, Federal Home Loan Bank advances and borrowings from the Federal Reserve Discount Window. We experienced a net increase in total deposits of $265.5 million during the year ended September 30, 2012 compared to a net decrease of $136.0 million during the year ended September 30, 2011. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors. Principal and interest owed on loans serviced for others decreased $24.4 million during the year ended September 30, 2012 compared to a net decrease of $132.6 million during the year ended September 30, 2011.
Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB of Cincinnati and the Federal Reserve Discount Window, each of which provides an additional source of funds. At September 30, 2012 we had $488.2 million of FHLB of Cincinnati advances as compared to $139.9 million at September 30, 2011. The majority of the $488.2 million balance in the current year is comprised of lower cost, short term (overnight) advances. The Association had no outstanding borrowings from the Federal Reserve Discount Window at September 30, 2012 and 2011. During the year ended September 30, 2012, we had average outstanding advances from the FHLB of Cincinnati of $359.7 million as compared to average outstanding advances of $123.6 million during the year ended September 30, 2011, as we used the advances to augment our liquidity and manage our funding costs. At September 30, 2012 we had the ability to immediately borrow an additional $466.6 million from the FHLB of Cincinnati and $233.3 million from the Federal Reserve Discount Window. From the perspective of collateral value securing FHLB of Cincinnati advances, our capacity limit for additional borrowings at September 30, 2012 was $4.22 billion, subject to satisfaction of the FHLB of Cincinnati common stock ownership requirement. To satisfy the common stock ownership requirement we would have to increase our ownership of FHLB of Cincinnati common stock by an additional $75.0 million.
The Association is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. On June 6, 2012, the OCC and the other federal bank regulatory agencies issued a series of proposed rules to revise their risk-based and leverage capital requirements and their method for calculating risk-weighted assets to make them consistent with the agreements that were reached by the Basel Committee on Banking Supervision in "Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems" ("Basel III"). The proposed rules would apply to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more, and top-tier savings and loan holding companies ("banking organizations"). Among other things, the proposed rules establish a new common equity tier 1 (CET1) minimum capital requirement (4.5% of risk-weighted assets) and a higher minimum tier 1 capital requirement (from 4.0% to 6.0% of risk-weighted assets), and assign higher risk weightings (150%) to exposures that are more than 90 days past due or are on nonaccrual status and certain commercial real estate facilities that finance the acquisition, development or construction of real property.
When fully phased in, Basel III requires financial institutions to maintain: (a) as a newly adopted international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0%); (b) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation); (c) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation); and (d) as a newly adopted international standard, a minimum leverage ratio of 3.0%, calculated as the ratio of Tier 1 capital balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter). In addition, the proposed rules also limit a banking organization's capital distributions and certain discretionary bonus payments if the banking organization does not hold a "capital conservation buffer".
When issued, the proposed rules indicated that final rules would become effective on January 1, 2013, and that the changes set forth in the final rules would be phased in from January 1, 2013 through January 1, 2019. On November 9, 2012, pursuant to a joint release, the federal bank agencies announced that they "do not expect that any of the proposed rules would become effective on January 1, 2013. As members of the Basel Committee on Banking Supervision, the U.S. agencies take seriously our internationally agreed timing commitments regarding the implementation of Basel III and are working as expeditiously as possible to complete the rulemaking process. As with any rule, the agencies will take operational and other considerations into account when determining appropriate implementation dates and associated transition periods." The
Company expects that future risk weighted capital ratios determined pursuant to asset risk weightings as they may ultimately be structured under the prospective Basel III computational framework will differ unfavorably when compared to current computations. In light of the current uncertainty regarding the final structure of the computational framework, the Company cannot currently estimate the impact of the proposal on reported risk weighted capital ratios.
At September 30, 2012, Third Federal Savings and Loan exceeded all regulatory capital requirements. Third Federal Savings and Loan is considered “well capitalized” under regulatory guidelines.
The net proceeds from the stock offering significantly increased our liquidity and capital resources during fiscal 2007. Our financial condition and results of operations have been enhanced by the net proceeds from the stock offering, and have resulted in increased net interest-earning assets and net interest income during the periods following completion of the offering in April 2007. However, due to the increase in equity that resulted from the net proceeds of our stock offering, our return on equity ratios have been adversely affected and can be expected to continue to be so affected prospectively.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. In addition, we routinely enter into commitments to securitize and sell mortgage loans. For additional information, see Note 15 of the Notes to our Consolidated Financial Statements.
Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities and agreements with respect to investments.
The following table summarizes our significant fixed and determinable contractual obligations and other funding needs by payment date at September 30, 2012. The payment amounts represent those amounts due to the recipient and do not include any unamortized premiums or discounts or other similar carrying amount adjustments.
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(1)
Includes accrued interest payable at September 30, 2012.
(2)
Includes the unused portion (including commitments for accounts suspended as a result of material default or a decline in equity) of home equity lines of credit of $1.53 billion.
The Company provides mortgage reinsurance on certain mortgage loans in its own portfolio, including Home Today loans, and loans in its servicing portfolio through contracts with two primary mortgage insurance companies. Under these contracts, the Company absorbs mortgage insurance losses in excess of a specified percentage of the principal balance of a given pool of loans, subject to a contractual limit, in exchange for a portion of the pools’ mortgage insurance premiums. As of September 30, 2012, approximately $370.9 million of mortgage loans in our portfolios was covered by such mortgage reinsurance contracts. At September 30, 2012, the maximum losses under the reinsurance contracts were limited to $14.4 million. The Company has incurred $4.1 million in losses under these reinsurance contracts and provided a liability for estimated losses totaling $3.4 million as of September 30, 2012. Management believes it has made adequate provision for estimated losses.
Impact of Inflation and Changing Prices
Our consolidated financial statements and related notes have been prepared in accordance with GAAP. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
Recent Accounting Pronouncements
Pending as of September 30, 2012
Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2011-12, “Comprehensive Income (Topic 220), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income
Standards Update No. 2011-05” defers indefinitely the provisions of FASB ASU 2011-05 that require entities to present reclassification adjustments for items that are reclassified from other comprehensive income (“OCI”) to net income by component in both the statement in which net income is presented and the statement in which OCI is presented. The only impact of these amendments on the Company's consolidated financial statements would be a change in the presentation of OCI.
FASB ASU 2011-05, “Presentation of Comprehensive Income” eliminates the option to present OCI in the statement of shareholders' equity and provides an entity the option to present the total of comprehensive income, the components of net income, and the components of OCI either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of OCI along with a total for OCI, and a total amount for comprehensive income. Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from OCI to net income in the statement(s). The amendments in this update will be applied retrospectively for all periods presented and are effective for the Company for the interim and annual periods beginning October 1, 2012, with early adoption permitted. The only impact of these amendments on the Company's consolidated financial statements will be a change in the presentation of OCI.
FASB ASU 2011-08, “Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment” was issued in September 2011 to reduce the cost and complexity of performing the first step of the two-step goodwill impairment test. This amendment permits an entity to first assess qualitative factors to determine whether the existence of events or circumstances leads to a more likely than not (more than 50% likelihood) outcome that the fair value of the reporting unit is less than its carrying amount. The performance of the two-step impairment test becomes unnecessary if, after assessing the totality of events and circumstances, the entity determines that it is not more likely than not that the fair value of the reporting unit is less than its carrying amount. The amendment is effective for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company is adopting this guidance for the fiscal year beginning October 1, 2012. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
Adopted in fiscal year ended September 30, 2012
FASB ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS” eliminates unnecessary wording differences between U.S. GAAP and International Financial Reporting Standards, clarifies the intent of existing fair value measurements, and expands disclosure requirements. ASU 2011-04 indicates that the highest and best use and valuation premise in a fair value measurement only apply to non-financial assets. In addition, ASU 2011-04 expands qualitative and quantitative fair value disclosures including those related to descriptions of valuation processes used, the sensitivity of the fair value to changes in unobservable inputs and the interrelationships between those inputs, and quantitative disclosures about unobservable inputs and assumptions. The amendments in ASU 2011-04 are effective for interim and annual reporting periods beginning after December 15, 2011. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements. The new and amended disclosures are included in Note 10, Fair Value.
FASB ASU 2011-03, “Reconsideration of Effective Control for Repurchase Agreements” eliminates from U.S. GAAP the requirement for entities to consider whether a transferor (i.e., seller) has the ability to repurchase the financial assets in a repurchase agreement (“repo”). This requirement was one of the criteria under ASC 860 that entities used to determine whether the transferor maintained effective control. Although entities must consider all the effective-control criteria under ASC 860, the elimination of this requirement may lead to more conclusions that a repurchase arrangement should be accounted for as a
secured borrowing rather than as a sale. The amendments in ASU 2011-03 are effective for interim and annual reporting periods beginning after December 15, 2011. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements.
The Company has determined that all other recently issued accounting pronouncements will not have a material impact on the Company’s consolidated financial statements or do not apply to its operations.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk has historically been interest rate risk. In general, our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates. Accordingly, our board of directors has established risk parameter limits deemed appropriate given our business strategy, operating environment, capital, liquidity and performance objectives. Additionally, our board of directors has also established an Asset/Liability Management Committee comprised of key operating personnel which is responsible for managing this risk consistent with the guidelines and risk limits approved by the board of directors.
We have sought to manage our interest rate risk in order to control the exposure of our earnings and capital to changes in interest rates. As part of our ongoing asset-liability management, we have historically used the following strategies to manage our interest rate risk:
(i)
marketing adjustable-rate loan products;
(ii)
lengthening the weighted average remaining term of major funding sources, primarily by offering attractive interest rates on deposit products, particularly longer-term certificates of deposit, and through the use of longer-term advances from the Federal Home Loan Bank of Cincinnati;
(iii)
investing in shorter- to medium-term investments and mortgage-backed securities;
(iv)
maintaining high levels of capital; and
(v)
securitizing and/or selling long-term, fixed-rate residential real estate mortgage loans.
During the years ended September 30, 2012, 2011 and 2010, $11.4 million, $33.6 million and $1.03 billion, respectively, of long-term, fixed rate mortgage loans were sold. Prior to fiscal 2011, when a significant volume of loan sales were undertaken our objective was to improve our interest rate risk position in the event that market interest rates increased. During fiscal 2011 the limited loan sales activities reflected a whole loan transaction with a private, third-party investor and an isolated securitization/sale to Fannie Mae. Loan sales during fiscal 2012 were transactions with Fannie Mae related to its Home Affordability Refinanace Program (HARP II) initiative and were primarily oriented to the avoidance of credit risk related to refinancings of loans that were owned by Fannie Mae.
Effective July 1, 2010, Fannie Mae, historically the Association’s primary loan investor, implemented certain loan origination requirement changes affecting loan eligibility that, to date, we have not fully adopted. Accordingly, the Association’s ability to reduce interest rate risk via our traditional loan sales of newly originated longer-term fixed rate residential loans is limited until either the Association changes its loan origination processes or Fannie Mae, Freddie Mac or other market participants, revise their loan eligibility standards. Otherwise, and except for HARP II-related sales as described above, future sales of fixed-rate mortgage loans will predominantly be limited to those loans that have established payment histories, strong borrower credit profiles and are supported by adequate collateral values. In response to this change, since July 2010, we have actively marketed an adjustable-rate mortgage loan product and beginning in fiscal 2012 have promoted a ten year fixed-rate mortgage loan. Each of these products provide us with improved interest rate risk characteristics when compared to longer-term, fixed-rate mortgage loans. Shortening the average maturity of our interest-earning assets by increasing our investments in shorter-term loans and investments, as well as loans and investments with variable rates of interest, helps to better match the maturities and interest rates of our assets and liabilities, thereby reducing the exposure of our net interest income to changes in market interest rates. By following these strategies, we believe that we are better-positioned to react to increases in market interest rates.
Economic Value of Equity. Using customized modeling software, the Association prepares periodic estimates of the amounts by which the net present value of its cash flows from assets, liabilities and off balance sheet items (the institution’s economic value of equity or “EVE”) would change in the event of a range of assumed changes in market interest rates. The simulation model uses a discounted cash flow analysis and an option-based pricing approach in measuring the interest rate sensitivity of EVE. The model estimates the economic value of each type of asset, liability and off-balance sheet contract under
the assumption that instantaneous changes (measured in basis points) occur at all maturities along the United States Treasury yield curve and other relevant market interest rates. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 2% to 3% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. The model is tailored specifically to our organization, which, we believe, improves its accuracy. The following table presents the estimated changes in the Association’s EVE at September 30, 2012 that would result from the indicated instantaneous changes in the United States Treasury yield curve and other relevant market interest rates. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
____________
(1)
Assumes an instantaneous uniform change in interest rates at all maturities.
(2)
EVE is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.
(3)
Present value of assets represents the discounted present value of incoming cash flows on interest-earning assets.
