XNAS:TFSL TFS Financial Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period ended March 31, 2012

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For transition period from              to             

Commission File Number 001-33390

 

 

TFS FINANCIAL CORPORATION

(Exact Name of Registrant as Specified in its Charter)

 

 

 

United States of America   52-2054948

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

7007 Broadway Avenue

Cleveland, Ohio

  44105
(Address of Principal Executive Offices)   (Zip Code)

(216) 441-6000

Registrant’s telephone number, including area code:

Not Applicable

(Former name or former address, if changed since last report)

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨ (do not check if a smaller reporting company)    Smaller Reporting Company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x.

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of the latest practicable date.

As of May 3, 2012 there were 308,915,893 shares of the Registrant’s common stock, par value $0.01 per share, outstanding, of which 227,119,132 shares, or 73.52% of the Registrant’s common stock, were held by Third Federal Savings and Loan Association of Cleveland, MHC, the Registrant’s mutual holding company.

 

 

 


Table of Contents

TFS Financial Corporation

INDEX

 

         Page  

PART l – FINANCIAL INFORMATION

  

Item 1.

  Financial Statements (unaudited)      3   
 

Consolidated Statements of Condition
March 31, 2012 and September 30, 2011

     3   
 

Consolidated Statements of Income
Three and six months ended March 31, 2012 and 2011

     4   
 

Consolidated Statements of Shareholders’ Equity
Six months ended March 31, 2012 and 2011

     5   
 

Consolidated Statements of Cash Flows
Six months ended March 31, 2012 and 2011

     6   
 

Notes to Unaudited Interim Consolidated Financial Statements

     7   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      27   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      60   

Item 4.

  Controls and Procedures      62   

Part II — OTHER INFORMATION

  

Item 1.

  Legal Proceedings      63   

Item 1A.

  Risk Factors      63   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      63   

Item 3.

  Defaults Upon Senior Securities      63   

Item 4.

  Mine Safety Disclosures      63   

Item 5.

  Other Information      63   

Item 6.

  Exhibits      63   
SIGNATURES      65   

 

2


Table of Contents

Item 1. Financial Statements

TFS FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CONDITION (unaudited)

(In thousands, except share data)

 

     March 31,     September 30,  
     2012     2011  

ASSETS

    

Cash and due from banks

   $ 43,739      $ 35,532   

Other interest-earning cash equivalents

     298,676        259,314   
  

 

 

   

 

 

 

Cash and cash equivalents

     342,415        294,846   
  

 

 

   

 

 

 

Investment securities:

    

Available for sale (amortized cost $14,380 and $15,760, respectively)

     14,487        15,899   

Held to maturity (fair value $377,500 and $398,725, respectively)

     374,517        392,527   
  

 

 

   

 

 

 
     389,004        408,426   
  

 

 

   

 

 

 

Mortgage loans held for sale, at lower of cost or market

     245,921        0   

Loans held for investment, net:

    

Mortgage loans

     9,985,914        9,920,907   

Other loans

     5,141        6,868   

Deferred loan fees, net

     (18,122     (19,854

Allowance for loan losses

     (101,296     (156,978
  

 

 

   

 

 

 

Loans, net

     9,871,637        9,750,943   
  

 

 

   

 

 

 

Mortgage loan servicing assets, net

     23,879        28,919   

Federal Home Loan Bank stock, at cost

     35,620        35,620   

Real estate owned

     18,452        19,155   

Premises, equipment, and software, net

     60,197        59,487   

Accrued interest receivable

     34,918        35,854   

Bank owned life insurance contracts

     174,013        170,845   

Other assets

     90,712        88,853   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 11,286,768      $ 10,892,948   
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Deposits

   $ 8,823,176      $ 8,715,910   

Borrowed funds

     419,094        139,856   

Borrowers’ advances for insurance and taxes

     55,722        58,235   

Principal, interest, and related escrow owed on loans serviced

     150,870        151,859   

Accrued expenses and other liabilities

     38,103        53,164   
  

 

 

   

 

 

 

Total liabilities

     9,486,965        9,119,024   
  

 

 

   

 

 

 

Commitments and contingent liabilities

    

Preferred stock, $0.01 par value, 100,000,000 shares authorized, none issued and outstanding

     0        0   

Common stock, $0.01 par value, 700,000,000 shares authorized; 332,318,750 shares shares issued; 308,915,893 outstanding at March 31, 2012 and September 30, 2011

     3,323        3,323   

Paid-in capital

     1,689,810        1,686,216   

Treasury stock, at cost; 23,402,857 shares at March 31, 2012 and

    

September 30, 2011

     (282,090     (282,090

Unallocated ESOP shares

     (76,917     (79,084

Retained earnings—substantially restricted

     471,317        461,836   

Accumulated other comprehensive loss

     (5,640     (16,277
  

 

 

   

 

 

 

Total shareholders’ equity

     1,799,803        1,773,924   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 11,286,768      $ 10,892,948   
  

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

3


Table of Contents

TFS Financial Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME (LOSS) (unaudited)

(In thousands, except share and per share data)

 

     For the Three Months Ended
March 31,
     For the Six Months Ended
March 31,
 
     2012      2011      2012      2011  

INTEREST INCOME:

           

Loans, including fees

   $ 102,696       $ 102,394       $ 205,903       $ 205,594   

Investment securities available for sale

     33         44         70         155   

Investment securities held to maturity

     1,538         2,793         3,272         6,130   

Other interest and dividend earning assets

     551         502         1,108         1,295   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest and dividend income

     104,818         105,733         210,353         213,174   
  

 

 

    

 

 

    

 

 

    

 

 

 

INTEREST EXPENSE:

           

Deposits

     38,390         44,386         79,096         91,664   

Borrowed funds

     643         446         1,217         923   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

     39,033         44,832         80,313         92,587   
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INTEREST INCOME

     65,785         60,901         130,040         120,587   

PROVISION FOR LOAN LOSSES

     27,000         22,500         42,000         57,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

     38,785         38,401         88,040         63,587   
  

 

 

    

 

 

    

 

 

    

 

 

 

NON-INTEREST INCOME

           

Fees and service charges, net of amortization

     3,284         4,418         6,097         7,322   

Increase in and death benefits from bank owned life insurance contracts

     1,610         1,579         3,222         3,219   

Other

     1,517         2,270         2,801         4,545   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest income

     6,411         8,267         12,120         15,086   
  

 

 

    

 

 

    

 

 

    

 

 

 

NON-INTEREST EXPENSE

           

Salaries and employee benefits

     21,049         19,815         41,434         37,300   

Marketing services

     2,377         2,103         4,754         4,204   

Office property, equipment and software

     5,073         4,887         10,071         9,997   

Federal insurance premium and assesments

     3,512         5,847         7,389         11,832   

State franchise tax

     1,716         1,428         2,705         2,367   

Real estate owned expense, net

     1,672         1,987         4,007         3,912   

Appraisal and other loan review expense

     1,163         1,576         2,153         3,902   

Other operating expenses

     6,758         6,332         13,286         13,405   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

     43,320         43,975         85,799         86,919   
  

 

 

    

 

 

    

 

 

    

 

 

 

INCOME (LOSS) BEFORE INCOME TAXES

     1,876         2,693         14,361         (8,246

INCOME TAX EXPENSE (BENEFIT)

     854         469         4,880         (3,122
  

 

 

    

 

 

    

 

 

    

 

 

 

NET INCOME (LOSS)

   $ 1,022       $ 2,224       $ 9,481       $ (5,124
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings (loss) per share—basic and diluted

     0.00       $ 0.01       $ 0.03       $ (0.02
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding

           

Basic

     301,153,080         300,215,753         301,098,610         300,177,749   

Diluted

     301,706,570         300,957,564         301,547,664         300,177,749   

See accompanying notes to unaudited interim consolidated financial statements.

