Executive Summary / Key Takeaways

• TFS Financial Corporation operates a stable, relationship-focused retail banking model centered on mortgage lending and deposit gathering, underpinned by its unique mutual holding company structure and conservative values.
• Following the lifting of regulatory constraints, the company has aggressively pursued a "three-dimensional approach" focused on organic balance sheet growth, strategic share repurchases, and consistent dividend payments to minority shareholders, facilitated by the mutual holding company's dividend waiver.
• Recent financial performance for the quarter and six months ended March 31, 2025, demonstrates stability, with net income showing slight increases driven by improved net interest income (quarter), non-interest income growth, and effective expense control, despite pressures from the interest rate environment.
• While excelling in regional customer loyalty and prudent credit risk management (evidenced by low delinquency rates on recent originations and net recoveries), TFSL faces competitive challenges from larger, more technologically advanced peers in terms of scale, digital capabilities, and operational efficiency.
• The investment case is significantly influenced by the company's strong capital position (exceeding "Well Capitalized" requirements), its commitment to returning capital through buybacks and dividends, and its ability to execute organic growth in targeted expansion markets, balanced against risks from interest rate sensitivity, credit quality in certain portfolios (HELOCs), and the evolving regulatory landscape.

Setting the Scene: A Foundation Built on Relationships and Prudence

TFS Financial Corporation, rooted in its 1938 origins as a mutually-owned savings and loan, operates today as a federally chartered stock holding company primarily through its thrift subsidiary, Third Federal Savings and Loan Association of Cleveland. This structure, where the mutual holding company (MHC) retains a significant majority stake (approximately 80.90%), underpins a business model deeply embedded in retail consumer banking, with a core focus on mortgage lending and deposit gathering. Guided by foundational values emphasizing relationships and service, TFSL has historically prioritized stability and prudence, a strategy that proved particularly relevant in navigating the turbulent financial landscape following the 2008 housing crisis.

The post-crisis era presented significant challenges, including heightened credit risk concerns and the complexities of managing interest rate risk, especially during periods of volatile or inverted yield curves. Regulatory oversight, including a Memorandum of Understanding (MOU), further constrained strategic flexibility. However, the lifting of this MOU in April 2014 marked a pivotal moment, allowing TFSL to fully re-engage its core strategic framework: a "three-dimensional approach" centered on growing the balance sheet, executing share buybacks, and providing dividends to its shareholders. This approach aims to build and maintain a "fortuitous type balance sheet" designed for resilience across economic cycles.

Navigating the Competitive Currents and Technological Realities

TFSL operates within a competitive landscape populated by a diverse array of financial institutions, from large national banks to regional peers and increasingly, fintech innovators. Key competitors include major regional players like Fifth Third Bancorp (FITB), Truist Financial Corporation (TFC), PNC Financial Services (PNC), and KeyCorp (KEY), all of whom offer overlapping retail banking, mortgage, and deposit products.

TFSL's competitive positioning is characterized by distinct strengths and vulnerabilities. Its community-focused brand and established presence in core markets like Ohio and Florida foster strong customer loyalty, particularly within its branch network. This relationship-driven approach, coupled with its conservative underwriting standards, provides a degree of resilience in niche segments. The company's focus on specific products like the Smart Rate adjustable-rate mortgage and 10-year fixed-rate loans, alongside its active marketing of HELOCs, represents a strategic effort to tailor offerings to customer needs while managing interest rate exposure.

However, compared to larger, more diversified competitors, TFSL faces challenges related to scale and, notably, technological capabilities. While TFSL utilizes tools like customized modeling software for risk analysis and leverages its internet site and call center for geographic expansion, the company does not appear to possess specific differentiated technology, significant R&D initiatives, or quantifiable technological advantages over alternatives. In contrast, competitors like FITB and PNC are noted for their focus on data-driven strategies, analytics, and digital platforms, which can translate into greater operational efficiency, faster processing speeds, and potentially lower costs per unit. This technological lag represents a competitive disadvantage for TFSL, potentially impacting its ability to compete on efficiency and digital customer experience against more technologically advanced rivals. The strategic implication is that TFSL must rely more heavily on its relationship-based model, product design, and prudent management to offset these scale and technology gaps and maintain its market position.