(4)
EVE Ratio represents EVE divided by the present value of assets.
The table above indicates that at September 30, 2012, in the event of an increase of 200 basis points in all interest rates, the Association would experience a 25.6% decrease in EVE. In the event of a 100 basis point decrease in interest rates, the Association would experience a 0.3% decrease in EVE.
The following table is based on the calculations contained in the previous table, and sets forth the change in the EVE at a +200 basis point rate of shock at September 30, 2012, with comparative information as of September 30, 2011. The Association measures and manages its interest rate risk for interest rate shocks relative to established risk tolerances in EVE.
Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in EVE. Modeling changes in EVE are based upon certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the EVE tables presented above assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the EVE tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our EVE and will differ from actual results.
We have previously reported that our former primary regulator, the OTS, expressed concern with respect to several significant assumptions used in our prior internal interest rate risk (“IRR”) model, as well as the reliability of the resulting IRR profiles generated by that model. While we believe that the previous IRR model enabled us to efficiently, prudently and reasonably measure and manage IRR, we nevertheless replaced that modeling system with a system that offers enhanced functionality and capabilities. Based on validation and comparative analysis, we do not believe that the IRR profile reported as
of September 30, 2011 using our prior IRR model was materially different from the results that would have been derived if the new IRR modeling software had been available. Installation and implementation of the new IRR modeling software was finalized during the quarter ended March 31, 2012 and, for periods subsequent to December 31, 2011, the IRR disclosures as determined using the new model are reported in our SEC filings. In connection with the installation and implementation of the new IRR modeling software, factors related to prepayment, decay and default assumptions that impact the computation of EVE were customized, based on the results of an independent, third party study that was prepared using the Association's data. Use of these customized assumptions should further enhance the alignment of our EVE calculations with our risk profile. In addition to our month end modeling reports that use current month end balances and current month end interest rates, we also compute EVE using current month end balances and last month's interest rates in order to isolate the EVE impact resulting purely from interest rate changes. These results are then reviewed and discussed by management with appropriate actions taken if deemed necessary. At September 30, 2012 the results were in line with management's expectations. The new model also possesses random patterning capabilities that our prior model lacked and accommodates regression analytics applicable to the prepayment and decay profiles of our borrower and depositor portfolios. We believe that the new model expands our ability to run alternative modeling scenarios and improves the timeliness of and our access to decision making data that is integral to our IRR management processes.
Earnings at Risk. In addition to EVE calculations, we use our simulation model to analyze the sensitivity of our net interest income to changes in interest rates (the institution’s earnings at risk or “EaR”). Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. In our model, we estimate what our net interest income would be for twelve and twenty-four month periods using customized (based on our portfolio characteristics) assumptions with respect to loan prepayment rates and deposit decay rates, and a commercially available forward yield curve for assumptions as to projected interest rates. We then calculate what the net interest income would be for the same period in the event of instantaneous changes in market interest rates. As of September 30, 2012, we estimated that our EaR for the 12 months ending September 30, 2013 would decrease by 12.0% in the event of an instantaneous 200 basis point increase in market interest rates.
Certain shortcomings are also inherent in the methodologies used in determining interest rate risk through changes in EaR. Modeling changes in EaR require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the interest rate risk information presented above assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains substantially constant over the period being measured and assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although interest rate risk calculations provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results. In addition to the preparation of computations as described above, we also formulate simulations based on a variety of non-linear changes in interest rates and a variety of non-constant balance sheet composition scenarios.
The EVE and EaR analyses are similar in that they both start with the same month end balance sheet amounts, weighted average coupon and maturity. The underlying prepayment, decay and default assumptions are also the same and they both start with the same month end "markets" (Treasury and Libor yield curves, etc.). From that similar starting point, the models follow divergent paths. EVE is a stochastic model using 200 different interest rate paths to compute market value at the transaction level for each of the categories on the balance sheet whereas EaR uses the implied forward curve to compute interest income/expense at transaction level for each of the categories on the balance sheet.
EVE is considered as a point in time calculation with a "liquidation" view of the Association where all the cash flows (including interest, principal and prepayments) are modeled through the maturity of the instrument and discounted using discount factors derived from the current market yield curve. All "on balance sheet" amounts do not assume any new business volume. It provides a long term view and helps to define changes in equity and duration as a result of changes in interest rates. On the other hand, EaR is based on balance sheet projections going one year forward and assumes new business volume and pricing to calculate net interest income under different interest rate environments. EaR is calculated to determine the sensitivity of net interest income under different interest rate scenarios. With each of these models, specific policy limits have been established that are compared with the actual month end results. These limits have been approved by the Association's board of directors and are used as benchmarks to evaluate and moderate interest rate risk. In the event that there is a breach of policy limits, management is responsible for taking such action, similar to those described under the preceding heading of General, as may be necessary in order to return the Association's interest rate risk profile to a position that is in compliance with the policy. At September 30, 2012 the IRR profile as disclosed above did not breach our internal limits under any scenario that was considered more probable than extremely remote.
Item 8.
Item 8.
Financial Statements and Supplementary Data
The Financial Statements are included in Part IV, Item 15 of this Form 10-K.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A.
Item 9A.
Controls and Procedures
Disclosure Controls and Procedures
Under the supervision of and with the participation of the Company’s management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based upon that evaluation, our principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.
Changes in Internal Control Over Financial Reporting
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report Regarding Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as such terms are defined in Rule 13a-15(f) of the Exchange Act of 1934. Our system of internal controls is designed to provide reasonable assurance that the financial statements that we provide to the public are fairly presented.
Our internal control over financial reporting includes policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets, (ii) provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on our financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Accordingly, absolute assurance cannot be provided that the effectiveness of the internal control systems may not become inadequate in future periods because of changes in conditions, or because the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of September 30, 2012. In making this assessment, the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework was utilized. Based on this assessment, management believes that, as of September 30, 2012, the Company’s internal control over financial reporting is effective.
The Company’s independent registered public accounting firm has issued an attestation report on the Company’s internal control over financial reporting.
The Sarbanes-Oxley Act Section 302 Certifications have been filed as Exhibit 31.1 and Exhibit 31.2 to this Annual Report on Form 10-K.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
TFS Financial Corporation
Cleveland, OH
We have audited the internal control over financial reporting of TFS Financial Corporation and subsidiaries (the “Company”) as of September 30, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report Regarding Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2012, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended September 30, 2012 of the Company and our report dated November 29, 2012, expressed an unqualified opinion on those financial statements.
/s/ Deloitte & Touche LLP
Cleveland, OH
November 29, 2012
Item 9B.
Item 9B.
Other Information
Not applicable.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
Incorporated by reference from the Notice of Annual Meeting and Proxy Statement for the 2013 Annual Meeting of Shareholders (the “Proxy Statement”) sections entitled “Proposal One: Election of Directors,” “Executive Compensation,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance.” Such information will be filed with the SEC no later than 120 days after the end of the fiscal year covered by this report.
The table below sets forth information, as of September 30, 2012, regarding our executive officers other than Messrs. Stefanski and Kobak and Ms. Piterans.
Name
Title
Age
Ralph M. Betters
Chief Information Officer
David S. Huffman
Chief Financial Officer
Paul J. Huml
Chief Accounting Officer Chief Operating Officer, The Company
Terence C. Paulett
Chief Risk Officer
Meredith S. Weil
Chief Operating Officer, The Association
The executive officers of the Company and the Association are elected annually and hold office until their respective successors are elected or until death, resignation, retirement or removal by the board of directors.
The Business Background of Our Executive Officers
The business experience for the past five years of each of our executive officers other than Messrs. Stefanski and Kobak and Ms. Piterans is set forth below. Unless otherwise indicated, executive officers have held their positions for the past five years.
Ralph M. Betters is the Chief Information Officer for the Association, a position he has held since 1991. Prior to joining the Association, he was an information technology principal in the consulting practice of KPMG Peat Marwick, where he was employed from 1980 until 1991. Mr. Betters has more than 30 years of experience in the technology industry.
David S. Huffman joined the Association in 1993, and has served as its Chief Financial Officer since 2000. He has also served as Chief Financial Officer of the Company since 2004. Mr. Huffman has more than 30 years of experience in the financial institutions industry, including serving as Chief Financial Officer of First American Savings Bank of Canton, Ohio, from 1989 to 1993.
Paul J. Huml joined the Association as a Vice President in 1998 and was appointed Chief Operating Officer of the Company in 2002 and Chief Accounting Officer in June 2009. Prior to joining the Association, Mr. Huml spent 10 years in the hotel industry, focusing on the areas of finance, real estate development and risk management. Mr. Huml is a certified public accountant in the state of Ohio.
Terence C. Paulett joined the Association in 1994 and was named Chief Risk Officer in 2011. During his time with the Association, Mr. Paulett has managed many different operational departments, including underwriting, risk, compliance, legal and internal audit. Mr. Paulett’s more than 30 years in the banking industry have also included overseeing several credit and audit functions with both Commerce Exchange Bank and AmeriTrust.
Meredith S. Weil joined the Association in 1999 and was named Chief Operating Officer in July 2012. Prior to her current role, Ms. Weil held several senior management positions within the Association, including that of regional manager of retail delivery operations, overseeing customer service and internet services, as well as marketing. Ms. Weil has spent more than 20 years in the banking industry. Prior to joining the Association, she was Vice President of Strategic Management with Key Bank in Cleveland.
The Company has adopted a policy statement entitled CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS that applies to our chief executive officer and our senior financial officers. A copy of the CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS is available on our website, www.thirdfederal.com.
Incorporated by reference from the sections of the Proxy Statement entitled “Executive Compensation,” “Compensation Committee Report,” and “Director Compensation.” Such information will be filed with the SEC no later than 120 days after the end of the fiscal year covered by this report.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Incorporated by reference from the section of the Proxy Statement entitled “Security Ownership of Certain Beneficial Owners and Management.” Such information will be filed with the SEC no later than 120 days after the end of the fiscal year covered by this report.
The Company’s only equity compensation program that was not approved by shareholders is its employee stock ownership plan which was established in conjunction with our initial stock offering completed in April 2007.
The following table provides information as of September 30, 2012 regarding our 2008 Equity Incentive Plan that was approved by shareholders on May 29, 2008:
______________________
(1)
Weighted-Average Exercise Price of Outstanding Options, Rights and Warrants is calculated using 1,579,513 shares of restricted stock awards at $0.00 and 6,199,591 shares of stock option awards at $11.28.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Incorporated by reference from the sections of the Proxy Statement entitled “Certain Relationships and Related Transactions” and “Corporate Governance.” Such information will be filed with the SEC no later than 120 days after the end of the fiscal year covered by this report.
Item 14.
Item 14.
Principal Accounting Fees and Services
Incorporated by reference from the section of the Proxy Statement entitled “Fees Paid to Deloitte & Touche LLP.” Such information will be filed with the SEC no later than 120 days after the end of the fiscal year covered by this report.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
(a)(1) Financial Statements
The following documents are filed as part of this Annual Report on Form 10-K:
a.
The consolidated financial statements of TFS Financial Corporation and subsidiaries contained in Part II, Item 8 of this Annual Report on Form 10-K:
•
Consolidated Statement of Condition at September 30, 2012 and 2011;
•
Consolidated Statement of Income for the years ended September 30, 2012, 2011 and 2010;
•
Consolidated Statement of Shareholders' Equity for the years ended September 30, 2012, 2011 and 2010,
•
Consolidated Statement of Cash Flows for the years ended September 30, 2012, 2011 and 2010; and
•
Notes to the Consolidated Financial Statements
b. The exhibits listed in the Exhibits Index beginning on Page 141 of this Annual Report on Form 10-K.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
TFS Financial Corporation
Cleveland, OH
We have audited the accompanying consolidated statements of condition of TFS Financial Corporation and subsidiaries (the “Company”) as of September 30, 2012 and 2011, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended September 30, 2012. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of TFS Financial Corporation and subsidiaries as of September 30, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2012, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of September 30, 2012, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 29, 2012 expressed an unqualified opinion on the Company’s internal control over financial reporting.
/s/ Deloitte & Touche LLP
Cleveland, OH
November 29, 2012
TFS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
As of September 30, 2012 and 2011
(In thousands, except share data)
See accompanying notes to consolidated financial statements.
TFS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For each of the three years in the period ended September 30, 2012
(In thousands, except share and per share data)
See accompanying notes to consolidated financial statements.
TFS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For each of the three years in the period ended September 30, 2012
(In thousands, except share and per share data)
See accompanying notes to consolidated financial statements.
TFS FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For each of the three years in the period ended September 30, 2012
(In thousands)
See accompanying notes to consolidated financial statements.