 

4


Table of Contents

TFS FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (unaudited)

Six Months Ended March 31, 2012 and 2011

(In thousands)

 

                                    Accumulated other
comprehensive

income (loss)
       
     Common
stock
     Paid-in
capital
    Treasury
stock
    Unallocated
common stock
held by ESOP
    Retained
earnings
    Unrealized
gains/(losses)
on securities
    Pension
obligation
    Total
shareholders’
equity
 

Balance at September 30, 2010

   $ 3,323         1,686,062        (288,366     (82,699     452,633        90        (18,146   $ 1,752,897   

Comprehensive Loss

                 

Net loss

     —           —          —          —          (5,124     —          —          (5,124

Change in unrealized losses on securities available for sale

     —           —          —          —          —          (88     —          (88

Change in pension obligation

     —           —          —          —          —          —          549        549   
                 

 

 

 

Total comprehensive loss

     —           —          —          —          —          —          —          (4,663

ESOP shares allocated or committed to be released

     —           (305     —          1,448        —          —          —          1,143   

Compensation costs for stock-based plans

     —           3,625        (3     —          —          —          —          3,622   

Excess tax effect from stock-based compensation

     —           (17     —          —          —          —          —          (17

Treasury stock allocated to restricted stock plan

     —           (279     286        —          (7     —          —          —     
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2011

   $ 3,323         1,689,086        (288,083     (81,251     447,502        2        (17,597   $ 1,752,982   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

   $ 3,323         1,686,216        (282,090     (79,084     461,836        90        (16,367   $ 1,773,924   

Comprehensive Income

                 

Net income

     —           —          —          —          9,481        —          —          9,481   

Change in unrealized gains on securities available for sale

     —           —          —          —          —          (20     —          (20

Change in pension obligation

     —           —          —          —          —          —          10,657        10,657   
                 

 

 

 

Total comprehensive income

     —           —          —          —          —          —          —          20,118   

ESOP shares allocated or committed to be released

     —           (183     —          2,167        —          —          —          1,984   

Compensation costs for stock-based plans

     —           3,777        —          —          —          —          —          3,777   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2012

   $ 3,323         1,689,810        (282,090     (76,917     471,317        70        (5,710   $ 1,799,803   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited interim consolidated financial statements.

 

5


Table of Contents

TFS FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(In thousands)

 

     For the Six Months Ended
March 31,
 
     2012     2011  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income (loss)

   $ 9,481      $ (5,124

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

    

ESOP and stock-based compensation expense

     5,761        4,765   

Depreciation and amortization

     9,299        12,125   

Deferred income taxes

     300        800   

Provision for loan losses

     42,000        57,000   

Other net losses

     1,771        1,797   

Principal repayments on and proceeds from sales of loans held for sale

     0        5,290   

Loans originated for sale

     0        (13,231

Increase in and death benefits for bank owned life insurance contracts

     (3,208     (3,226

Net increase in interest receivable and other assets

     (8,986     (122

Net increase (decrease) in accrued expenses and other liabilities

     1,335        (8,868

Other

     416        428   
  

 

 

   

 

 

 

Net cash provided by operating activities

     58,169        51,634   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Loans originated

     (1,477,916     (1,634,641

Principal repayments on loans

     1,057,939        1,021,391   

Proceeds from sales, principal repayments and maturities of:

    

Securities available for sale

     1,355        9,457   

Securities held to maturity

     104,275        167,970   

Proceeds from sale of:

    

Loans

     0        8,023   

Real estate owned

     10,377        6,882   

Purchases of:

    

Securities available for sale

     (12     (2,148

Securities held to maturity

     (88,298     0   

Premises and equipment

     (1,300     (1,597

Other

     (21     (360
  

 

 

   

 

 

 

Net cash used in investing activities

     (393,601     (425,023
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Net increase (decrease) in deposits

     107,266        (95,999

Net decrease in borrowers’ advances for insurance and taxes

     (2,514     (1,659

Net decrease in principal and interest owed on loans serviced

     (989     (181,675

Net increase in short term borrowed funds

     279,238        99,990   

Repayment of long term borrowed funds

     0        (2,000

Excess tax benefit related to stock-based compensation

     0        (17
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     383,001        (181,360
  

 

 

   

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     47,569        (554,749

CASH AND CASH EQUIVALENTS—Beginning of period

     294,846        743,740   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS—End of period

   $ 342,415      $ 188,991   
  

 

 

   

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

    

Cash paid for interest on deposits

   $ 79,546      $ 92,370   

Cash paid for interest on borrowed funds

     1,207        927   

Cash paid for income taxes

     11,800        4,500   

SUPPLEMENTAL SCHEDULES OF NONCASH INVESTING AND FINANCING ACTIVITIES:

    

Transfer of loans to real estate owned

     9,656        11,316   

Transfer of loans from held for sale to held for investment

     0        25,027   

Transfer of loans from held for investment to held for sale

     245,920        0   

See accompanying notes to unaudited interim consolidated financial statements.

 

6


Table of Contents

TFS FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands unless otherwise indicated)

 

 

1. BASIS OF PRESENTATION

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 Holding Company and its subsidiaries (collectively, “TFS Financial” or the “Company”) is retail consumer banking, including mortgage lending, deposit gathering, and other insignificant financial services. On March 31, 2012, approximately 74% of the Holding Company’s outstanding shares were owned by a federally chartered mutual holding company, Third Federal Savings and Loan Association of Cleveland, MHC (“Third Federal Savings, MHC”). The thrift subsidiary of TFS Financial is Third Federal Savings and Loan Association of Cleveland (the “Association”).

The accounting and reporting policies followed by the Company conform in all material respects to accounting principles generally accepted in the United States of America (“U.S. GAAP”) and to general practices in the financial services industry. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates. The allowance for loan losses, the valuation of mortgage loan servicing rights, the valuation of deferred tax assets, and the determination of pension obligations and stock-based compensation are particularly subject to change.

The unaudited interim consolidated financial statements were prepared without an audit and reflect all adjustments of a normal recurring nature which, in the opinion of management, are necessary to present fairly the consolidated financial condition of TFS Financial at March 31, 2012, and its results of operations and cash flows for the periods presented. In accordance with Regulation S-X for interim financial information, these statements do not include certain information and footnote disclosures required for complete audited financial statements. The Holding Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2011 contains consolidated financial statements and related notes, which should be read in conjunction with the accompanying interim consolidated financial statements. The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2012.

 

2. 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 March 31, 2012 and 2011, respectively, the ESOP held 7,691,780 and 8,125,120 shares that were neither allocated to participants nor committed to be released to participants.

 

7


Table of Contents

The following is a summary of our earnings per share calculations.