Financial Performance: Stability in a Volatile Rate Environment

The financial results for the quarter and six months ended March 31, 2025, reflect TFSL's ability to maintain stability amidst ongoing economic and interest rate fluctuations.

For the three months ended March 31, 2025, net income increased slightly by $0.3 million, or 1%, to $21.0 million compared to $20.7 million in the prior year quarter. This was primarily driven by a $0.6 million increase in net interest income and a $1.4 million increase in non-interest income, partially offset by a $1.1 million decrease in non-interest expense and a $2.5 million increase in the provision for credit losses (from a release to a provision). Interest and dividend income rose by $2.5 million, or 1%, to $186.0 million, mainly due to an $8.5 million, or 5%, increase in interest income on loans, reflecting both a 17 basis point increase in average yield (to 4.47%) and a 1% increase in average loan balances. Interest expense increased by $1.8 million, or 2%, to $113.9 million, primarily due to higher interest expense on certificates of deposit ($5.6 million increase), partially offset by decreases in borrowed funds interest expense ($0.9 million decrease) and savings deposits interest expense. The net interest margin saw a modest increase of four basis points to 1.75% from 1.71%.

For the six months ended March 31, 2025, net income increased by $2.0 million, or 5%, to $43.4 million compared to $41.4 million in the prior year period. This improvement was mainly attributable to a $1.6 million increase in non-interest income and a $3.5 million decrease in non-interest expense, partially offset by a $2.0 million change in the provision for credit losses (from a release to zero provision) and a slight $0.1 million decrease in net interest income. Interest and dividend income increased by $12.0 million, or 3%, to $372.7 million, largely due to an $18.7 million, or 6%, increase in interest income on loans, driven by a 20 basis point yield increase (to 4.48%) and a 140.8 million increase in average loan balances. Interest expense rose by $12.1 million, or 5%, to $232.3 million, primarily from a $22.8 million increase in CD interest expense (due to higher average balance and rate), partially offset by decreases in savings account ($6.4 million decrease) and borrowed funds ($4.2 million decrease) interest expense. The net interest margin remained flat at 1.70%.

Credit quality remains a critical focus. As of March 31, 2025, total loans seriously delinquent (90 days or more past due) were 0.10% of total net loans, a slight increase from 0.09% at September 30, 2024. While delinquencies in most portfolios remain low, recent economic trends and elevated HELOC rates have led to an upward trend in delinquencies in that portfolio. The allowance for credit losses (ACL) on loans was $70.5 million at March 31, 2025, compared to $70.0 million at September 30, 2024. The total allowance for all credit losses (including unfunded commitments) increased to $99.9 million from $97.8 million over the same period. The company continues to report net recoveries ($0.7 million for the quarter, $2.1 million for the six months) on previously charged-off loans, primarily due to improvements in property values. The adoption of ASU 2022-2 changed the accounting for troubled debt restructurings (TDRs), now estimating losses on modified loans through the lifetime loss model.

Balance Sheet Strength and Capital Deployment

TFSL maintains a robust balance sheet, with total assets increasing slightly by $20.9 million to $17.11 billion at March 31, 2025, from $17.09 billion at September 30, 2024. This growth was primarily driven by a $38.1 million increase in loans held for investment, net, reaching $15.36 billion, partially offset by a $12.0 million decrease in mortgage loans held for sale. The increase in the held-for-investment portfolio was led by a $430.0 million increase in home equity loans and lines of credit, partially offset by a $390.3 million decrease in residential core mortgage loans.

Funding is primarily sourced from deposits, which increased by $202.6 million, or 2%, to $10.40 billion. This included a $230.1 million increase in certificates of deposit and a $12.1 million increase in savings accounts, partially offset by decreases in money market and checking accounts. Borrowed funds, primarily from the FHLB, decreased by $205.5 million, or 4%, to $4.59 billion. The company utilizes brokered CDs ($1.03 billion at March 31, 2025) and interest rate swaps ($3.55 billion notional value designated as cash flow hedges) to manage funding costs and extend the duration of liabilities. Uninsured deposits totaled $370.0 million at March 31, 2025, which the company states it has the capacity to fund entirely through alternative sources.