TFS FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of and for the years ended September 30, 2012, 2011, and 2010
(Dollars in thousands unless otherwise indicated)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies of TFS Financial Corporation and its subsidiaries (collectively, the “Company”) conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices within the thrift industry.
In preparing the accompanying consolidated financial statements, subsequent events were evaluated through the time the consolidated financial statements were issued. No material subsequent events have occurred requiring recognition in the consolidated financial statements or disclosure in the notes to the consolidated financial statements.
The following is a description of the significant accounting and reporting policies, which the Company follows in preparing and presenting its consolidated financial statements.
Business-TFS Financial Corporation (the “Holding Company”), a federally chartered stock holding company, conducts its principal activities through its wholly owned subsidiaries. The principal line of business of the Company is retail consumer banking, including mortgage lending, deposit gathering, and other insignificant financial services. Third Federal Savings and Loan Association of Cleveland, MHC (“Third Federal Savings, MHC”), its federally chartered mutual holding company parent, currently owns 73.50% of the outstanding shares of common stock of the Company.
The Company’s primary operating subsidiaries include Third Federal Savings and Loan Association of Cleveland (the "Association” or “Third Federal Savings and Loan”) and Third Capital, Inc. (“Third Capital”). The Association is a federal savings association, which provides retail loan and savings products to its customers in Ohio and Florida, through its 39 full-service branches, eight loan production offices, customer service call center and internet site. The Association also provides savings products and first mortgage refinance loans in states outside of its branch footprint. Third Capital was formed to hold non-thrift investments and subsidiaries, which include a limited liability company that acquires and manages commercial real estate, a Vermont captive reinsurance company, an entity that pursues merger and acquisition opportunities and investments in private equity investment funds.
Principles of Consolidation-The consolidated financial statements of the Company include the accounts of the Holding Company and its wholly owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation.
Cash and Cash Equivalents-Cash and cash equivalents consist of working cash on hand, and demand and interest bearing deposits at other financial institutions with maturities of three months or less. For purposes of reporting cash flows, cash and cash equivalents also includes federal funds sold. The Company has acknowledged informal agreements with banks where it maintains deposits. Under these agreements, service fees charged to the Company are waived provided certain average compensating balances are maintained throughout each month.
Investment Securities-Securities held to maturity are securities that the Company has the positive intent and the ability to hold to maturity; these securities are reported at amortized cost and adjusted for unamortized premiums and discounts. Securities held for trading are securities that are bought and held principally for the purpose of selling in the near term; these securities are reported at fair value, with unrealized gains and losses reported in current earnings. All other securities are classified as available for sale. Securities held as available for sale are reported at fair value, with unrealized gains and losses, net of tax, reported as a component of accumulated other comprehensive income (“AOCI”). Management determines the appropriate classification at the time of purchase.
Gains and losses on the sale of investment and mortgage-backed securities available for sale and trading are computed on a specific identification basis. Purchases and sales of securities are accounted for on a trade-date or settlement-date, depending on the settlement terms.
A decline in the fair value of any available for sale or held to maturity security, below cost, that is deemed to be other than temporary, results in a reduction in the carrying amount to fair value. The impairment loss is bifurcated between that related to credit loss which is recognized in non-interest income and that related to all other factors which is recognized in other comprehensive income. To determine whether an impairment is other than temporary, the Company considers, among other things, the duration and extent to which the fair value of an investment is less than its cost, changes in value subsequent to year end, forecast performance of the issuer, and whether the Company has the intent to hold the investment until market price
recovery, or, for debt securities, whether the Company has the intent to sell the security or more likely than not will be required to sell the debt security before its anticipated recovery.
Premiums and discounts are amortized using the level-yield method.
Mortgage Banking Activity-Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Mortgage loans included in pending agency contracts to sell and securitize loans are carried at fair value. Fair value is based on quoted secondary market pricing for loan portfolios with similar characteristics and includes consideration of deferred fees (costs). Net unrealized losses are recognized in a valuation allowance by charges to income.
The Company retains servicing on loans that are sold and recognizes an asset for mortgage loan servicing rights based on the fair value of the servicing rights. Mortgage loan servicing rights are recorded at the lower of cost or fair value. Mortgage loan servicing rights are reported net of accumulated amortization, which is recorded in proportion to, and over the period of, estimated net servicing revenues. The impairment analysis is based on predominant risk characteristics of the loans serviced, such as type, fixed and adjustable rate loans, original terms and interest rates. Fair values are estimated using discounted cash flows based on current interest rates and prepayment assumptions, and impairment is monitored periodically. The amount of impairment recognized is the amount by which the mortgage loan servicing assets exceed their fair value. The Company monitors prepayments and changes amortization of mortgage servicing rights accordingly.
Servicing fee income net of amortization and other loan fees collected on loans serviced for others are included in Fees and service charges, net of amortization on the financial statements.
Derivative Instruments-The Company enters into certain transactions, referred to as forward commitments, for the sale of mortgage loans principally to protect against the risk of adverse interest rate movements on the value of those assets. The Company recognizes the fair value of the contracts when the characteristics of those contracts meet the definition of a derivative. These derivatives are not designated in a hedging relationship; therefore, gains and losses are recognized immediately in the statement of income.
The Company enters into commitments to originate loans which, when funded, will be classified as held for sale. Such commitments meet the definition of a derivative and are not designated in a hedging relationship; therefore, gains and losses are recognized immediately in the statement of income.
Loans and Related Fees-Loans originated with the intent to hold into the foreseeable future are carried at unpaid principal balances adjusted for partial charge-offs, the allowance for loan losses and net deferred origination fees. Interest on loans is accrued and credited to income as earned. Interest is not accrued on loans when collectability is uncertain.
Loan fees and certain direct loan origination costs are deferred and recognized as an adjustment to interest income using the level-yield method over the contractual lives of related loans, if the loans are held for investment. If the loans are held for sale, net deferred fees (costs) are not amortized, but rather are recognized when the related loans are sold.
Allowance for Loan Losses-The allowance for loan losses is assessed on a quarterly basis and provisions for loan losses are made in order to maintain the allowance at a level sufficient to absorb credit losses in the portfolio. Impairment evaluations are performed on loans segregated into homogeneous pools based on similarities in credit profile, product and property types. Through the evaluation, general allowances for loan losses are assessed based on historical loan loss experience for each homogeneous pool. General allowances are adjusted to address other factors that affect estimated probable losses including the size of the portion of the portfolio that is not subjected to individual review; current delinquency statistics; the status of loans in foreclosure, real estate in judgment and real estate owned; national, regional and local economic factors and trends; asset disposition loss statistics (both current and historical); and the relative level of individually allocated valuation allowances to the balances of loans individually reviewed. The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management believes the allowance is adequate.
For further discussion on the allowance for loan losses, non-accrual, impairment, and troubled debt restructurings, see Note 5. LOANS AND ALLOWANCE FOR LOAN LOSSES.
Real Estate Owned-Real estate owned represents real estate acquired through foreclosure or deed in lieu of foreclosure and is carried at the lower of cost or fair value less estimated selling costs. Management performs periodic valuations and a charge to operations is recorded for any excess of the carrying value over the fair value less estimated costs to sell the property. Costs related to holding and maintaining the property are charged to expense.
Premises, Equipment, and Software-Depreciation and amortization of premises, equipment and software is computed on a straight-line basis over the estimated useful lives of the related assets. Estimated lives are 20 to 50 years for office
facilities and three to 10 years for equipment and software. Amortization of leasehold improvements is computed on a straight-line basis over the lesser of the lease term or the life of the related asset.
Impairment of Long-Lived Assets-Long-lived assets, consisting of premises, equipment and software, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the recovery amount or estimated fair value of the assets. No events or changes in circumstances have occurred causing management to evaluate the recoverability of the Company’s long-lived assets.
Private Equity Investments-Private equity investments are funds managed by third parties. Each fund is diversified according to the terms of the fund’s agreement and the general partner’s direction. These investments, which are not publicly traded, are initially valued at cost and subsequent changes are recorded at fair value. Fair value estimates are based upon currently available information and may not represent amounts that will ultimately be realized, which will depend on future events and circumstances. At September 30, 2012 and 2011, the fair value of private equity investments included in Other Assets was $944 and $1,604, respectively. The income related to these investments and changes in fair value estimates of $56, $1,067, and $669 for 2012, 2011, and 2010, respectively, are reported in Non-interest Income.
Goodwill-The excess of purchase price over the fair value of net assets of acquired companies is classified as goodwill and reported in Other Assets. Goodwill was $9,732 at September 30, 2012 and 2011. Goodwill is reviewed for impairment on an annual basis as of September 30. No impairment was identified as of September 30, 2012 or 2011.
Taxes on Income-Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Additional information about policies related to income taxes is included in Note 12. Income Taxes.
Deposits-Interest on deposits is accrued and charged to expense monthly and is paid or credited in accordance with the terms of the accounts.
Treasury Stock-Acquisitions of treasury stock are recorded at cost using the cost method of accounting. Repurchases may be made through open market purchases, block trades, and in negotiated private transactions, subject to the availability of stock, general market conditions, the trading price of the stock, alternative uses for capital, and the Company’s financial performance. Repurchased shares will be available for general corporate purposes.
Accumulated Other Comprehensive Loss-Accumulated other comprehensive loss consists of pension liability adjustments and gains (losses) on securities available for sale, net of the related tax effects.
Share-Based Compensation-Compensation expense for awards of equity instruments is recognized on a straight-line basis over the requisite service period based on the grant date fair value estimated in accordance with the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 718 “Compensation-Stock Compensation”. Share-based compensation expense is included in Salaries and employee benefits in the consolidated statements of income.
The grant date fair value of stock options is estimated using the Black-Scholes option-pricing model using assumptions for the expected option term, expected stock price volatility, risk-free interest rate, and expected dividend yield. Due to limited historical data on exercise of share options, the simplified method is used to estimate expected option term.
Advertising Costs-Advertising costs are expensed as incurred.
Earnings per Share-Basic earnings per share is computed by dividing net income (loss) by the weighted average shares of common stock outstanding. Outstanding shares include shares sold to subscribers, shares held by the Third Federal Foundation, shares of the Employee Stock Ownership Plan which have been allocated or committed to be released for allocation to participants, and shares held by Third Federal Savings, MHC.
Diluted earnings per share is computed using the same method as basic earnings per share, but reflects the potential dilution, if any, of unexercised stock options and unvested shares of restricted stock units that could occur if stock options were exercised and restricted stock units were issued and converted into common stock. These potentially dilutive shares would then be included in the weighted average number of shares outstanding for the period using the treasury stock method. At
September 30, 2012, 2011 and 2010, potentially dilutive shares include stock options and restricted stock units issued through stock-based compensation plans.
Use of Estimates-The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
2. STOCK TRANSACTIONS
The Holding Company completed its initial public stock offering on April 20, 2007 and sold 100,199,618 shares, or 30.16% of its post-offering outstanding common stock, to subscribers in the offering. Third Federal Savings, MHC, the Company’s mutual holding company parent, holds 227,119,132 shares of the Holding Company’s outstanding common stock. Additionally, the Association contributed $5,000 in cash and the Holding Company issued 5,000,000 shares of common stock, or 1.50% of its post-offering outstanding common stock, to Third Federal Foundation.
On March 12, 2009, the Board of Directors approved a fourth repurchase program authorizing the repurchase of up to an additional 3,300,000 shares of the Company’s outstanding common stock. No shares were repurchased during the year ended September 30, 2012. At September 30, 2012, there are 2,156,250 shares remaining to be purchased under the fourth repurchase program. As a result of the concerns communicated to the Company by the Office of Thrift Supervision (“OTS”), which was merged into the OCC on July 21, 2011, and pending an evaluation by the Company’s current, primary regulators, the OCC and the Board of Governors of the Federal Reserve System (“Federal Reserve” or "FRB") (see Note 3), the Company has suspended its repurchase program. The Company previously repurchased 23,000,000 shares of the Company’s common stock as part of the first three previous Board of Directors-approved share repurchase programs.
3. REGULATORY MATTERS
The Association is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements of the Association. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Association must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Association to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), Core capital (as defined) to adjusted assets (as defined), and Tangible capital (as defined) to tangible assets. Management believes that, as of September 30, 2012, the Association met all capital adequacy requirements to which it is subject.
The Association is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At September 30, 2012, the Association exceeded all regulatory capital requirements and is considered “well capitalized” under regulatory guidelines.
The following table summarizes the actual capital amounts and ratios of the Association as of September 30, 2012 and 2011, compared to the minimum capital adequacy requirements and the requirements for classification as a well capitalized institution.
The following table reconciles the Association’s total capital under GAAP to reported regulatory capital amounts as of September 30, 2012 and 2011.
There were no dividends paid to the Company during the years ended September 30, 2012 and September 30, 2011.