 

     For the Three Months Ended March 31,  
     2012      2011  
     Income
(loss)
     Shares      Per share
amount
     Income
(loss)
     Shares      Per share
amount
 
     (Dollars in thousands, except per share data)  

Net income

   $ 1,022             $ 2,224         

Less: income allocated to restricted stock units

     6               12         
  

 

 

          

 

 

       

Basic earnings per share:

                 

Income available to common shareholders

   $ 1,016         301,153,080       $ 0.00       $ 2,212         300,215,753       $ 0.01   
        

 

 

          

 

 

 

Diluted earnings per share:

                 

Effect of dilutive potential common shares

        553,490               741,811      
  

 

 

    

 

 

       

 

 

    

 

 

    

Income available to common shareholders

   $ 1,016         301,706,570       $ 0.00       $ 2,212         300,957,564       $ 0.01   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     For the Six Months Ended March 31,  
     2012      2011  
     Income
(loss)
     Shares      Per share
amount
     Income
(loss)
    Shares      Per share
amount
 
     (Dollars in thousands, except per share data)  

Net income (loss)

   $ 9,481             $ (5,124     

Less: income (loss) allocated to restricted stock units

     47               (29     
  

 

 

          

 

 

      

Basic earnings (loss) per share:

                

Income (loss) available to common shareholders

   $ 9,434         301,098,610       $ 0.03       $ (5,095     300,177,749       $ (0.02
        

 

 

         

 

 

 

Diluted earnings (loss) per share:

                

Effect of dilutive potential common shares

        449,054              0      
  

 

 

    

 

 

       

 

 

   

 

 

    

Income (loss) available to common shareholders

   $ 9,434         301,547,664       $ 0.03       $ (5,095     300,177,749       $ (0.02
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Outstanding stock options and restricted stock units are excluded from the computation of diluted earnings per share when their inclusion would be anti-dilutive. There were 5,429,223 unvested stock options, 854,202 vested stock options, and 40,000 restricted stock units outstanding at March 31, 2012 and 4,849,809 unvested stock options and 159,241 vested stock options outstanding at March 31, 2011 that were excluded from the computation of diluted earnings per share for the three and six months ended March 31, 2012 and 2011, respectively, because the effect would be antidilutive. Additionally, there were 1,636,950 restricted stock units outstanding at March 31, 2011 that were excluded from the computation of diluted earnings per share for the six months ended March 31, 2011 because the effect would be antidilutive.

 

3. INVESTMENT SECURITIES

Investments available for sale are summarized as follows:

 

     March 31, 2012  
     Amortized
Cost
     Gross
Unrealized
    Fair
Value
 
        Gains      Losses    

U.S. government and agency obligations

   $ 2,000       $ 40       $ 0      $ 2,040   

Real estate mortgage investment conduits (REMICs)

     4,261         72         (5     4,328   

Money market accounts

     8,119         0         0        8,119   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 14,380       $ 112       $ (5   $ 14,487   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents
     September 30, 2011  
     Amortized
Cost
     Gross
Unrealized
     Fair
Value
 
        Gains      Losses     

U.S. government and agency obligations

   $ 2,000       $ 46       $ 0       $ 2,046   

REMICs

     5,244         93         0         5,337   

Money market accounts

     8,516         0         0         8,516   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 15,760       $ 139       $ 0       $ 15,899   
  

 

 

    

 

 

    

 

 

    

 

 

 

Investment securities held to maturity are summarized as follows:

 

     March 31, 2012  
     Amortized
Cost
     Gross
Unrealized
    Fair
Value
 
        Gains      Losses    

Freddie Mac certificates

   $ 1,466       $ 75       $ 0      $ 1,541   

Ginnie Mae certificates

     17,773         466         0        18,239   

REMICs

     347,839         2,123         (430     349,532   

Fannie Mae certificates

     7,439         749         0        8,188   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 374,517       $ 3,413       $ (430   $ 377,500   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     September 30, 2011  
     Amortized
Cost
     Gross
Unrealized
    Fair
Value
 
        Gains      Losses    

Freddie Mac certificates

   $ 2,724       $ 118       $ 0      $ 2,842   

Ginnie Mae certificates

     19,532         501         0        20,033   

REMICs

     362,489         4,837         (58     367,268   

Fannie Mae certificates

     7,782         800         0        8,582   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 392,527       $ 6,256       $ (58   $ 398,725   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

4. LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans held for investment consist of the following:

 

     March 31,
2012
    September 30,
2011
 

Real estate loans:

    

Residential non-Home Today

   $ 7,407,288      $ 7,120,789   

Residential Home Today

     230,607        264,019   

Home equity loans and lines of credit

     2,316,224        2,491,198   

Construction

     57,348        82,048   
  

 

 

   

 

 

 

Real estate loans

     10,011,467        9,958,054   

Consumer and other loans

     5,141        6,868   

Less:

    

Deferred loan fees—net

     (18,122     (19,854

Loans-in-process (“LIP”)

     (25,553     (37,147

Allowance for loan losses

     (101,296     (156,978
  

 

 

   

 

 

 

Loans held for investment, net

   $ 9,871,637      $ 9,750,943   
  

 

 

   

 

 

 

At March 31, 2012, $245,921 of long-term, fixed-rate loans were reclassified from the portfolio of loans held for investment to mortgage loans held for sale.

In an October 2011 directive, the Office of the Comptroller of the Currency required all specific valuation allowances (“SVA”) on collateral-dependent loans (SVAs established when the recorded investment in an impaired loan exceeded the

 

9


Table of Contents

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. As a result, reported loan charge-offs for the six months ended March 31, 2012 were impacted by the charge-off of specific valuation allowances, which had a balance of $55,507 at September 30, 2011. This one-time charge-off did not impact the provision for loan losses for the quarter ended December 31, 2011; however, reported loan charge-offs during the December 2011 quarter increased and the balances of loans, the allowance for loan losses, non-accrual status loans and loan delinquencies as of December 31, 2011, all decreased accordingly.

A large concentration of the Company’s lending is in Ohio and Florida. As of March 31, 2012 and September 30, 2011, the percentages of residential real estate loans held in Ohio were 79% and 81%, and the percentages held in Florida were 17% and 17%, respectively. As of March 31, 2012 and September 30, 2011, home 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 for loans originated 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 were changed to be substantially the same as the Association’s traditional first mortgage product. As of March 31, 2012 and September 30, 2011, the balance of Home Today loans originated prior to March 27, 2009 was $226,722 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 pay option adjustable-rate mortgages.

The recorded investment of loan receivables in non-accrual status is summarized in the following table. Balances are net of deferred fees.

 

     March 31,
2012
     September 30,
2011
 

Real estate loans:

     

Residential non-Home Today

   $ 99,022       $ 125,014   

Residential Home Today

     46,368         69,602   

Home equity loans and lines of credit

     34,318         36,872   

Construction

     785         3,770   
  

 

 

    

 

 

 

Total real estate loans

     180,493         235,258   

Consumer and other loans

     0         0   
  

 

 

    

 

 

 

Total non-accrual loans

   $ 180,493       $ 235,258   
  

 

 

    

 

 

 

Loans are placed in nonaccrual status when they are contractually 90 days or more past due. Loans modified in troubled debt restructurings that were in nonaccrual status prior to the restructurings remain in nonaccrual status for a minimum of six months. Home equity loans and lines of credit where the customer also has a delinquent first mortgage greater than 180 days past due or delinquent first mortgage modification greater than 90 days past due will also be placed on nonaccrual status. At March 31, 2012, the recorded investment in nonaccrual status loans includes $14,595 of performing second lien loans subordinate to first mortgages delinquent greater than 180 days or subordinate to senior lien modifications delinquent greater than 90 days. 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 nonaccrual 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 nonaccrual status are applied to the oldest scheduled, unpaid principal and interest payment first. A nonaccrual loan, other than a troubled debt restructuring, a loan with a partial charge-off, or equity loan or line of credit with a delinquent first mortgage greater than 180 days or delinquent first mortgage modification greater than 90 days, is returned to accrual status when contractual payments are less than 90 days past due. The number of days past due is determined by the number of days the oldest contractual principal and interest payment remains unpaid. Total performing nonaccrual loans at March 31, 2012 and September 30, 2011 includes

 

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Table of Contents

$15,352 and $16,465, respectively, in troubled debt restructurings which are current according to the terms of their agreement but included with nonaccrual loans for a minimum period of six months from the restructuring date due to their nonaccrual status prior to restructuring or because they have been partially charged-off.