Capital remains a significant source of financial strength. As of March 31, 2025, both the Company and the Association exceeded all regulatory requirements to be considered "Well Capitalized." The Company's Common Equity Tier 1 Capital ratio was 18.13%, and the Association's was 16.72%, both well above the 6.50% requirement. The Association intends to maintain minimum capital ratios exceeding 13.00% Total Capital, 9.00% Tier 1 Leverage, and 11.00% Tier 1 Capital. Total shareholders equity increased by $34.0 million, or 2%, to $1.90 billion, reflecting net income and a net increase in accumulated other comprehensive income (primarily from swap contracts), partially offset by dividends.

Capital deployment is a key pillar of TFSL's strategy. The company's eighth stock repurchase program authorizes the repurchase of up to 10 million shares, with 5.19 million shares remaining as of March 31, 2025. While no shares were repurchased during the six months ended March 31, 2025, management has historically expressed a strong appetite for buybacks. The company also declared a quarterly cash dividend of $0.2825 per share, payable in June 2025. The ability to pay dividends to minority shareholders is significantly aided by the MHC's waiver of its portion of the dividend, a process that requires periodic member approval and regulatory non-objection. The MHC members approved the waiver for dividends declared through July 9, 2025, and the MHC intends to seek member approval for future waivers. These capital return activities are planned to continue as a focus for future capital deployment.

Outlook and Risks: Navigating the Path Ahead

Management expresses optimism about operating successfully in the current economic climate, reinforced by recent performance. The strategic focus remains on the three-dimensional approach: organic growth, buybacks, and dividends. Growth efforts continue to target geographic expansion beyond the traditional footprint, particularly for HELOCs, where the company hopes to turn the corner from runoff to portfolio growth. The expectation is that the extension of the draw period on newer HELOC originations will keep conversions to term loans relatively low for several years.

Despite the positive outlook and strategic execution, several risks warrant investor attention. Interest rate risk remains significant, stemming from the potential mismatch between longer-term assets and shorter-term liabilities. While strategies like originating adjustable-rate loans, extending funding duration with swaps and brokered CDs, and selective loan sales are employed, adverse movements in market rates could still impact net interest income and economic value of equity (EVE). The company's EVE sensitivity analysis at March 31, 2025, indicates that a 200 basis point increase in rates would decrease EVE by 27.19% for the Company and 31.32% for the Association, while a 200 basis point decrease would increase EVE by 11.74% and 13.50%, respectively.

Credit risk, particularly within the home equity portfolio and due to geographic concentrations in Ohio and Florida, requires ongoing monitoring. While overall delinquencies remain low, the recent upward trend in HELOC delinquencies tied to elevated prime rates highlights this vulnerability. The company's expanded loan level evaluation and allowance methodology (including qualitative adjustments and the CECL framework) are intended to mitigate this, but unforeseen changes in economic conditions or property values could necessitate future provisions.

Furthermore, the regulatory environment continues to pose challenges, with potential impacts from evolving rules and requirements. The ongoing escheat audit covering Ohio, Kentucky, and Florida represents a specific contingent liability with an outcome that is not yet reasonably estimable.

Conclusion

TFS Financial Corporation presents a compelling investment narrative centered on stability, prudent management, and a clear commitment to capital return. Rooted in its mutual heritage and relationship-focused banking model, TFSL has successfully navigated past economic and regulatory headwinds by strategically adjusting its balance sheet composition and focusing on organic growth in targeted markets. The lifting of regulatory constraints has unlocked the full potential of its three-dimensional strategy, allowing the company to actively pursue share buybacks and provide dividends to minority shareholders, a process uniquely facilitated by the MHC dividend waiver.

Recent financial results underscore the resilience of this model, demonstrating stable profitability driven by effective expense control and strategic management of interest rate dynamics, even as the company works to overcome competitive disadvantages in scale and technological advancement. While risks related to interest rate sensitivity, credit quality in specific portfolios, and regulatory uncertainty persist, TFSL's strong capital position and management's stated commitment to balancing growth, capital return, and risk management provide a solid foundation. For investors seeking exposure to a well-capitalized, income-generating regional bank with a clear strategy for enhancing shareholder value, TFSL's unique structure and focused execution warrant close consideration.