Because of concerns communicated to the Company by the OTS, which was merged into the OCC on July 21, 2011, and pending an evaluation by the Company’s current federal regulators, the OCC (for the Association) and the FRB (for the Holding Company), the Company does not intend to declare or pay a cash dividend or to repurchase any of its outstanding common stock until the concerns of the Company’s regulators are resolved. In addition, prior to the suspension of the dividends, Third Federal Savings, MHC waived its right to receive each dividend paid by the Company, which allowed dividends to only be paid to the 26.5% of the shares which are not owned by Third Federal Savings, MHC. Recent interim final rules issued by the FRB require that a majority of the mutual holding company's members eligible to vote must approve a dividend waiver by a mutual holding company within 12 months prior to the declaration of the dividend being waived. As part of its rulemaking process, the FRB is reviewing comments on the interim final rule and there can be no assurance that the final rule will not require such a member vote.
The terms of an August 13, 2010 OTS memorandum of understanding, which was terminated and replaced effective February 7, 2011 (collectively, the “MOU”) which covers the Company, the Association and Third Federal Savings, MHC required the following actions to be prepared or obtained by management, all of which have been performed: (1) completion of a home equity lending reduction plan; (2) enhanced home equity lending, credit risk and other management policies and procedures; (3) an assessment of the Association's interest rate risk management policy and a plan to address any deficiencies and (4) an assessment of the enterprise risk management and a plan to address any deficiencies. Management believes that it has substantially completed the measures required by the MOU, although compliance will be determined by the OCC and the Federal Reserve.
4. INVESTMENT SECURITIES
Investments available for sale are summarized as follows:
During the quarter ended June 30, 2012, all of the Company's investment securities previously classified as held to maturity, $343,687, were transferred to the available for sale portfolio to ensure that the securities would be eligible for inclusion in the computation of regulatory liquidity. At the time of transfer, a net unrealized gain of $2,228 was recorded in accumulated other comprehensive income. At September 30, 2012, all investment securities held by the Company are classified as available for sale.
Investment securities held to maturity are summarized as follows:
There were no sales from the investment securities available for sale portfolio or the investment securities held-to-maturity portfolio during the years ended September 30, 2012, 2011 and 2010.
Gross unrealized losses on securities and the estimated fair value of the related securities, aggregated by investment category and length of time the individual securities have been in a continuous loss position, at September 30, 2012 and 2011, were as follows:
The unrealized losses on investment securities were attributable to market rate increases. The contractual terms of U.S. government and agency obligations do not permit the issuer to settle the security at a price less than the par value of the investment. The contractual cash flows of mortgage-backed securities are guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. REMICs are issued by or backed by securities issued by these governmental agencies. It is expected that the securities would not be settled at a price substantially less than the amortized cost of the investment. During the financial market upheaval of 2008, concern arose about the financial health of Fannie Mae and Freddie Mac and, therefore, the viability of the payment guarantees issued by the agencies. This market was preserved when, in September 2008, the Federal Housing Finance Agency placed Fannie Mae and Freddie Mac into conservatorship. Shortly after taking control, the U.S. Treasury Department established financing agreements to ensure Fannie Mae and Freddie Mac meet their obligations to holders of mortgage-backed securities that they have issued or guaranteed.
Since the decline in value is attributable to changes in interest rates and not credit quality and because the Association has neither the intent to sell the securities nor is it more likely than not the Association will be required to sell the securities for the time periods necessary to recover the amortized cost, these investments are not considered other-than-temporarily impaired.
At September 30, 2012 and 2011, the carrying amount of U.S. government and agency obligations pledged to secure public deposits totaled $0 and $2,000, respectively.
At September 30, 2012, the amortized cost and fair value of U.S. government and agency obligations available for sale due in more than one year but less than five years are $2,000 and $2,046, respectively. There are no other investment securities held to maturity at September 30, 2012.
5. LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans held for investment consist of the following:
At September 30, 2012 and 2011, respectively, $124,528 and $0 of long-term, fixed-rate loans were classified as mortgage loans held for sale.
In an October 2011 directive, the OCC required all specific valuation allowances (“SVA”) on collateral-dependent loans (SVAs established when the recorded investment in an impaired loan exceeded the measured value of the collateral) maintained by savings institutions to be charged off by March 31, 2012. As permitted, the Company elected to early-adopt this methodology effective for the quarter ended December 31, 2011. Additionally, the OCC issued guidance in July, 2012 which requires loans, where at least one borrower has been discharged of their obligation in Chapter 7 bankruptcy proceedings, and have not reaffirmed the debt to be classified as troubled debt restructurings. Additionally, this guidance requires the charge off of performing loans to collateral value when, due to a discharge of indebtedness, the Company's only recourse in the event of nonpayment is to foreclose on the property. As a result, reported loan charge-offs for the year ended September 30, 2012 included the charge-off of specific valuation allowances, which had a balance of $55,507 at September 30, 2011 and the charge-off of $15,827 in connection with the bankruptcy related guidance. The one-time SVA related charge-off did not impact the provision for loan losses for the year ended September 30, 2012; however, reported loan charge-offs during the year increased and the balances of loans, the allowance for loan losses, non-accrual status loans and loan delinquencies as of September 30, 2012, all decreased accordingly.A large concentration of the Company’s lending is in Ohio. As of September 30, 2012 and 2011, the percentage of total residential non-Home Today and Home Today loans held in Ohio were 77% and 81%, and the percentage held in Florida were 17% and 17%, respectively. As of September 30, 2012 and 2011, equity loans and lines of credit were concentrated in the states of Ohio (39% and 39%), Florida (29% and 29%) and California (12% and 12%), respectively. The economic conditions and market for real estate in those states have significantly impacted the ability of borrowers in those areas to repay their loans.
Home Today is an affordable housing program targeted to benefit low- and moderate-income home buyers. Through this program, prior to March 27, 2009, the Association provided loans to borrowers who would not otherwise qualify for the Association’s loan products, generally because of low credit scores. Although the credit profiles of borrowers in the Home Today program prior to March 27, 2009 might be described as sub-prime, Home Today loans generally contain the same features as loans offered to our non-Home Today borrowers. Borrowers in the Home Today program must complete financial management education and counseling and must be referred to the Association by a sponsoring organization with which the Association has partnered as part of the program. Borrowers must also meet a minimum credit score threshold. Because prior to March 27, 2009 the Association applied less stringent underwriting and credit standards to these loans, loans originated under the Home Today program prior to that date have greater credit risk than its traditional residential real estate mortgage loans. Effective March 27, 2009, the Home Today underwriting guidelines are substantially the same as the Association’s traditional first mortgage product. As of September 30, 2012 and 2011, the principal balance of Home Today loans originated prior to March 27, 2009 was $204,733 and $261,817 respectively. The Association does not offer, and has not offered, loan products frequently considered to be designed to target sub-prime borrowers containing features such as higher fees or higher rates, negative amortization, a loan-to-value ratio greater than 100%, or option adjustable-rate mortgages.
Beginning March 20, 2012, the Association offers new home equity lines of credit to qualifying existing home equity customers, subject to certain property and credit performance conditions. Between June 28, 2010 and March 19, 2012, the Association suspended the acceptance of new equity line of credit applications. Prior to March 11, 2009, the Association offered residential mortgage loan products where the borrower pays only interest for a portion of the loan term. The recorded investment in interest only loans is comprised of the following:
Home equity lines of credit are interest only for a maximum of 10 years and convert to fully amortizing for the remaining term up to 20 years at which time they are included in the home equity loan balance. Residential loans are interest only for a maximum of 5 years and convert to fully amortizing for the remaining term of up to 30 years.
The recorded investment of loan receivables in non-accrual status is summarized in the following table. Balances are net of deferred fees.
Loans are placed in non-accrual status when they are contractually 90 days or more past due. Loans modified in troubled debt restructurings that were in non-accrual status prior to the restructurings remain in non-accrual status for a minimum of six months. Total performing non-accrual loans at September 30, 2012 and 2011 includes $47,742 and $16,465, respectively, in troubled debt restructurings which are current according to the terms of their agreement but included with non-accrual loans for a minimum period of six months from the restructuring date. SVAs, which had a balance of $55,507 at September 30, 2011, were charged-off per an OCC directive reducing the balance of loans in non-accrual during the year ended September 30, 2012. Beginning with the quarter ended March 31, 2012, home equity loans and lines of credit where the customer has a severely delinquent first mortgage are also placed in non-accrual status. Beginning in the quarter ended September 30, 2012, loans in Chapter 7 bankruptcy status where all borrowers have been discharged of their obligation are also placed in non-accrual status. At September 30, 2012, the recorded investment in non-accrual status loans includes $8,807 of performing second lien loans subordinate to first mortgages delinquent greater than 90 days past due. At September 30, 2012, the recorded investment in non-accrual status loans includes $30,631 of performing loans in Chapter 7 bankruptcy status where all borrowers have been discharged of their obligations. Interest on loans in accrual status, including certain loans individually reviewed for impairment, is recognized in interest income as it accrues, on a daily basis. Accrued interest on loans in non-accrual status is reversed by a charge to interest income and income is subsequently recognized only to the extent cash payments are received. Cash payments on loans in non-accrual status are applied to the oldest scheduled, unpaid payment first. Cash payments on loans with a partial charge-off are applied fully to principal, then to recovery of the charged off amount prior to interest income being recognized. A non-accrual loan is generally returned to accrual status when contractual payments are less than 90 days past due. However, a loan may remain in nonaccrual status when collectability is uncertain, such as a troubled debt restructuring that has not met minimum payment requirements, a loan with a partial charge-off, an equity loan or line of credit with a delinquent first mortgage greater than 90 days, or a loan in Chapter 7 bankruptcy status where all borrowers have been discharged of their obligation. The number of days past due is determined by the number of scheduled payments that remain unpaid, assuming a period of 30 days between each scheduled payment. An age analysis of the recorded investment in loan receivables that are past due at September 30, 2012 and 2011 is summarized in the following tables. When a loan is more than one month past due on its scheduled payments, the loan is considered 30 days or more past due. Balances are net of deferred fees and any applicable loans-in-process.
Activity in the allowance for loan losses is summarized as follows:
The recorded investment in loan receivables at September 30, 2012 and 2011 is summarized in the following table. The table provides details of the recorded balances according to the method of evaluation used for determining the allowance for loan losses, distinguishing between determinations made by evaluating individual loans and determinations made by evaluating groups of loans not individually evaluated. Balances of recorded investments are net of deferred fees and any applicable LIP.
An analysis of the allowance for loan losses at September 30, 2012 and 2011 is summarized in the following table. The analysis provides details of the allowance for loan losses according to the method of evaluation, distinguishing between allowances for loan losses determined by evaluating individual loans and allowances for loan losses determined by evaluating groups of loans not individually evaluated.
At September 30, 2012, individually evaluated loans that required an allowance were comprised only of loans evaluated for impairment based on the present value of cash flows, such as performing troubled debt restructurings, performing second liens subordinate to first mortgages delinquent greater than 90 days and loans with a further deterioration in the fair value of collateral not yet identified as uncollectible. All other individually evaluated loans received a charge-off if applicable. At September 30, 2011, individually evaluated loans were comprised of loans evaluated for impairment based on the present value of cash flows, such as performing troubled debt restructurings, and impaired loans for which the recorded investment in the impaired loan exceeded the measured value of the collateral, previously referred to as a SVA. Effective for the quarter ended December 31, 2011, and in accordance with the previously described regulatory directive, SVAs were charged-off against the recorded loan balance.
Because many variables are considered in determining the appropriate level of general valuation allowances, directional changes in individual considerations do not always align with the directional change in the balance of a particular component of the general valuation allowance. At September 30, 2012 and 2011, respectively, individually allocated, collateral-based reserves on impaired loans were $0 and $55,507; allowances on other individually reviewed loans evaluated for impairment based on the present value of cash flows, such as performing troubled debt restructurings were $17,720 and $7,010; allowances on performing second liens subordinate to first mortgages delinquent greater than 90 days were $1,550 and $0; and allowances on loans with further deteriorations in the fair value of collateral not yet identified as uncollectible were $666 and $395. Prior to the quarter ended December 31, 2011, specific valuation allowances were assessed on impaired loans as described throughout this footnote.
Residential non-Home Today mortgage loans represent the largest piece of the residential real estate portfolio. The Company believes overall credit risk is low based on the nature, composition, collateral, products, lien position and performance of the portfolio. The portfolio does not include loan types or structures that have recently experienced severe performance problems at other financial institutions (sub-prime, no documentation or pay option adjustable rate mortgages).