Age analysis of the recorded investment in loan receivables that are past due at March 31, 2012 and September 30, 2011 is summarized in the following tables. When a loan is more than 30 days past due on its scheduled principal and interest payments, the loan is considered 30 days or more past due. Balances are net of deferred fees and any applicable loans-in-process.

 

     30-59
Days
Past Due
     60-89
Days
Past Due
     90 Days or
More Past
Due
     Total Past
Due
     Current      Total  

March 31, 2012

                 

Real estate loans:

                 

Residential non-Home Today

   $ 11,056       $ 8,675       $ 91,451       $ 111,182       $ 7,271,387       $ 7,382,569   

Residential Home Today

     6,952         3,834         35,510         46,296         180,643         226,939   

Home equity loans and lines of credit

     8,666         4,341         19,393         32,400         2,294,529         2,326,929   

Construction

     0         0         457         457         30,898         31,355   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate loans

   $ 26,674       $ 16,850       $ 146,811       $ 190,335       $ 9,777,457       $ 9,967,792   

Consumer and other loans

     0         0         0         0         5,141         5,141   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 26,674       $ 16,850       $ 146,811       $ 190,335       $ 9,782,598       $ 9,972,933   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     30-59
Days
Past Due
     60-89
Days
Past Due
     90 Days or
More Past
Due
     Total Past
Due
     Current      Total  

September 30, 2011

                 

Real estate loans:

                 

Residential non-Home Today

   $ 19,509       $ 9,818       $ 118,517       $ 147,844       $ 6,942,424       $ 7,090,268   

Residential Home Today

     12,399         7,131         59,985         79,515         183,372         262,887   

Home equity loans and lines of credit

     11,299         6,126         36,521         53,946         2,449,707         2,503,653   

Construction

     72         0         3,770         3,842         40,403         44,245   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate loans

     43,279         23,075         218,793         285,147         9,615,906         9,901,053   

Consumer and other loans

     0         0         0         0         6,868         6,868   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 43,279       $ 23,075       $ 218,793       $ 285,147       $ 9,622,774       $ 9,907,921   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Activity in the allowance for loan losses is summarized as follows:

 

     For the Three Months Ended
March 31, 2012
 
     Beginning
Balance
     Provisions      Charge-offs     Recoveries      Ending
Balance
 

Real estate loans:

             

Residential non-Home Today

   $ 29,227       $ 8,462       $ (7,626   $ 239       $ 30,302   

Residential Home Today

     20,092         5,814         (5,820     32         20,118   

Home equity loans and lines of credit

     46,435         12,204         (10,349     1,041         49,331   

Construction

     1,129         520         (106     2         1,545   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate loans

     96,883         27,000         (23,901     1,314         101,296   

Consumer and other loans

     0         0         0        0         0   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 96,883       $ 27,000       $ (23,901   $ 1,314       $ 101,296   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

11


Table of Contents
     For the Three Months Ended
March 31, 2011
 
     Beginning
Balance
     Provisions     Charge-offs     Recoveries      Ending
Balance
 

Real estate loans:

            

Residential non-Home Today

   $ 48,737       $ 4,495      $ (3,896   $      83       $ 49,419   

Residential Home Today

     18,143         8,053        (1,528     17         24,685   

Home equity loans and lines of credit

     76,759         10,310        (14,958     399         72,510   

Construction

     4,606         (358     (126     10         4,132   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total real estate loans

   $ 148,245       $ 22,500      $ (20,508   $ 509       $ 150,746   

Consumer and other loans

     1         0        0        0         1   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 148,246       $ 22,500      $ (20,508   $ 509       $ 150,747   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

 

     For the Six Months Ended
March 31, 2012
 
     Beginning
Balance
     Provisions      Charge-offs     Recoveries      Ending
Balance
 

Real estate loans:

             

Residential non-Home Today

   $ 49,484       $ 15,640       $ (35,164   $ 342       $ 30,302   

Residential Home Today

     31,025         18,717         (29,708     84         20,118   

Home equity loans and lines of credit

     74,071         7,307         (33,573     1,526         49,331   

Construction

     2,398         336         (1,192     3         1,545   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate loans

   $ 156,978       $ 42,000       $ (99,637   $ 1,955       $ 101,296   

Consumer and other loans

     0         0         0        0         0   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 156,978       $ 42,000       $ (99,637   $ 1,955       $ 101,296   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

     For the Six Months Ended
March 31, 2011
 
     Beginning
Balance
     Provisions     Charge-offs     Recoveries      Ending
Balance
 

Real estate loans:

            

Residential non-Home Today

   $ 41,246       $ 15,969      $ (7,960   $ 164       $ 49,419   

Residential Home Today

     13,331         14,641        (3,347     60         24,685   

Home equity loans and lines of credit

     73,780         26,690        (28,773     813         72,510   

Construction

     4,882         (300     (483     33         4,132   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total real estate loans

   $ 133,239       $ 57,000      $ (40,563   $ 1,070       $ 150,746   

Consumer and other loans

     1         0        0        0         1   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 133,240       $ 57,000      $ (40,563   $ 1,070       $ 150,747   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

The recorded investment in loan receivables at March 31, 2012 and September 30, 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 loans-in-process.

 

     March 31, 2012      September 30, 2011  
     Individually      Collectively      Total      Individually      Collectively      Total  

Real estate loans:

                 

Residential non-Home Today

   $ 139,527       $ 7,243,042       $ 7,382,569       $ 159,924       $ 6,930,344       $ 7,090,268   

Residential Home Today

     106,963         119,976         226,939         134,381         128,506         262,887   

Home equity loans and lines of credit

     20,397         2,306,532         2,326,929         39,738         2,463,915         2,503,653   

Construction

     1,311         30,044         31,355         5,729         38,516         44,245   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate loans

     268,198         9,699,594         9,967,792         339,772         9,561,281         9,901,053   

Consumer and other loans

     0         5,141         5,141         0         6,868         6,868   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 268,198       $ 9,704,735       $ 9,972,933       $ 339,772       $ 9,568,149       $ 9,907,921   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

12


Table of Contents

An analysis of the allowance for loan losses at March 31, 2012 and September 30, 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.

 

     March 31, 2012      September 30, 2011  
     Individually      Collectively      Total      Individually      Collectively      Total  

Real estate loans:

                 

Residential non-Home Today

   $ 4,283       $ 26,019       $ 30,302       $ 25,395       $ 24,089       $ 49,484   

Residential Home Today

     6,193         13,925         20,118         21,938         9,087         31,025   

Home equity loans and lines of credit

     2,195         47,136         49,331         14,324         59,747         74,071   

Construction

     106         1,439         1,545         1,255         1,143         2,398   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate loans

     12,777         88,519         101,296         62,912         94,066         156,978   

Consumer and other loans

     0         0         0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 12,777       $ 88,519       $ 101,296       $ 62,912       $ 94,066       $ 156,978   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At March 31, 2012, individually evaluated loans that required an allowance were comprised only of loans dependent on cash flows, such as performing troubled debt restructurings, 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 dependent on 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 an 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. Principal balances are used for the individually evaluated portion of the allowance for loan losses. At March 31, 2012 and September 30, 2011, respectively, individually allocated, collateral-based reserves on impaired loans were $0 and $55,507; $10,773 and $7,010 were allowances on other individually reviewed loans dependent on cash flows, such as performing TDRs; and $2,003 and $395 were allowances on loans with further deteriorations in the fair value of collateral not yet identified as uncollectible. Prior to the quarter ended December 31, 2011, specific valuation allowances were assessed on impaired loans as described later in this footnote.