As described earlier in this footnote, Home Today loans, particularly those originated prior to March 27, 2009, have greater credit risk than traditional residential real estate mortgage loans. At September 30, 2012, more than 54% of Home Today loans include private mortgage insurance coverage. The majority of the coverage on these loans was provided by PMI Mortgage Insurance Co. (“PMIC”) which the Arizona Department of Insurance seized in 2011 and indicated that all claims payments would be reduced by 50%. Appropriate adjustments have been made to all of the Association’s affected valuation allowances and charge-offs, and estimated loss severity factors were increased for loans evaluated collectively. The amount of loans in our owned portfolio covered by mortgage insurance provided by PMIC as of September 30, 2012 was $303,621 of which $273,225 was current. The amount of loans in our owned portfolio covered by mortgage insurance provided by Mortgage Guaranty Insurance Corporation ("MGIC") as of September 30, 2012 was $118,055 of which $116,132 was current. As of September 30, 2012, MGIC's long-term debt rating, as published by the major credit rating agencies, did not meet the requirements to qualify as "investment grade"; however, MGIC continues to make claims payments in accordance with its contractual obligations and the Association has not increased its estimated loss given default factors related to MGIC's claim paying ability. No other loans were covered by mortgage insurers that were deferring claim payments or which we assessed as being non-investment grade.
Home equity lines of credit represent a significant portion of the residential real estate portfolio. The state of the economy and low housing prices continue to have an adverse impact on this portfolio since the home equity lines generally are in a second lien position. Between June 28, 2010 and March 19, 2012, due to the perceived deterioration in the overall housing conditions including concerns for loans and lines in a second lien position, equity lines of credit and home equity loans were not offered. Beginning March 20, 2012, the Association offers new home equity lines of credit to qualifying existing home equity customers, subject to certain property and credit performance conditions.
Construction loans generally have greater credit risk than traditional residential real estate mortgage loans. The repayment of these loans depends upon the sale of the property to third parties or the availability of permanent financing upon completion of all improvements. In the event we make a loan on property that is not yet approved for the planned development, there is the risk that approvals will not be granted or will be delayed. These events may adversely affect the borrower and the collateral value of the property. Construction loans also expose the Association to the risk that improvements will not be completed on time in accordance with specifications and projected costs. In addition, the ultimate sale or rental of the property may not occur as anticipated. Effective August 30, 2011, the Association made the strategic decision to exit the commercial construction loan business and ceased accepting new builder relationships. Existing builder commitments to provide additional financing were honored for a period of not longer than one year, giving our customers the ability to secure new borrowing relationships.
Consumer loans are comprised of loans secured by certificate of deposit accounts, which are fully recoverable in the event of non-payment.
Reflective of the much publicized foreclosure and mortgage servicing problems that have confronted the industry, the Company has generally experienced longer foreclosure timelines than those experienced in the past, particularly in Florida. The longer foreclosure timelines in Florida generally have a greater impact on the Association’s first position liens as opposed to subordinate liens primarily because the significant property value decline in Florida since 2008, when coupled with the subordinate lien position of home equity lending products, generally results in a high percentage of full charge-offs on the date of initial evaluation. As a result, once a home equity loan or line of credit has been fully charged off, foreclosure timing is no longer relevant. Longer foreclosure timelines generally result in greater loss experience rates on first position liens where full charge-offs are not as prevalent, particularly to the extent that property values continue to decline during the foreclosure process. These expected higher loss experience rates are factored into the determination of collateral fair value and are considered in making charge-off decisions.
The recorded investment and the unpaid principal balance of impaired loans, including those whose terms have been modified in troubled debt restructurings, as of September 30, 2012 and 2011 are summarized as follows. Balances of recorded investments are net of deferred fees.
At September 30, 2012 and 2011, respectively, the recorded investment in impaired loans includes $221,399 and $166,197 of loans modified in troubled debt restructurings of which $39,127 and $28,617 are 90 days or more past due.
For all classes of loans, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest according to the contractual terms of the loan agreement. Factors considered in determining that a loan is impaired may include the deteriorating financial condition of the borrower indicated by missed or delinquent payments, a pending legal action, such as bankruptcy or foreclosure, or the absence of adequate security for the loan. Impairment is measured based on the fair value of the collateral less costs to dispose when it is probable that the sole source of repayment for the loan is the underlying collateral. The fair value less estimated cost to dispose of the underlying property is compared to the recorded investment in the loan, net of anticipated mortgage insurance claims, to estimate a loss recorded as a charge-off in the allowance for credit losses. This applies to all mortgage loans and lines of credit. Equity loans, bridge loans, equity lines of credit and loans modified in troubled debt restructurings are included in loans individually evaluated based on the fair value of the collateral at 90 or more days past due. Also, loans in Chapter 7 bankruptcy, where all borrowers' obligations related to the loan have been discharged, regardless of delinquency, are evaluated based on collateral. Collateral-based evaluations on all other loans are performed at 180 or more days past due. An individual impairment evaluation may be performed on a loan in any portfolio prior to the guidelines established when a it becomes evident that a loss is probable. A loan in any portfolio that is identified for individual evaluation based on a failure to make timely payments will continue to be reported as impaired until it is less than 30 days past due and does not have a prior charge-off. A loan in any portfolio that has a partial charge-off consequent to an impairment evaluation will continue to be individually evaluated for impairment until, at a minimum, the impairment has been recovered.
Loans are charged off when less than the full payment is accepted as satisfaction for a loan; a foreclosure action is completed and the fair value of the collateral received is insufficient to satisfy the loan; management concludes the costs of
foreclosure exceed the potential recovery; or, in the case of equity loans and lines of credit, management determines the collateral is not sufficient to satisfy the loan.
Loans modified in troubled debt restructurings, not evaluated based on collateral, are separately evaluated for impairment on a loan by loan basis at the time of restructuring and at each subsequent reporting date for as long as they are reported as troubled debt restructurings. The impairment evaluation is based on the present value of expected future cash flows discounted at the effective interest rate of the original loan. Expected future cash flows include a discount factor representing a potential for default. Valuation allowances are recorded for the excess of the recorded investments over the result of the cash flow analysis. Loans in Chapter 7 bankruptcy, where at least one borrower has not had the debt discharged, are evaluated based on the expected future cash flows. Consumer loans are not considered for restructuring. A loan modified in a troubled debt restructuring is classified as an impaired loan for a minimum of one year. After one year, a loan is no longer included in the balance of impaired loans if the loan was modified to yield a market rate for loans of similar credit risk at the time of restructuring and the loan is not impaired based on the terms of restructuring agreement. No troubled debt restructurings were reclassified out of impaired loans during the year ended September 30, 2012.
The average recorded investment in impaired loans and the amount of interest income recognized during the time within the period that the loans were impaired are summarized below. Beginning for the three months ended June 30, 2011, the reported amount of interest income recognized includes interest income on all impaired loans. Prior to that period, the reported amount included interest income from only impaired loans with an allowance, resulting in a reported amount that was less than, but not materially different from, the actual amount of interest income recognized. Balances of average recorded investments are net of deferred fees.
The amount of interest income on impaired loans recognized using a cash-basis method is $1,734 for the year ended September 30, 2012, not considered materially different from $1,064 for the year ended September 30, 2011, and not material for the year ended September 30, 2010.
For all loans modified during the years ended September 30, 2012 and 2011 (set forth in the tables below), the pre-modification outstanding recorded investment was not materially different from the post-modification outstanding recorded investment.
The following tables set forth the recorded investment in troubled debt restructured loans modified during the year presented, according to the types of concessions granted. Loans in Chapter 7 bankruptcy status, where at least one borrower has been discharged of their obligation, that were not in Chapter 7 bankruptcy status at September 30, 2011 are included in reported values for the year ended September 30, 2012 in accordance with updated OCC guidance. Reported values for the prior year have not been adjusted for Chapter 7 bankruptcies.
Troubled debt restructured loans may be modified more than once. Among other requirements, a re-modification may be available for a borrower upon the expiration of temporary modification terms if the borrower cannot return to regular loan payments. If the borrower is experiencing an income curtailment that temporarily has reduced his/her capacity to repay, such as loss of employment, reduction of hours, non-paid leave or short term disability, a temporary modification is considered. If the borrower lacks the capacity to repay the loan at the current terms due to a permanent condition, a permanent modification is considered. In evaluating the need for a re-modification, the borrower’s ability to repay is generally assessed utilizing a debt to income and cash flow analysis. As the economy remains sluggish and high unemployment persists, the need for re-modifications continues to linger, resulting in approximately 10% of short-term modifications extended into more permanent or longer-term modifications. This is slightly less than the 12% at September 30, 2011 primarily due to the increase in total troubled debt restructurings from the addition of loans in Chapter 7 bankruptcy status.
The following table provides information on troubled debt restructured loans modified within the last 12 months that defaulted, or were at least 30 days past due on one scheduled payment, during the period presented. Reported values for the year ended September 30, 2012 include loans in Chapter 7 bankruptcy status, where at least one borrower has been discharged of their obligation, that were not in Chapter 7 bankruptcy status at September 30, 2011. Prior year activity has not been adjusted for Chapter 7 bankruptcies.
The following tables provide information about the credit quality of residential loan receivables by an internally assigned grade. Balances are net of deferred fees and any applicable LIP.
Residential loans are internally assigned a grade that complies with the guidelines outlined in the OCC’s Handbook for Rating Credit Risk. Pass loans are assets well protected by the current paying capacity of the borrower. Special Mention loans have a potential weakness that the Association feels deserve management’s attention and may result in further deterioration in their repayment prospects and/or the Association’s credit position. Substandard loans are inadequately protected by the current payment capacity of the borrower or the collateral pledged with a defined weakness that jeopardizes the liquidation of the debt. Beginning with the quarter ended March 31, 2012, performing home equity loans and lines of credit where the customer has a severely delinquent subordinate first mortgage are classified Substandard. Beginning in the quarter ended September 30, 2012, loans in Chapter 7 bankruptcy status where all borrowers have had their obligations discharged, and have not reaffirmed the debt, are classified Substandard. Loss loans are considered uncollectible and effective as of December 31, 2011, are charged off when identified. Prior to December 31, 2011, loss loans carried an SVA.
At September 30, 2012 and 2011, respectively, the recorded investment of impaired loans includes $133,508 and $121,115 of troubled debt restructurings that are individually evaluated for impairment, but have adequately performed under the terms of the restructuring and are classified as pass loans. At September 30, 2012 and 2011, respectively, there are $20,475 and $24,576 of loans classified substandard and $9,868 and $13,553 of loans classified special mention that are not included in the recorded investment of impaired loans; rather, they are included in loans collectively evaluated for impairment.
The following table provides information about the credit quality of consumer loan receivables by payment activity.
Consumer loans are internally assigned a grade of nonperforming when they are considered 90 days or more past due.
6. MORTGAGE LOAN SERVICING ASSETS
The Company sells certain types of loans through whole loan sales and through securitizations. In each case, the Company retains a servicing interest in the loans or securitized loans. Certain assumptions and estimates are used to determine the fair value allocated to these retained interests at the date of transfer and at subsequent measurement dates. These assumptions and estimates include loan repayment rates and discount rates.
Changes in interest rates can affect the average life of loans and mortgage-backed securities and the related servicing assets. A reduction in interest rates normally results in increased prepayments, as borrowers refinance their debt in order to reduce their borrowing costs. This creates reinvestment risk, which is the risk that the Company may not be able to reinvest the proceeds of loan and securities prepayments at rates that are comparable to the rates earned on the loans or securities prior to receipt of the repayment.
During 2012, 2011 and 2010, $11,363, $33,554 and $1,028,670, respectively, of mortgage loans were securitized and/or sold including accrued interest thereon. In these transactions, the Company retained residual interests in the form of mortgage loan servicing assets. Primary economic assumptions used to measure the value of the Company’s retained interests at the date of sale resulting from the completed transactions were as follows (per annum):
Key economic assumptions and the sensitivity of the current fair value of mortgage loan servicing assets to immediate 10% and 20% adverse changes in those assumptions are as presented in the following table. The three key economic assumptions that impact the valuation of the mortgage loan servicing rights are: (1) the prepayment speed, or how long the MSR will be outstanding; (2) the estimate of servicing costs that will be incurred in fulfilling the MSR responsibilities; and (3) the discount factor applied to future net cash flows to convert them to present value. The Company established these factors based on independent analysis of our portfolio and reviews these assumptions periodically to ensure that they reasonably reflect current market conditions and our loan portfolio experience. Additionally, to confirm the appropriateness of the Company's mortgage loan servicing rights valuation, an independent third party is engaged at least annually, and more frequently if warranted by market volatility, to value our mortgage loan servicing rights portfolio. The results of the third party valuation are compared and reconciled to the Company's valuation, thereby validating the Company's approach and assumptions.
These sensitivities are hypothetical and should be used with caution. As indicated in the table above, changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship in the change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which could magnify or counteract the sensitivities.