Residential non-Home Today mortgage loans represent the largest portion 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 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 March 31, 2012, approximately 55% 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.

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. Effective June 28, 2010, due to the deterioration in overall housing conditions including concerns for loans and lines in a second lien position, home equity lines of credit and home equity loans were no longer offered by the Association. Beginning March 20, 2012, The Association offered new home equity lines of credit to qualifying existing customers for whom the draw period of their current home equity line of credit was about to expire upon which date the home equity line of credit would otherwise convert to a ten year amortizing loan.

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

 

13


Table of Contents

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 will be honored for a period not longer than one year, giving our customers the ability to secure new borrowing relationships.

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. 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 March 31, 2012 and September 30, 2011 are summarized as follows. Balances of recorded investments are net of deferred fees.

 

     March 31, 2012      September 30, 2011  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

With no related allowance recorded:

                 

Residential non-Home Today

   $ 79,478       $ 77,201       $ 0       $ 32,713       $ 32,854       $ 0   

Residential Home Today

     40,012         40,103         0         8,614         8,651         0   

Home equity loans and lines of credit

     14,902         14,850         0         12,121         12,061         0   

Construction

     457         457         0         798         804         0   

Consumer and other loans

     0         0         0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 134,849       $ 132,611       $ 0       $ 54,246       $ 54,370       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

                 

Residential non-Home Today

   $ 60,049       $ 61,973       $ 4,283       $ 127,211       $ 127,758       $ 25,395   

Residential Home Today

     66,951         68,638         6,193         125,767         126,309         21,938   

Home equity loans and lines of credit

     5,495         5,571         2,195         27,617         27,480         14,324   

Construction

     854         854         106         4,931         4,971         1,255   

Consumer and other loans

     0         0         0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 133,349       $ 137,036       $ 12,777       $ 285,526       $ 286,518       $ 62,912   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans:

                 

Residential non-Home Today

   $ 139,527       $ 139,174       $ 4,283       $ 159,924       $ 160,612       $ 25,395   

Residential Home Today

     106,963         108,741         6,193         134,381         134,960         21,938   

Home equity loans and lines of credit

     20,397         20,421         2,195         39,738         39,541         14,324   

Construction

     1,311         1,311         106         5,729         5,775         1,255   

Consumer and other loans

     0         0         0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 268,198       $ 269,647       $ 12,777       $ 339,772       $ 340,888       $ 62,912   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At March 31, 2012 and September 30, 2011, respectively, the recorded investment in impaired loans includes $156,530 and $166,197 of loans modified in troubled debt restructurings of which $20,291 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 sell when it is probable that the sole source of repayment for the loan is the underlying collateral. Beginning September 30, 2010, equity loans, bridge loans, and loans modified in troubled debt restructurings were included in loans individually evaluated based on the fair value of the collateral at 90 or more days past due. Prior to September 30, 2010, the collateral-based evaluation was performed on these loans at 180 or more days past due. A loan 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

 

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have a prior charge-off. Loans in all portfolios that have a partial charge-off due to meeting the criteria for individual impairment evaluation will continue to be individually evaluated for impairment until, at a minimum, the impairment has been recovered.

Loans modified in troubled debt restructurings 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 when the loan is less than 90 days past due. 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 analyses. Troubled debt restructurings that are 90 days or more past due or have a partial charge-off are evaluated for impairment based on the fair value of the collateral. The fair value less estimated cost to dispose of the underlying property is compared to the recorded investment in the loan 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. 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. The majority of the Company’s modifications do not meet these criteria.

The average recorded investment in impaired loans and the amount of interest income recognized during the period that the loans were impaired are summarized below. Beginning with the three month period ended December 31, 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.

 

     Three Months Ended March 31,  
     2012      2011  
     Average
Recorded
Investment
     Interest
Income
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance recorded:

           

Residential non-Home Today

   $ 78,237       $ 283       $ 41,507       $ 0   

Residential Home Today

     41,377         437         30,761         0   

Home equity loans and lines of credit

     18,170         37         16,760         0   

Construction

     654         1         152         0   

Consumer and other loans

     0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 138,438       $ 758       $ 89,180       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

           

Residential non-Home Today

     59,536       $ 765       $ 112,467       $ 593   

Residential Home Today

     67,164         658         103,197         564   

Home equity loans and lines of credit

     4,339         41         33,774         40   

Construction

     1,283         8         6,990         9   

Consumer and other loans

     0         0         1         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 132,322       $ 1,472       $ 256,429       $ 1,206   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans:

           

Residential non-Home Today

   $ 137,773       $ 1,048       $ 153,974       $ 593   

Residential Home Today

     108,541         1,095         133,958         564   

Home equity loans and lines of credit

     22,509         78         50,534         40   

Construction

     1,937         9         7,142         9   

Consumer and other loans

     0         0         1         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 270,760       $ 2,230       $ 345,609       $ 1,206   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     Six Months Ended March 31,  
     2012      2011  
     Average
Recorded
Investment
     Interest
Income
Recognized
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance recorded:

           

Residential non-Home Today

   $ 56,096       $ 504       $ 39,919       $ 0   

Residential Home Today

     24,313         702         32,206         0   

Home equity loans and lines of credit

     13,512         91         17,855         0   

Construction

     628         13         194         0   

Consumer and other loans

     0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 94,549       $ 1,310       $ 90,174       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

           

Residential non-Home Today

     93,630       $ 1,486       $ 111,794       $ 1,107   

Residential Home Today

     96,359         1,277         99,656         1,059   

Home equity loans and lines of credit

     16,556         80         33,785         101   

Construction

     2,893         28         7,499         18   

Consumer and other loans

     0         0         1         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 209,438       $ 2,871       $ 252,735       $ 2,285   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total impaired loans:

           

Residential non-Home Today

   $ 149,726       $ 1,990       $ 151,713       $ 1,107   

Residential Home Today

     120,672         1,979         131,862         1,059   

Home equity loans and lines of credit

     30,068         171         51,640         101   

Construction

     3,521         41         7,693         18   

Consumer and other loans

     0         0         1         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 303,987       $ 4,181       $ 342,909       $ 2,285   
  

 

 

    

 

 

    

 

 

    

 

 

 

The amounts of interest income on impaired loans recognized using a cash-basis method are $728 and $1,294 for the three and six months ended March 31, 2012, respectively, and are not considered material for the three and six months ended March 31, 2011.

For all loans modified during the three and six month periods ended March 31, 2012 (set forth in the table below), the pre-modification outstanding recorded investment was not materially different from the post-modification outstanding recorded investment.

The following table sets forth the recorded investment in troubled debt restructured loans modified during the period, by the types of concessions granted.

 

     For the Three Months Ended March 31, 2012  
     Reduction in
Interest Rates
     Payment
Extensions
     Forbearance or
Other Actions
     Multiple
Concessions
    Multiple
Modifications
    Total  

Residential non-Home Today

   $ 2,638       $ 261       $      193       $ 1,703      $ 364      $   5,159   

Residential Home Today

     201         0         124         819        875        2,019   

Home equity loans and lines of credit

     24         0         0         14        67        105   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total

   $ 2,863       $ 261       $      317       $ 2,536       $ 1,306        $ 7,283   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

     For the Six Months Ended March 31, 2012  
     Reduction in
Interest Rates
     Payment
Extensions
     Forbearance or
Other Actions
     Multiple
Concessions
     Multiple
Modifications
     Total  

Residential non-Home Today

   $ 5,360       $ 261       $ 1,430       $ 4,417       $ 1,613       $ 13,081   

Residential Home Today

     1,368         0         1,285         1,740         2,671         7,064   

Home equity loans and lines of credit

     24         0         62         14         158         258   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 6,752       $ 261       $ 2,777       $ 6,171       $ 4,442       $ 20,403   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

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 13% of short-term modifications extended into more permanent or longer-term modifications.