Servicing assets are evaluated periodically for impairment based on the fair value of those rights. Eighteen risk tranches are used in evaluating servicing rights for impairment, segregated primarily by interest rate stratum within original term to maturity categories with additional stratum for less uniform account types.
Activity in mortgage servicing assets is summarized as follows:
The Company receives annual servicing fees ranging from 0.12% to 0.31% of the outstanding loan balances. Servicing income, net of amortization of capitalized servicing assets, included in Non-interest income, amounted to $7,327 in 2012, $11,392 in 2011 and $16,885 in 2010. The unpaid principal balance of mortgage loans serviced for others was approximately $3,810,786, $5,434,138 and $7,043,946 at September 30, 2012, 2011 and 2010, respectively. The ratio of capitalized servicing assets to the unpaid principal balance of mortgage loans serviced for others was 0.52%, 0.54%, and 0.55% at September 30, 2012, 2011 and 2010, respectively.
7. PREMISES, EQUIPMENT AND SOFTWARE, NET
Premises, equipment and software at cost are summarized as follows:
During the years ended September 30, 2012, 2011 and 2010, depreciation and amortization expense on premises, equipment, and software was $5,414, $5,485 and $6,625, respectively.
The Company leases certain of its branches under renewable operating lease agreements. Future minimum payments under non-cancelable operating leases with initial or remaining terms of one year or more consisted of the following at September 30, 2012:
During the years ended September 30, 2012, 2011 and 2010, rental expense was $6,019, $5,983 and $5,681, respectively.
The Company, as lessor, leases certain commercial office buildings. The Company anticipates receiving future minimum payments of the following as of September 30, 2012:
During each of the years ended September 30, 2012, 2011, and 2010, rental income was $893, $2,569 and $2,569 respectively, and appears in other non-interest income in the accompanying statements.
8. ACCRUED INTEREST RECEIVABLE
Accrued interest receivable is summarized as follows:
9. DEPOSITS
Deposit account balances are summarized by interest rate as follows:
At September 30, 2012 and 2011, the weighted average interest rate was 0.4% and 0.5% on savings accounts, respectively; 0.3% and 0.3% on negotiable order of withdrawal accounts, respectively; 2.1% and 2.6% on certificates of deposit, respectively; and 1.5% and 1.9% on total deposits, respectively.
The aggregate amount of certificates of deposit in denominations of $100 or more totaled approximately $2,250,550 and $2,039,440 at September 30, 2012 and 2011, respectively. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law, which, in part, permanently increased the maximum amount of deposit insurance to $250 per depositor, retroactive to January 1, 2009. The Company does not have any brokered deposits.
The scheduled maturity of certificates of deposit is as follows:
Interest expense on deposits is summarized as follows:
10. BORROWED FUNDS
Federal Home Loan Bank (“FHLB”) borrowings at September 30, 2012 are summarized in the table below:
The Association’s maximum borrowing capacity at the FHLB, under the most restrictive measure, was an additional $466,616 at September 30, 2012. Pursuant to collateral agreements with FHLB Cincinnati, advances are secured by a blanket lien on qualifying first mortgage loans. The Association’s capacity limit for additional borrowings from the FHLB Cincinnati was $4,218,731 at September 30, 2012, subject to satisfaction of the FHLB Cincinnati common stock ownership requirement. To satisfy the common stock ownership requirement, we would have to increase our ownership of FHLB of Cincinnati common stock by an additional $75.0 million. The terms of the advances include various restrictive covenants including limitations on the acquisition of additional debt in excess of specified levels. As of September 30, 2012, the Association was in compliance with all such covenants. The Association’s borrowing capacity at the Federal Reserve Discount Window was $233,296 at September 30, 2012.
11. OTHER COMPREHENSIVE INCOME (LOSS)
The following table represents the components of other comprehensive income (loss) and the related tax effect allocated to component:
12. INCOME TAXES
The components of the income tax provision are as follows:
Reconciliation from tax at the statutory rate to the income tax provision is as follows:
Deferred income tax expense results from temporary differences in the recognition of revenue and expenses for tax and financial statement purposes. The sources of these differences and the tax effect of each were as follows:
Temporary differences between the financial statement carrying amounts and tax basis of assets and liabilities that gave rise to significant portions of net deferred taxes relate to the following:
In the accompanying statement of condition the net deferred tax asset is included in Other assets.
A valuation allowance is established to reduce deferred tax assets if it is more likely than not that the related tax benefits will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. During the years ended September 30, 2012, 2011 and 2010, there was a net increase (decrease) in the valuation allowance on the charitable contribution carryforward of $(500), $600, and $1,900, respectively. The charitable contribution carryforward expired September 30, 2012.
Retained earnings at September 30, 2012 and 2011 included approximately $104,861 for which no provision for federal income tax has been made. This amount represents allocations of income during years prior to 1988 to bad debt deductions for tax purposes only. These qualifying and nonqualifying base year reserves and supplemental reserves will be recaptured into income in the event of certain distributions and redemptions. Such recapture would create income for tax purposes only, which would be subject to the then current corporate income tax rate. However, recapture would not occur upon the reorganization, merger, or acquisition of the Association, nor if the Association is merged or liquidated tax-free into a bank or undergoes a charter change. If the Association fails to qualify as a bank or merges into a nonbank entity, these reserves will be recaptured into income.
The provisions of Accounting for Uncertainty in Income Taxes, codified within FASB ASC 740 “Income Taxes,” prescribe a recognition threshold and measurement attribute for the financial statement recognition and measurement for a tax position taken or expected to be taken in a tax return. FASB ASC 740 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Tax positions must meet a more-likely-than-not recognition threshold in order for the related tax benefit to be recognized or continue to be recognized. As of September 30, 2012, 2011 and 2010, there were no unrecognized tax benefits. The Company does not anticipate the total amount of unrecognized tax benefits to significantly change within the next 12 months.
The Company recognizes interest and penalties on income tax assessments or income tax refunds, where applicable, in the financial statements as a component of its provision for income taxes. During the fiscal year ended September 30, 2012, the Company reached a settlement with the Internal Revenue Service ("IRS") related to the timing of bad debt deductions on the federal tax returns of the Company and its subsidiaries for fiscal years ended 2008, 2009 and 2010. For the year ended September 30, 2012, and pursuant to this settlement, the Company recognized $1,013 of interest expense, net of tax benefit, and $697 of charitable contribution benefit that would have otherwise expired unused.There is $729 of estimated interest
included in income tax liability at September 30, 2012. There were no amounts recognized or paid for interest and penalties for the years ended September 30, 2011 and 2010. There were no amounts accrued at September 30, 2011.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state and city jurisdictions. With few exceptions, the Company is no longer subject to federal and state income tax examinations for tax years prior to 2009. The State of Ohio Department of Taxation is currently conducting an audit of the Association's Ohio Franchise Tax Returns for fiscal years ended September 30, 2009, 2010 and 2011.
13. EMPLOYEE BENEFIT PLANS
Defined Benefit Plan-Third Federal Savings Retirement Plan (the "Plan”) is a defined benefit pension plan. Effective December 31, 2002, the Plan was amended to limit participation to employees who met the Plan’s eligibility requirements on that date. After December 31, 2002, employees not participating in the Plan, upon meeting the applicable eligibility requirements, participate in the third tier of the 401(k) Savings Plan described below. Benefits under the Plan are based on years of service and the employee’s average annual compensation. The funding policy of the Plan is consistent with the funding requirements of U.S. Federal and other governmental laws and regulations. The Plan was amended in the current year to freeze future benefit accruals for participants in the Plan effective December 31, 2011. As of December 31, 2011, the projected benefit obligation, as well as the unfunded liability recorded, was reduced by $16,149, the portion attributable to future salary increases. Those eligible participants who no longer receive service credits under the Plan are also eligible to participate in the third tier of the 401(k) Savings Plan described below.
The following table sets forth the change in projected benefit obligation for the defined benefit plan:
Changes in certain actuarial assumptions, including a lower discount rate and interest assumptions for lump sum benefit amounts, increased the projected benefit obligation at September 30, 2012 by $6,562 and at September 30, 2011 by $2,224.
The following table reconciles the beginning and ending balances of the fair value of plan assets and presents the funded status of the Plan recognized in the statement of condition at the September 30 measurement date:
At September 30, 2012 and 2011, the accumulated benefit obligation under the Plan was $70,788 and $59,798, respectively. At September 30, 2012, the fair value of plan assets was deficient by $12,113 while at September 30, 2011, the fair value of plan assets was deficient by $12,114.
The components of net periodic benefit cost recognized in the statement of income are as follows:
Plan assets carried at fair value are classified into one of the three levels of the fair value hierarchy based on an assessment of inputs used in the valuation techniques. See Note. 16 Fair Value for additional information about fair value measurements, the fair value hierarchy, and a description of the inputs used within each level of the hierarchy.
Plan assets consist of investments in pooled separate accounts that invest in mutual funds, equity securities, debt securities, or real estate investments. Pooled separate accounts are valued at net asset value (“NAV”) of shares held by the pension plan at the reporting date. NAV is categorized as a level 2 fair value measurement except when the investment so measured could not have been redeemed at NAV as of the measurement date. At September 30, 2012 and 2011, there are no such restrictions on plan assets. Unless otherwise restricted, pooled separate accounts can be redeemed on a daily basis. At September 30, 2010, there was a temporary withdrawal limitation on one pooled separate account that delayed certain withdrawal transactions until sufficient liquidity levels were achieved. Withdrawal requests were transacted at NAV on the date of distribution. This investment was included in level 3 of the fair value hierarchy until September 30, 2011, the end of the period in which the restriction was lifted, at which time it was transfered to level 2 of the hierarchy.
The following tables present the fair value of plan assets by asset category at the measurement date.
______________________
(1)
Includes pooled separate accounts that invest mainly in fixed income securities such as corporate bonds, asset backed securities, commercial mortgage backed securities or in a single mutual fund.
The following table reconciles the beginning and ending balances for plan assets measured at fair value using significant unobservable inputs (Level 3):
Asset allocation ranges have been established by broad asset categories. The ranges are designed to provide an appropriate balance between risk and return, while positioning Plan assets, over extended economic cycles, in a manner consistent with the long-term return assumptions used in measurements and valuations. For equity securities the target is 55 to 60% while the target for debt and real estate securities (including cash equivalents) is 40 to 45%.
The following additional information is provided with respect to the Plan:
The discount rate for fiscal year 2012 was 4.95% for the three months ended December 31, 2011, which was the date future benefit accruals were frozen and 4.40% for the remainder of the year. The expected long-term return on assets assumption has been derived based upon the average rates of earnings expected on the funds invested to provide for Plan benefits. Management evaluates the historical performance of the various asset categories, as well as current expectations in determining the adequacy of the assumed rates of return in meeting Plan obligations. If warranted, the assumption is modified.
The following table provides estimates of expected future benefit payments during each of the next five fiscal years, as well as in the aggregate for years six through ten. Additionally, the table includes the expected employer contribution during the next fiscal year.
Effective September 30, 2006, the Company adopted the provisions of FASB ASC 715 “Compensation - Retirement Benefits” which requires an employer to recognize the funded status of its Plan in the statement of financial condition by a charge to AOCI. AOCI includes the following items that have not yet been recognized as components of net periodic benefit cost as of the measurement date (there was no transition obligation at any date):
The Company expects that $555 of net actuarial losses will be recognized as AOCI components of net periodic benefit cost during the fiscal year ended September 30, 2013.
401(k) Savings Plan-The Company maintains a 401(k) savings plan that is comprised of three tiers. The first tier allows eligible employees to contribute up to 75% of their compensation to the plan, subject to limitations established by the Internal Revenue Service, with the Company matching 100% of up to 4% on funds contributed. The second tier permits the Company to make a profit-sharing contribution at its discretion. The first and second tiers cover substantially all employees who have reached age 21 and have worked 1,000 hours in one year of service. The third tier permits the Company to make discretionary contributions allocable to eligible employees including those eligible employees who are participants, but no longer receiving service credits, under the Company’s defined benefit pension plan. Voluntary contributions made by employees are vested at all times whereas Company contributions and Company matching contributions are subject to various vesting periods which range from immediately vested to fully vesting upon five years of service.
The total of the Company’s matching and discretionary contributions related to the 401(k) savings plan for the years ended September 30, 2012, 2011 and 2010 was $2,717, $1,943 and $2,014 respectively.
Other Deferred Compensation-The Company also maintains an Executive Retirement Benefit Plan, which provides additional retirement benefits to certain key associates, as designated by the board of directors. The total cost related to the Executive Retirement Benefit Plan was $26 in 2012, $39 in 2011 and $38 in 2010. Future contributions will consist of interest on the vested balance.
The Company also maintains several other non-qualified defined contribution plans for certain key associates. Awards granted and participation in these plans are at the discretion of the board of directors. The total expense relating to these plans amounted to $167 in 2012, $139 in 2011 and $166 in 2010.
Employee (Associate) Stock Ownership Plan (“ESOP”)-The Company established an ESOP for its employees effective January 1, 2006. The ESOP is a tax-qualified plan designed to invest primarily in the Company’s common stock and provides employees with an opportunity to receive a funded retirement benefit, based primarily on the value of the Company’s common stock. The ESOP covers all eligible employees of the Company and its wholly-owned subsidiaries. Employees are eligible to participate in the ESOP after attainment of age 18, completion of 1,000 hours of service, and employment on the last day of the plan’s calendar year. Company contributions to the plan are at the discretion of the board of directors. The ESOP is accounted for in accordance with the provisions for stock compensation in FASB ASC 718. Compensation expense for the ESOP is based on the market price of the Company’s stock and is recognized as shares are committed to be released to
participants. The total compensation expense related to this plan in the 2012, 2011 and 2010 fiscal year was $4,004, $3,222 and $6,300, respectively.
The ESOP was authorized to purchase, and did purchase, 11,605,824 shares of the Company’s common stock at a price of $10 per share with a 2006 plan year cash contribution and the proceeds of a loan from the Company to the ESOP. The outstanding loan principal balance as of September 30, 2012 and 2011 was $79,381 and $82,591, respectively. Shares of the Company’s common stock pledged as collateral for the loan are released from the pledge for allocation to participants as loan payments are made. At September 30, 2012, 3,805,709 shares have been allocated to participants and 325,005 shares were committed to be released. Shares that are committed to be released will be allocated to participants at the end of the plan year (December 31). ESOP shares that are unallocated or not yet committed to be released totaled 7,475,110 at September 30, 2012, and had a fair market value of $67,799.
14. EQUITY INCENTIVE PLAN
At a special meeting of shareholders held on May 29, 2008, shareholders of the Company approved the TFS Financial Corporation 2008 Equity Incentive Plan (the "Equity Plan”). The Company adopted the provisions related to share-based compensation in FASB ASC 718 and FASB ASC 505, upon approval of the Equity Plan, and began to expense the fair value of all share-based compensation granted over the requisite service periods.
During the year ended September 30, 2012, the Compensation Committee of the Company’s Board of Directors approved the issuance of an additional 1,277,500 stock options and 444,700 restricted stock units to certain officers and employees of the Company. The awards were made pursuant to the Equity Plan.
FASB ASC 718 requires the Company to report as a financing cash flow the benefits of realized tax deductions in excess of the deferred tax benefits previously recognized for compensation expense. The excess tax benefit for 2012, 2011 and 2010 was $0, $0, and $57 respectively.
The stock options have a contractual term of 10 years and vest over a three to seven year service period. The Company recognizes compensation expense for the fair values of these awards, which have installment vesting, on a straight-line basis over the requisite service period of the awards.
Restricted stock units vest over a one to ten year service period. The product of the number of units granted and the grant date market price of the Company’s common stock determines the fair value of restricted stock units under the Equity Plan. The Company recognizes compensation expense for the fair value of restricted stock units on a straight-line basis over the requisite service period.
During the years ended September 30, 2012, 2011 and 2010, the Company recorded $7,112, $6,919 and $6,841, respectively, of share-based compensation expense, comprised of stock option expense of $3,570, $2,848 and $2,632, respectively and restricted stock units expense of $3,542, $4,071 and $4,209, respectively. The tax benefit recognized in net income related to share-based compensation expense was $3,664, $1,685 and $1,527, respectively.
The following is a summary of the status of the Company’s restricted stock units as of September 30, 2012 and changes therein during the year then ended:
The total fair value of restricted stock units vested during the years ended September 30, 2012, 2011 and 2010 was $2,383, $8,354, and $1,089, respectively. Expected future compensation expense relating to the non-vested restricted stock units at September 30, 2012 is $8,363 over a weighted average period of 2.88 years.
The following is a summary of the Company’s stock option activity and related information for the Equity Plan for the year ended September 30, 2012:
The fair value of the option grants was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions.
The expected dividend yield was assumed to be 0% since no dividends have been paid since May 2010. Volatility of the company’s stock was used in the estimation of fair value. Management estimated the expected life of the options using the simplified method allowed under SEC Staff Accounting Bulletin (SAB) 110, which expresses the views of the SEC regarding the use of a “simplified” method, as discussed in SAB No. 107. The five and seven year Treasury yield in effect at the time of the grant provides the risk-free rate of return for periods within the expected term of the options.
The weighted average grant date fair value of options granted during the year ended September 30, 2012 was $2.58 per share. There were no options granted or other option activity during the year ended September 30, 2011. Expected future compensation expense relating to the non-vested options outstanding as of September 30, 2012 is $6,482 over a weighted average period of 2.36 years. Upon exercise of vested options, management expects to draw on treasury stock as the source of the shares. At September 30, 2012, the number of common shares authorized for award under the Equity Plan was 23,000,000, of which 14,382,759 shares remain available for future award.
15. COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business, the Company enters into commitments with off-balance-sheet risk to meet the financing needs of its customers. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments to originate loans generally have fixed expiration dates of 60 to 360 days or other termination clauses and may require payment of a fee. Unfunded commitments related to home equity lines of credit generally expire 10 years following the date that the line of credit was established, subject to various conditions including compliance with payment obligation, adequacy of collateral securing the line and maintenance of a satisfactory credit profile by the borrower. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Off-balance sheet commitments to extend credit involve elements of credit risk and interest rate risk in excess of the amount recognized in the consolidated statements of condition. The Company’s exposure to credit loss in the event of nonperformance by the other party to the commitment is represented by the contractual amount of the commitment. The Company generally uses the same credit policies in making commitments as it does for on-balance-sheet instruments. Interest rate risk on commitments to extend credit results from the possibility that interest rates may have moved unfavorably from the position of the Company since the time the commitment was made.
At September 30, 2012, the Company had commitments to originate loans as follows:
At September 30, 2012, the Company had unfunded commitments outstanding as follows:
At September 30, 2012, the unfunded commitment on home equity lines of credit, including commitments for accounts suspended as a result of material default or a decline in equity, is $1,534,970.
The Company assumes mortgage guaranty insurance on an excess of loss basis for the mortgage guaranty risks of certain mortgage loans in its own portfolio, including Home Today loans and loans in its servicing portfolio, through reinsurance contracts with two primary mortgage insurance companies. Under these contracts, the Company absorbs mortgage insurance losses in a range of five to 12 percentage points in excess of the initial five percentage point loss layer of a given pool of loans, in exchange for a portion of the pool’s mortgage insurance premiums. The first five percent layer of loss must be exceeded before the Company assumes any liability. At September 30, 2012, the maximum losses under the reinsurance contracts were limited to $14,362. The Company has paid $4,059 of losses under these reinsurance contracts and has provided a liability for the remaining estimated losses totaling $3,351 as of September 30, 2012. When evaluating whether or not the reserves provide a reasonable provision for unpaid loss and loss adjustment expenses, it is necessary to project future loss and loss adjustment expense emergence and payments for loan delinquencies occurring through the balance sheet date. The actual future loss and loss adjustment expense may not develop as actuarially projected. They may in fact vary materially from the projections as mortgage insurance results are influenced by factors such as unemployment, housing market conditions and loan repayment rates. Management believes it has made adequate provision for estimated losses. Based upon notice from the Company’s two primary mortgage insurance companies, no new contracts are being added to the Company’s risk exposure. The Company’s insurance partners will retain all new mortgage insurance premiums and all new risk.
The following table summarizes the activity in the liability for unpaid losses and loss adjustment expenses:
At September 30, 2012 and 2011, the Company had commitments to securitize and sell mortgage loans which totaled $2,836 and $0, respectively.
In management’s opinion, the above commitments will be funded through normal operations.
16. FAIR VALUE
Under U.S. GAAP, fair value is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date and a fair value framework is established whereby assets and liabilities measured at fair value are grouped into three levels of a fair value hierarchy, based on the transparency of inputs and the reliability of assumptions used to estimate fair value. The Company’s policy is to recognize transfers between levels of the hierarchy as of the end of the reporting period in which the transfer occurs. The three levels of inputs are defined as follows:
Level 1 -
quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 -
quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets with few transactions, or model-based valuation techniques using assumptions that are observable in the market.
Level 3 -
a company’s own assumptions about how market participants would price an asset or liability.
As permitted under the fair value guidance in U.S. GAAP, the Company elects to measure at fair value mortgage loans classified as held for sale that are subject to pending agency contracts to securitize and sell loans. This election is expected to reduce volatility in earnings related to timing issues on these contracts. At September 30, 2012 and 2011, respectively, there were $3,017 and $0 loans held for sale, with unpaid principal balances of $2,830 and $0, subject to pending agency contracts for which the fair value option was elected. For the years ended September 30, 2012, 2011 and 2010, net gain (loss) on the sale of loans includes $210, $0 and $(204), respectively, related to changes during the period in the fair value of loans held for sale subject to pending agency contracts.
Presented below is a discussion of the methods and significant assumptions used by the Company to estimate fair value.
Investment Securities Available for Sale-Investment securities available for sale are recorded at fair value on a recurring basis. At September 30, 2012 and 2011, respectively, this includes $413,729 and $7,383 of investments in U.S. government and agency obligations including U.S. Treasury notes and sequentially structured, highly liquid collateralized mortgage obligations (“CMOs”) issued by Fannie Mae, Freddie Mac, and Ginnie Mae and $7,701 and $8,516 of secured institutional money market deposits insured by the FDIC up to the current coverage limits, with any excess collateralized by the holding institution. Both are measured using the market approach. The fair values of treasury notes and CMOs represent unadjusted price estimates obtained from third party independent nationally recognized pricing services using pricing models or quoted prices of securities with similar characteristics and are included in Level 2 of the hierarchy. At the time of initial measurement and, subsequently, when changes in methodologies occur, management obtains and reviews documentation of pricing methodologies used by third party pricing services to verify that prices are determined in accordance with fair value guidance in U.S. GAAP and to ensure that assets are properly classified in the fair value hierarchy. Additionally, third party pricing is reviewed on a monthly basis for reasonableness based on the market knowledge and experience of company personnel that interact daily with the markets for these types of securities. The carrying amount of the money market deposit accounts is considered a reasonable estimate of their fair value because they are cash deposits in interest bearing accounts valued at par. These accounts are included in Level 1 of the hierarchy.
Mortgage Loans Held for Sale-The fair value of mortgage loans held for sale is estimated using a market approach based on quoted secondary market pricing for loan portfolios with similar characteristics. Loans held for sale are carried at the lower of cost or fair value except, as described above, the Company elects the fair value measurement option for mortgage loans held for sale subject to pending agency contracts to securitize and sell loans. Loans held for sale are included in Level 2 of the hierarchy. At September 30, 2012, there were $3,017 of loans held for sale measured at fair value and $121,511 of loans held for sale carried at cost. There were no loans held for sale at September 30, 2011.
Impaired Loans-Impaired loans represent certain loans held for investment that are subject to a fair value measurement under U.S. GAAP because they are individually evaluated for impairment and that impairment is measured using a fair value measurement, such as the observable market price of the loan or the fair value of the collateral less estimated costs to sell. Impairment is measured using the market approach based on the fair value of the collateral less estimated costs to sell for loans the Company considers to be collateral-dependent due to a delinquency status or other adverse condition severe enough to indicate that the borrower can no longer be relied upon as the continued source of repayment.These conditions are described more fully in Note 5, Loans and Allowance for Loan Losses.
The fair value of the collateral for a collateral-dependent loan is estimated using an exterior appraisal in the majority of instances. Only if supporting market data is unavailable or the appraiser is unable to complete the assignment will an alternative valuation method be used. Typically that would entail obtaining a Broker Price Opinion (“BPO”). If neither of these
methods is available, a commercially available automated valuation model (“AVM”) will be used to estimate value. These models are independently developed and regularly updated. The Association has engaged an independent firm to assist with the validation of automated valuation models.
Updated property valuations are obtained for all collateral-dependent impaired loans that become contractually 180 days past due, except that updated appraisals are obtained for equity lines of credit, equity loans, bridge loans, and loans modified in troubled debt restructurings that become contractually 90 days past due. Subsequently, updated appraisals are obtained at least annually for all loans that remain delinquent.
To calculate impairment of collateral-dependent loans, the fair market values are generally reduced by a calculated cost to sell derived from historical experience and recent market conditions to reflect average net proceeds. A valuation allowance is recorded by a charge to income for any indicated impairment loss. When no impairment loss is indicated, the carrying amount is considered to approximate the fair value of that loan to the Company because contractually that is the maximum recovery the Company can expect. Loans individually evaluated for impairment based on the fair value of the collateral are included in Level 3 of the hierarchy with assets measured at fair value on a non-recurring basis.