The following table provides information on troubled debt restructured loans modified within the last 12 months that defaulted during the period presented.

 

     For the Three Months Ended
March 31, 2012
     For the Six Months Ended
March 31, 2012
 
Troubled Debt Restructurings That Subsequently Defaulted    Number of
Contracts
     Recorded
Investment
     Number of
Contracts
     Recorded
Investment
 
     (Dollars in thousands)      (Dollars in thousands)  

Residential non-Home Today

     11       $ 1,172         12       $ 1,217   

Residential Home Today

     52         4,189         60         4,960   

Home equity loans and lines of credit

     1         22         1         22   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     64       $ 5,383         73       $ 6,199   
  

 

 

    

 

 

    

 

 

    

 

 

 

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.

 

     Pass      Special
Mention
     Substandard      Loss      Total  

March 31, 2012

              

Real Estate Loans:

              

Residential non-Home Today

   $ 7,282,395       $ 0       $ 100,174       $           0       $ 7,382,569   

Residential Home Today

     179,596         0         47,343         0         226,939   

Home equity loans and lines of credit

     2,282,215         10,377         34,337         0         2,326,929   

Construction

     30,379         0         976         0         31,355   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 9,774,585       $ 10,377       $ 182,830       $ 0       $ 9,967,792   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Pass      Special
Mention
     Substandard      Loss      Total  

September 30, 2011

              

Real Estate Loans:

              

Residential non-Home Today

   $ 6,963,582       $ 0       $ 104,290       $ 22,396       $ 7,090,268   

Residential Home Today

     192,034         0         52,719         18,134         262,887   

Home equity loans and lines of credit

     2,449,273         13,591         27,033         13,756         2,503,653   

Construction

     39,378         0         3,761         1,106         44,245   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 9,644,267       $ 13,591       $ 187,803       $ 55,392       $ 9,901,053   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Residential loans are internally assigned a grade that complies with the guidelines outlined in the Comptroller’s Handbook for Rating Credit Risk. Pass loans are assets well protected by the current paying capacity of the borrower and the value of the underlying collateral. Special Mention loans have a potential weakness that the Association feels deserves 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. Loss loans are considered uncollectible and effective as of December, 31, 2011, will be charged off. Prior to December 31, 2011, loss loans carried an SVA.

At March 31, 2012 and September 30, 2011, respectively, the recorded investment of impaired loans includes $119,885 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 March 31, 2012 and September 30, 2011, respectively,

 

17


Table of Contents

there were $34,554 and $24,576 of loans classified substandard and $10,340 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.

 

     March 31,
2012
     September 30,
2011
 

Performing

   $ 5,141       $ 6,868   

Nonperforming

     0         0   
  

 

 

    

 

 

 

Total

   $ 5,141       $ 6,868   
  

 

 

    

 

 

 

Consumer loans are internally assigned a grade of nonperforming when they become 90 days or more past due.

 

5. DEPOSITS

Deposit account balances are summarized as follows:

 

     March 31,
2012
     September 30,
2011
 

Negotiable order of withdrawal accounts

   $ 1,016,152       $ 975,443   

Savings accounts

     1,772,789         1,681,586   

Certificates of deposit

     6,033,642         6,057,838   
  

 

 

    

 

 

 
     8,822,583         8,714,867   

Accrued interest

     593         1,043   
  

 

 

    

 

 

 

Total deposits

   $ 8,823,176       $ 8,715,910   
  

 

 

    

 

 

 

 

6. INCOME TAXES

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 2008. The Internal Revenue Service is currently conducting an audit of the Company’s 2008, 2009, and 2010 federal tax returns. The State of Ohio Department of Taxation is currently conducting an audit of the Company’s 2008, 2009, and 2010 Ohio Franchise Tax Returns.

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.

 

7. DEFINED BENEFIT PLAN

The 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 a separate tier of the Company’s defined contribution 401(k) Savings Plan. Benefits under the Plan are based on years of service and the employee’s average annual compensation (as defined in the Plan). The funding policy of the Plan is consistent with the funding requirements of U.S. federal and other governmental laws and regulations.

 

18


Table of Contents

The components of net periodic benefit cost recognized in the statements of income are as follows:

 

     Three Months Ended
March 31,
    Six Months Ended
March 31,
 
     2012     2011     2012     2011  

Service cost

   $ 0      $ 1,084      $ 1,005      $ 2,168   

Interest cost

     678        984        1,595        1,968   

Expected return on plan assets

     (945     (841     (1,837     (1,683

Amortization of net loss

     58        438        458        876   

Amortization of prior service cost

     0        (15     (15     (30

Recognized net gain due to curtailment

     0        0        (267     0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

   $ (209   $ 1,650      $ 939      $ 3,299   
  

 

 

   

 

 

   

 

 

   

 

 

 

Minimum employer contributions paid during the six months ended March 31, 2012 were $2,350. Minimum employer contributions expected during the remainder of the fiscal year are $2,101.

During the quarter ended December 31, 2011, the Company adopted an amendment to freeze Plan benefit accruals as of December 31, 2011 for participants in the Plan. 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. As a result of the freeze, net periodic benefit cost recognized in the statement of income will be significantly reduced after December 31, 2011. Offsetting a portion of that decrease will be a future benefit contribution attributable to employees impacted by the freeze, as they became eligible for the third tier of benefits under the 401(k) savings plan after December 31, 2011. The combined expense expected to be recorded during fiscal 2012 for the net periodic benefit cost of the pension plan and the additional third tier contributions for the affected employees is estimated to be $1,500.

 

8. EQUITY INCENTIVE PLAN

On December 19, 2011, 1,277,500 options to purchase our common stock and 444,700 restricted stock units were granted to certain officers and employees of the Company. The awards were made pursuant to the shareholder-approved 2008 Equity Incentive Plan.

During the six months ended March 31, 2012 and 2011, the Company recorded $3,777 and $3,625, respectively, of stock-based compensation expense, comprised of stock option expense of $1,939 and $1,426, respectively, and restricted stock units expense of $1,838 and $2,199, respectively.

At March 31, 2012, 6,283,425 shares were subject to options, with a weighted average exercise price of $11.28 per share and a weighted average grant date fair value of $2.95 per share. Expected future expense related to the 5,429,223 non-vested options outstanding as of March 31, 2012 is $8,274 over a weighted average of 2.8 years. At March 31, 2012, 1,486,165 restricted stock units, with a weighted average grant date fair value of $10.82 per unit, are unvested. Expected future compensation expense relating to the 1,682,900 restricted stock units outstanding as of March 31, 2012 is $10,097 over a weighted average period of 3.3 years. Each unit is equivalent to one share of common stock.

 

9. 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 ten years following the date that the line of credit was established, subject to various conditions including compliance with payment obligations, 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

 

19


Table of Contents

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 March 31, 2012, the Company had commitments to originate loans as follows:

 

Fixed-rate mortgage loans

   $ 253,128   

Adjustable-rate mortgage loans

     414,550   

Equity and bridge loans

     862   
  

 

 

 

Total

   $ 668,540   
  

 

 

 

At March 31, 2012, the Company had unfunded commitments outstanding as follows:

 

Home equity lines of credit (excluding commitments for suspended accounts)

   $ 1,393,823   

Construction loans

     26,088   

Private equity investments

     13,813   
  

 

 

 

Total

   $ 1,433,724   
  

 

 

 

At March 31, 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 $1,631,350.

The Company assumes a portion of the 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 5% to 12% in excess of the initial 5% loss layer of a given pool of loans, in exchange for a portion of the pool’s mortgage insurance premiums. The first 5% layer of loss must be exceeded before the Company assumes any liability. At March 31, 2012, the maximum losses under the reinsurance contracts were limited to $15,087. The Company has paid $3,334 of losses under these reinsurance contracts and has provided a liability for the remaining estimated losses totaling $3,778 as of March 31, 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 a number of 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:

 

     Three Months Ended
March 31,
    Six Months Ended
March 31,
 
     2012     2011     2012     2011  

Balance, beginning of period

   $ 3,979      $ 4,787      $ 4,023      $ 5,082   

Incurred increase (decrease)

     329        (128     500        (142

Paid claims

     (530     (251     (745     (532
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 3,778      $ 4,408      $ 3,778      $ 4,408   
  

 

 

   

 

 

   

 

 

   

 

 

 

Management expects that the above commitments will be funded through normal operations.

 

10. 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. 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.

 

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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 loan securitization 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 March 31, 2012 and September 30, 2011, respectively, this includes $6,368 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 $8,119 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. Loans held for sale at March 31, 2012 are 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 4, 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 home equity lines of credit, home 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 of the collateral are reduced by estimated costs to sell to reflect average net proceeds. Costs to sell, derived from historical experience and recent market conditions, range from 11% to 43%. Historically, a specific valuation allowance was recorded by a charge to income for any indicated impairment loss. Beginning with the quarter ended December 31, 2011, any indicated impairment loss is charged off. When no impairment loss is indicated, the carrying amount is considered to approximate the fair value of that loan to the Company

 

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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.

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 basis 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 March 31, 2012 and September 30, 2011, respectively, there was $13,402 and $10,533 of real estate owned included in Level 3 of the hierarchy with assets measured at fair value on a non-recurring basis where 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 $823 and $446 related to these properties at March 31, 2012 and September 30, 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. There was no impairment of the mortgage loan servicing asset recognized at March 31, 2012 and September 30, 2011.

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 cost basis or fair value less estimated costs to sell or develop and is included in other assets in the Consolidated Statements 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 March 31, 2012, land held for development is carried at its 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. At September 30, 2011, the acquisition cost of these properties exceeded their fair values less estimated cost to sell or develop by $3,000.

Derivatives – Derivative instruments include forward commitments on contracts to deliver loans or mortgage-backed securities. Derivatives are reported at fair value in other assets or other liabilities in the Consolidated Statement of Condition with changes in value recorded in current earnings. Fair value is estimated using quoted secondary market pricing for loan portfolios with similar characteristics. Forward commitments on contracts to deliver mortgage-backed securities are included in Level 2 of the hierarchy. The fair value of forward commitments on contracts to deliver loans was $0 at March 31, 2012 and September 30, 2011.

 

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Assets and liabilities carried at fair value on a recurring basis in the Consolidated Statements of Condition at March 31, 2012 and September 30, 2011 are summarized below.

 

            Recurring Fair Value Measurements at Reporting Date  Using  
         March 31,    
2012
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Assets

           

Investment securities available for sale:

           

U.S. government and agency obligations

   $ 2,040       $ 0       $ 2,040       $ 0   

REMIC’s

     4,328         0         4,328         0   

Money market accounts

     8,119         8,119         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 14,487       $ 8,119       $ 6,368       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

            Recurring Fair Value Measurements at Reporting Date  Using  
     September 30,
2011
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Assets

           

Investment securities available for sale:

           

U.S. government and agency obligations

   $ 2,046       $ 0       $ 2,046       $ 0   

REMIC’s

     5,337         0         5,337         0   

Money market accounts

     8,516         8,516         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 15,899       $ 8,516       $ 7,383       $ 0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Summarized in the tables 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, 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.

 

            Nonrecurring Fair Value Measurements at Reporting Date  Using  
     March 31,
2012
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable

Inputs
(Level 3)
 

Impaired loans, net of allowance

   $ 134,919       $ 0       $ 0       $ 134,919   

Real estate owned1

     13,402         0         0         13,402   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 148,321       $ 0       $ 0       $ 148,321   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

1 

Amounts represent fair value measurements of properties before deducting estimated costs to sell.

 

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Table of Contents
            Nonrecurring Fair Value Measurements at Reporting Date  Using  
     September 30,
2011
     Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable Inputs
(Level 3)
 

Impaired loans, net of allowance

   $ 145,698       $ 0       $ 0       $ 145,698   

Real estate owned1

     10,533         0         0         10,533   

Land held for development

     111         0         0         111   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 156,342       $ 0       $ 0       $ 156,342   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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.

 

    

Fair Value

3/31/12

  

Valuation Technique(s)

  

Unobservable Input

  

Range (Weighted

Average)

Real Estate

Owned

  

$13,402

   Market comparables, adjusted to reflect current economic and market conditions.   

Discount on appraised value for recent market conditions:

 

• Properties appraised $0 to $50

 

• Properties appraised greater than $50

  

 

1% - 60% (25.6%)

 

1% - 28% (8%)

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.

 

     At March 31, 2012      At September 30, 2011  
     Carrying
Amount
     Estimated
Fair Value
     Carrying
Amount
     Estimated
Fair Value
 

Assets:

           

Cash and due from banks

   $ 43,739       $ 43,739       $ 35,532       $ 35,532   

Other interest bearing cash equivalents

     298,676         298,676         259,314         259,314   

Investment securities:

           

Available for sale

     14,487         14,487         15,899         15,899   

Held to maturity

     374,517         377,500         392,527         398,725   

Mortgage loans held for sale

     245,921         254,276         0         0   

Loans-net:

           

Mortgage loans held for investment

     9,866,496         10,081,884         9,744,075         9,953,386   

Other loans

     5,141         5,489         6,868         7,597   

Federal Home Loan Bank stock

     35,620         35,620         35,620         35,620   

Private equity investments

     1,188         1,188         1,604         1,604   

Accrued interest receivable

     34,918         34,918         35,854         35,854   

Liabilities:

           

NOW and passbook accounts

   $ 2,788,941       $ 2,788,941       $ 2,657,029       $ 2,657,029   

Certificates of deposit

     6,034,235         6,188,339         6,058,881         6,248,137   

Borrowed funds

     419,094         422,397         139,856         142,889   

Borrowers’ advances for taxes and insurance

     55,722         55,722         58,235         58,235   

Principal, interest and escrow owed on loans serviced

     150,870         150,870         151,859         151,859   

Presented below is a discussion of the valuation techniques and inputs used by the Company to estimate fair value and the level of the fair value hierarchy within which the measurements are categorized.

 

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Table of Contents

Cash and Due from Banks, Interest Earning Cash Equivalents— The carrying amount is a reasonable estimate of fair value. (Level 1)

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 that are obtained from third party independent nationally recognized pricing services using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. (Level 2)

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. Impaired loans are measured at the lower of cost or fair value as described above in this note. (Level 3)

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 at the carrying value, which is par. All transactions in capital stock of the FHLB of 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 Consolidated Statements of Condition at fair value. (Level 3)

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. (Level 2)

Borrowed Funds— Estimated fair value for borrowed funds is estimated using discounted cash flows and rates currently charged for borrowings of similar remaining maturities. (Level 2)

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. (Level 2)

 

11. DERIVATIVE INSTRUMENTS

The Company may enter 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 such contracts when the characteristics of those contracts meet the definition of a derivative. Such derivatives are not designated in a hedging relationship; therefore, gains and losses are recognized immediately in the statement of income. In addition, the Company may enter 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. The fair value of forward commitments for the sale of mortgage loans was $0 at March 31, 2012 and September 30, 2011. The Company had no derivatives designated as hedging instruments under Accounting Standards Codification (“ASC”) 815, “Derivatives and Hedging,” during the three and six months ended March 31, 2012 and 2011.