Loans held for investment that have been restructured in troubled debt restructurings and are performing according to the modified terms of the loan agreement are individually evaluated for impairment using the present value of future cash flows based on the loan’s effective interest rate, which is not a fair value measurement. At September 30, 2012 and 2011, respectively, this included $137,468 and $137,580 in recorded investment of troubled debt restructurings with related allowances for loss of $17,602 and $6,981.
Real Estate Owned-Real estate owned includes real estate acquired as a result of foreclosure or by deed in lieu of foreclosure and is carried at the lower of acquisition cost or fair value less estimated costs to sell. Fair value is estimated under the market approach using independent third party appraisals. As these properties are actively marketed, estimated fair values may be adjusted by management to reflect current economic and market conditions. At September 30, 2012 and 2011, respectively, $16,131 and $10,533 of real estate owned were included in Level 3 of the hierarchy with assets measured at fair value on a non-recurring basis because the acquisition costs exceeded the fair values less estimated costs to sell of these properties. Real estate owned, as reported in the consolidated statements of condition, includes estimated costs to sell of $1,383 and $446 related to properties measured at fair value and $4,899 and $9,068 of properties carried at their original or adjusted cost basis at September 30, 2012 and 2011, respectively.
Mortgage Loan Servicing Assets-Mortgage loan servicing assets are initially recorded at fair value and subsequently amortized over the estimated period of servicing income. The servicing assets are assessed for impairment, based on fair value, on a quarterly basis using a discounted cash flow model incorporating assumptions market participants would use including estimated prepayment speeds, discount factors, and estimated costs to service. For measurement purposes, servicing assets are separated into stratum segregated primarily by the predominant risk characteristics of the loans serviced, such as type, fixed and adjustable rates, original terms, and interest rates. When the carrying value of the servicing asset for an individual stratum exceeds the fair value, the stratum is considered impaired. The amount of impairment is recognized through a valuation allowance recorded in current earnings and the stratum is included in Level 3 of the hierarchy with assets measured at fair value on a non-recurring basis.
Land held for development-Land held for development includes real estate surrounding the Company’s main office in Cleveland, Ohio, acquired to preserve and redevelop the community. It is carried at the lower of acquisition cost or fair value less estimated costs to sell or develop and is included in other assets on the Consolidated Statement of Condition. Fair value is estimated under the market approach using values for comparable projects, adjusted by management to reflect current economic and market conditions. At September 30, 2012, land held for development is carried at its adjusted cost basis. At September 30, 2011 there was $111 of land held for development included in Level 3 of the hierarchy with assets measured at fair value on a non-recurring basis; the acquisition costs of these properties exceeded their fair values less estimated cost to sell or develop by $3,000.
Derivatives-Derivative instruments include interest rate locks on commitments to originate loans for the held for sale portfolio and contracts to deliver mortgage loans. Derivatives are reported at fair value in other assets or other liabilities on the Consolidated Statement of Condition with changes in value recorded in current earnings. Fair value is estimated using a market approach based on quoted secondary market pricing for loan portfolios with characteristics similar to loans underlying the derivative instruments. The fair value of interest rate lock commitments is adjusted by a closure rate based on the estimated percentage of commitments that will result in closed loans. A significant change in the closure rate may result in a significant change in the ending fair value measurement of these derivatives relative to their total fair value. Because the closure rate is a significantly unobservable assumption, interest rate lock commitments are included in Level 3 of the hierarchy. Contracts to deliver mortgage-backed securities are included in Level 2 of the hierarchy.
Assets and liabilities carried at fair value on a recurring basis on the consolidated statements of condition at September 30, 2012 and September 30, 2011 are summarized below.
The table below presents a reconciliation of the beginning and ending balances of derivative instruments measured at fair value on a recurring basis using significant unobservable inputs (Level 3).
The table below summarizes the classification of gains and losses recorded in earnings due to changes in fair value for derivative instruments measured at fair value on a recurring basis using significant unobservable inputs.
Summarized in the table below are those assets measured at fair value on a nonrecurring basis. This includes loans held for investment that are individually evaluated for impairment, excluding performing troubled debt restructurings valued using the present value of cash flow method, land held for development that is carried at lower of acquisition cost or fair value less estimated cost to sell or develop, and properties included in real estate owned that are carried at fair value less estimated costs to sell at the reporting date.
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(1) Amounts represent fair value measurements of properties before deducting estimated costs to sell.
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(1) Amounts represent fair value measurements of properties before deducting estimated costs to sell.
The following provides quantitative information about significant unobservable inputs categorized within Level 3 of the Fair Value Hierarchy.
The following table presents the estimated fair value of the Company’s financial instruments. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
Cash and Due from Banks, Interest Bearing Cash Equivalents-The carrying amount is a reasonable estimate of fair value.
Investment and Mortgage-Backed Securities-Estimated fair value for investment and mortgage-backed securities is based on quoted market prices, when available. If quoted prices are not available, management will use as part of their estimation process fair values which are obtained from third party independent nationally recognized pricing services using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows.
Loans-For mortgage loans held for investment and other loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining term. The use of current rates to discount cash flows reflects current market expectations with respect to credit exposure. Inputs and valuation techniques used to estimate the fair value of loans held for sale and impaired loans is described earlier in this note.
Federal Home Loan Bank Stock-It is not practical to estimate the fair value of FHLB stock due to restrictions on its transferability. The fair value is estimated to be the carrying value, which is par. All transactions in capital stock of the FHLB Cincinnati are executed at par.
Private Equity Investments-Private equity investments are initially valued based upon transaction price. The carrying value is subsequently adjusted when it is considered necessary based on current performance and market conditions. The carrying values are adjusted to reflect expected exit values. These investments are included in Other assets in the accompanying statements of condition at fair value.
Deposits-The fair value of demand deposit accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using discounted cash flows and rates currently offered for deposits of similar remaining maturities.
Borrowed Funds-Estimated fair value for borrowed funds is estimated using discounted cash flows and rates currently charged for borrowings of similar remaining maturities.
Accrued Interest Receivable, Borrowers’ Advances for Insurance and Taxes, and Principal, Interest and Escrow Owed on Loans Serviced-The carrying amount is a reasonable estimate of fair value.
17. DERIVATIVE INSTRUMENTS
The Company has entered into forward commitments for the sale of mortgage loans principally to protect against the risk of adverse interest rate movements on net income. The Company recognizes the fair value of the contracts when the characteristics of those contracts meet the definition of a derivative. These derivatives are not designated in a hedging relationship; therefore, gains and losses are recognized immediately in the statement of income. In addition, the Company has entered into commitments to originate loans, which when funded, were classified as held for sale. Such commitments meet the definition of a derivative and are not designated in a hedging relationship; therefore, gains and losses are recognized immediately in the statement of income. The Company had no derivative instruments at September 30, 2011. The Company had no derivatives designated as hedging instruments ASC 815, “Derivatives and Hedging,” at September 30, 2012 or 2011.
The following tables provide the locations within the Consolidated Statements of Condition and the fair values for derivatives not designated as hedging instruments.
The following table summarizes the location and amount of the gains and losses on derivative instruments not designated as hedging instruments.
18. PARENT COMPANY ONLY FINANCIAL STATEMENTS
The following condensed financial statements for TFS Financial Corporation (parent company only) reflect the investments in, and transactions with, its wholly-owned subsidiaries. Intercompany activity is eliminated in the consolidated financial statements.
19. EARNINGS PER SHARE
Basic earnings per share is the amount of earnings available to each share of common stock outstanding during the reporting period. Diluted earnings per share is the amount of earnings available to each share of common stock outstanding during the reporting period adjusted to include the effect of potentially dilutive common shares. For purposes of computing earnings per share amounts, outstanding shares include shares held by the public, shares held by the ESOP that have been allocated to participants or committed to be released for allocation to participants, the 227,119,132 shares held by Third Federal Savings, MHC, and, for purposes of computing dilutive earnings per share, stock options and restricted stock units with a dilutive impact. At September 30, 2012 and 2011, respectively, the ESOP held 7,475,110 and 7,908,450 shares that were neither allocated to participants nor committed to be released to participants.
The following is a summary of the Company’s earnings per share calculations.
Outstanding stock options and restricted stock units are excluded from the computation of diluted earnings per share when their inclusion would be anti-dilutive.The following is a summary of outstanding stock options and restricted stock units that are excluded from the computation of diluted earnings per share because their inclusion would be anti-dilutive.
20. RELATED PARTY TRANSACTIONS
The Company, through an indirect, majority-owned subsidiary, receives real estate and management services from an
entity under the control of a former Director. His directorship ended February 25, 2010. Management fees of $635, $694, and $693 were paid to the entity under the control of the former Director for the years ended September 30, 2012, 2011, and 2010, respectively.
The Company has made loans and extensions of credit, in the ordinary course of business, to certain Directors. These loans were under normal credit terms, including interest rate and collateralization, and do not represent more than the normal risk of collection. The aggregate amount of loans to such related parties at September 30, 2012 and 2011 was $213 and $1,030, respectively. None of these loans were past due, considered impaired or on nonaccrual at September 30, 2012.
21. RECENT ACCOUNTING PRONOUNCEMENTS
Pending as of September 30, 2012
FASB Accounting Standards Update (“ASU”) 2011-12, “Comprehensive Income (Topic 220), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05” defers indefinitely the provisions of FASB ASU 2011-05 that require entities to present reclassification adjustments for items that are reclassified from other comprehensive income (“OCI”) to net income by component in both the statement in which net income is presented and the statement in which OCI is presented. The only impact of these amendments on the Company's consolidated financial statements would be a change in the presentation of OCI.
FASB ASU 2011-05, “Presentation of Comprehensive Income” eliminates the option to present OCI in the statement of shareholders' equity and provides an entity the option to present the total of comprehensive income, the components of net income, and the components of OCI either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of OCI along with a total for OCI, and a total amount for comprehensive income. Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from OCI to net income in the statement(s). The amendments in this update will be applied retrospectively for all periods presented and are effective for the Company for the interim and annual periods beginning October 1, 2012, with early adoption permitted. The only impact of these amendments on the Company's consolidated financial statements will be a change in the presentation of OCI.
FASB ASU 2011-08, “Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment” was issued in September 2011 to reduce the cost and complexity of performing the first step of the two-step goodwill impairment test. This amendment permits an entity to first assess qualitative factors to determine whether the existence of events or circumstances leads to a more likely than not (more than 50% likelihood) outcome that the fair value of the reporting unit is less than its carrying amount. The performance of the two-step impairment test becomes unnecessary if, after assessing the totality of events and circumstances, the entity determines that it is not more likely than not that the fair value of the reporting unit is less than its carrying amount. The amendment is effective for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company is adopting this guidance for the fiscal year beginning October 1, 2012. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
Adopted in fiscal year ended September 30, 2012
FASB ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS” eliminates unnecessary wording differences between U.S. GAAP and International Financial Reporting Standards, clarifies the intent of existing fair value measurements, and expands disclosure requirements. ASU 2011-04 indicates that the highest and best use and valuation premise in a fair value measurement only apply to nonfinancial assets. In addition, ASU 2011-04 expands qualitative and quantitative fair value disclosures including those related to descriptions of valuation processes used, the sensitivity of the fair value to changes in unobservable inputs and the interrelationships between those inputs, and quantitative disclosures about unobservable inputs and assumptions. The amendments in ASU 2011-04 are effective for interim and annual reporting periods beginning after December 15, 2011. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements. The new and amended disclosures are included in Note 10, Fair Value.
FASB ASU 2011-03, “Reconsideration of Effective Control for Repurchase Agreements” eliminates from U.S. GAAP the requirement for entities to consider whether a transferor (i.e., seller) has the ability to repurchase the financial assets in a repurchase agreement (“repo”). This requirement was one of the criteria under ASC 860 that entities used to determine whether the transferor maintained effective control. Although entities must consider all the effective control criteria under ASC 860, the elimination of this requirement may lead to more conclusions that a repurchase arrangement should be accounted for as a
secured borrowing rather than as a sale. The amendments in ASU 2011-03 are effective for interim and annual reporting periods beginning after December 15, 2011. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements.
The Company has determined that all other recently issued accounting pronouncements will not have a material impact on the Company's consolidated financial statements or do not apply to its operations.
22. SELECTED QUARTERLY DATA (UNAUDITED)
The following tables are a summary of certain quarterly financial data for the fiscal years ended September 30, 2012 and 2011.
Per share amounts for the full fiscal year, as reported in the Consolidated Statements of Income may differ from the totals of the four fiscal quarters as presented above, due to rounding.
FORM 10-K EXHIBIT INDEX
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
TFS Financial Corporation
Dated:
November 29, 2012
/S/ MARC A. STEFANSKI
Marc A. Stefanski
Chairman of the Board, President
and Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.