The following table summarizes the effect of previously held derivative instruments not designated as hedging instruments.

 

          Amount of Gain or (Loss) Recognized in Income
on Derivative
 
          Three Months Ended
March 31,
    Six Months Ended
March 31,
 
    

Location of Gain or (Loss)

Recognized in Income

   2012      2011     2012      2011  

Forward commitments for the sale of mortgage loans

  

Net gain on the sale of loans

     0         (5     0         (5
     

 

 

    

 

 

   

 

 

    

 

 

 

Total

      $ 0       $ (5   $ 0       $ (5
     

 

 

    

 

 

   

 

 

    

 

 

 

 

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12. RECENT ACCOUNTING PRONOUNCEMENTS

Pending as of March 31, 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 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 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 adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

Adopted in quarter ended March 31, 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. 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.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements

This report contains forward-looking statements, which can be identified by the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions. These forward-looking statements include:

 

   

statements of our goals, intentions and expectations;

 

   

statements regarding our business plans and prospects and growth and operating strategies;

 

   

statements concerning trends in our provision for loan losses and charge-offs;

 

   

statements regarding the asset quality of our loan and investment portfolios; and

 

   

estimates of our risks and future costs and benefits.

These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following important factors that could affect the actual outcome of future events:

 

   

significantly increased competition among depository and other financial institutions;

 

   

inflation and changes in the interest rate environment that reduce our interest margins or reduce the fair value of financial instruments;

 

   

general economic conditions, either nationally or in our market areas, including employment prospects and conditions that are worse than expected;

 

   

decreased demand for our products and services and lower revenue and earnings because of a recession or other events;

 

   

adverse changes and volatility in the securities markets;

 

   

adverse changes and volatility in credit markets;

 

   

legislative or regulatory changes that adversely affect our business, including changes in regulatory costs and capital requirements and changes related to our ability to pay dividends and the ability of Third Federal Savings and Loan Association of Cleveland, MHC to waive dividends;

 

   

our ability to enter new markets successfully and take advantage of growth opportunities, and the possible short-term dilutive effect of potential acquisitions or de novo branches, if any;

 

   

changes in consumer spending, borrowing and savings habits;

 

   

changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board and the Public Company Accounting Oversight Board;

 

   

future adverse developments concerning Fannie Mae or Freddie Mac;

 

   

changes in monetary and fiscal policy of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board;

 

   

changes in policy and/or assessment rates of taxing authorities that adversely affect us;

 

   

changes in expense trends (including, but not limited to, trends affecting non-performing assets, charge-offs and provisions for loan losses);

 

   

the impact of the continuing governmental effort to restructure the U.S. financial and regulatory system;

 

   

inability of third-party providers to perform their obligations to us;

 

   

adverse changes and volatility in real estate markets;

 

   

a slowing or failure of the moderate economic recovery;

 

   

the extensive reforms enacted in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), which will impact us;

 

   

the adoption of implementing regulations by a number of different regulatory bodies under the Dodd-Frank Act, and uncertainty in the exact nature, extent and timing of such regulations and the impact they will have on us;

 

   

the impact of our coming under the jurisdiction of new federal regulators;

 

   

changes in our organization, or compensation and benefit plans;

 

   

the strength or weakness of the real estate markets and of the consumer and commercial credit sectors and its impact on the credit quality of our loans and other assets; and

 

   

the ability of the U.S. Federal government to manage federal debt limits.

Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

 

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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, prior to 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 educational programs we have established and/or supported. We intend to continue to adhere to our primary values and 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 continue to 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 have been higher than interest rates associated with shorter term assets. 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 six months ended March 31, 2012 no loans were sold while during the six months ended March 31, 2011, $5.3 million of long-term, fixed-rate mortgage loans were sold. For the full fiscal year ended September 30, 2011, we sold $33.6 million of long-term, fixed-rate mortgage loans. The total balance of loans sold subsequent to June 30, 2010 has been nominal in relation to the balance of our owned fixed-rate portfolio. As described in the following paragraphs, the low volume of loan sales since June 30, 2010 reflects the impact of changes by Fannie Mae related to requirements for loans that it accepts and a reduced level of fixed-rate loan originations.

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 that, 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 of its overall 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

 

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Fannie Mae loan eligibility standards. In the near term, the Association expects 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. During the three months ended March 31, 2012, we reclassified a pool of high credit quality, fixed-rate, first mortgage loans, with a principal balance of $248.1 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. As a condition to any transaction, the Association will retain the mortgage servicing rights associated with any loans sold. At March 31, 2012 those loans had a recorded investment of $245.9 million.

Since June 30, 2010, 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 and in March 2012, as stated above, we reclassified $248.1 million in principal balances of fixed-rate mortgage loans to “held for sale” with the intent to sell those loans on a servicing retained basis to private investors. Also, 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 six months ended March 31, 2012 and 2011, adjustable-rate mortgage loan production totaled $773.1 million and $802.7 million, respectively, while during the same time periods, fixed-rate mortgage loan production totaled $564.4 million and $647.3 million, respectively. By comparison, during the six months ended March 31, 2010, adjustable-rate mortgage loan production totaled $15.4 million while fixed rate production totaled $725.4 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 retained 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 $2.45 billion of long-term adjustable-rate loans in our residential mortgage loans held for investment portfolio at March 31, 2012, as compared to $1.83 billion at September 30, 2011 and $1.58 billion at March 31, 2011. In addition, fixed-rate mortgage loan activity described above resulted in $5.19 billion of long-term fixed rate loans in our residential mortgage loans held for investment portfolio at March 31, 2012, as compared to $5.56 billion at September 30, 2011 and $5.64 billion at March 31, 2011. The March 31, 2012 measurement excludes $245.9 million of long-term, fixed-rate loans reported as “held for sale”. At September 30, 2011 and March 31, 2011, “held for sale” loans excluded from the portfolio balances of fixed-rate loans described above totaled $0 and $8.1 million, respectively.

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 federal banking 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 customers for whom the draw period of their current home equity line of credit was about to expire, upon which date the home equity line of credit would otherwise convert to a ten year amortizing loan; additionally, we have begun to allow, subject to certain property and credit performance conditions, home equity line of credit customers not approaching repayment to refinance into new home equity lines of credit for other purposes, typically increases in the available line. At March 31, 2012, commitments to extend new home equity lines of credit to our existing customers totaled $240 thousand. 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.

 

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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 March 31, 2012, 89% 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. Beginning March 31, 2012, performing home equity lines of credit were transferred to non-accrual status in those instances in which the borrower was 180 days or more delinquent on a first lien obligation or 90 days or more delinquent on a first lien modification. At March 31, 2012 the recorded investment of home equity lines of credit transferred to non-accrual was $14.6 million.

In response to current 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, including $506.1 million in outstanding balances, to $3.83 billion. Further reductions occurred during the quarter ended March 31, 2012 and as a result, through March 31, 2012 home equity lending commitments had been reduced by $1.42 billion, including $587.3 million in outstanding balances, to $3.72 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 229% at March 31, 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 memoranda 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, at various dates through December 31, 2011, 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 and the plan to address deficiencies was submitted on February 25, 2011); (2) an independent review of management compensation (the review was submitted to the OTS on June 30, 2011); (3) the submission of an independent enterprise risk management study and a plan to address any deficiencies (the study and plan to address deficiencies was submitted to the OTS on February 11, 2011); (4) the submission 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 enterpr