Table of Contents
Filed Pursuant to Rule 424(b)(3)
Registration No. 333-139295
Prospectus Supplement
Interests in
THIRD FEDERAL 401(k) SAVINGS PLAN
Offering of Participation Interests in up to 4,919,960 Shares of
TFS FINANCIAL CORPORATION
Common Stock
In connection with the adoption of a stock issuance plan by TFS Financial Corporation, participants in the Third Federal 401(k) Savings Plan are being permitted to invest all or a portion of their accounts in participation interests in the shares of common stock of TFS Financial Corporation. TFS Financial Corporation has registered a number of participation interests through the 401(k) Plan in order to enable the trustee of the 401(k) Plan to purchase up to 4,919,960 shares of the common stock, assuming a purchase price of $10.00 per share. This prospectus supplement relates to the initial election of 401(k) Plan participants to direct the trustee of the 401(k) Plan to invest all or a portion of their 401(k) Plan accounts in the TFS Financial Corporation Stock Fund at the time of the stock offering.
TFS Financial Corporation’s prospectus, dated February 12, 2007, accompanies this prospectus supplement. It contains detailed information regarding the stock offering and the stock issuance plan, TFS Financial Corporation common stock and the financial condition, results of operations and business of TFS Financial Corporation and Third Federal Savings and Loan. This prospectus supplement provides information regarding the 401(k) Plan. You should read this prospectus supplement together with the prospectus and keep both for future reference.
For a discussion of risks that you should consider, see “Risk Factors” beginning on page 20 of the attached prospectus.
The interests in the 401(k) Plan and the offering of the shares of common stock have not been approved or disapproved by the Office of Thrift Supervision, the Securities and Exchange Commission or any other federal or state agency. Any representation to the contrary is a criminal offense.
The securities offered in this prospectus supplement are not deposits or accounts and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.
This prospectus supplement may be used only in connection with offers and sales by TFS Financial Corporation of participation interests in shares of common stock pursuant to the 401(k) Plan. No one may use this prospectus supplement to reoffer or resell interests or shares of common stock acquired through the 401(k) Plan.
Table of Contents
You should rely only on the information contained in this prospectus supplement and the accompanying prospectus. TFS Financial Corporation, Third Federal Savings and Loan and the 401(k) Plan have not authorized anyone to provide you with information that is different.
This prospectus supplement does not constitute an offer to sell or solicitation of an offer to buy any securities in any jurisdiction to any person to whom it is unlawful to make an offer or solicitation in that jurisdiction. Neither the delivery of this prospectus supplement and the prospectus nor any sale of shares of common stock shall under any circumstances imply that there has been no change in the affairs of TFS Financial Corporation, Third Federal Savings and Loan or the 401(k) Plan since the date of this prospectus supplement, or that the information contained in this prospectus supplement or incorporated by reference is correct as of any time after the date of this prospectus supplement.
The date of this prospectus supplement is February 12, 2007.
Table of Contents
| i | ||
| i | ||
| Election to Purchase Common Stock in the Stock Offering — Priorities |
i | |
| iii | ||
| iii | ||
| iii | ||
| v | ||
| v | ||
| v | ||
| v | ||
| 1 | ||
| 1 | ||
| 1 | ||
| 2 | ||
| 2 | ||
| 2 | ||
| 3 | ||
| 3 | ||
| 3 | ||
| 4 | ||
| Withdrawals from your Plan Account Prior to Termination of Employment |
5 | |
| 6 | ||
| 6 | ||
| 8 | ||
| 9 | ||
| 13 | ||
| 14 | ||
| 14 | ||
| 15 | ||
| 15 | ||
| 17 | ||
| Securities and Exchange Commission Reporting and Short-Swing Profit Liability |
17 | |
| 18 | ||
| 18 |
Table of Contents
i
Table of Contents
| TFS Financial Corporation common stock in the subscription offering and you may use funds in
In the event the stock offering is oversubscribed, i.e. there are more orders for shares of
common |
ii
Table of Contents
iii
Table of Contents
| • After your election is accepted by Principal, it will be rounded down to the closest dollar amount divisible by $10.00. The difference will remain in the TFS Stock Offering Option until the final transaction has been completed. At that time, the common shares purchased based on your election will be transferred to the TFS Financial Corporation Stock Fund and any remaining funds will be transferred out of the TFS Stock Offering Option for investment in other funds under the 401(k) Plan based on your election currently on file for future contributions.
• You will continue to have the ability to transfer amounts not in the TFS Stock Offering Option among all the other investment funds on a daily basis.
• The amount transferred to the TFS Stock Offering Option needs to be segregated and held until the offering closes. Therefore, this money is not available for distributions, loans or withdrawals until the transaction is completed which is after the closing of the stock offering.
You are allowed only one election to transfer funds to the TFS Stock Offering Option. Follow these steps to make your election to use all or part of your account balance in the 401(k) Plan to purchase shares in the stock offering:
• Go to www.principal.com and log into your 401k account
• Click on the “Make Changes” tab or the “Transferring Existing Balances” link.
• Stay on the first page of the election screen to make an election using percentages from your existing fund balances.
• Find the “Additional Investment Transfers Options” link to make an election from a specific source of money (e.g. Tier I, Tier II, etc) or to make a dollar election.
• Complete all the steps in the election process until you receive a request number (Note: your election is not complete until you have confirmed your request with your password and you receive a request number).
• Once you have a request number, your election cannot be changed.
• After you have completed your election, you will also need to complete the Stock Information Form and return it in the self-addressed envelope provided by March 19, 2007. It is critical that this Stock Information Form be completed and returned. |
iv
Table of Contents
v
Table of Contents
DESCRIPTION OF THE 401(k) PLAN
Third Federal Savings and Loan originally adopted the 401(k) Savings Plan effective as of July 1, 1989, and restated it most recently effective as of January 1, 2007. The 401(k) Plan is a tax-qualified plan with a cash or deferred compensation feature established in accordance with the requirements under Section 401(a) and Section 401(k) of the Internal Revenue Code of 1986, as amended (the “Code”), and contains and employee stock ownership feature.
Third Federal Savings and Loan intends that the 401(k) Plan, in operation, will comply with the requirements under Section 401(a) and Section 401(k) of the Code. Third Federal Savings and Loan will adopt any amendments to the 401(k) Plan that may be necessary to ensure the continuing qualified status of the 401(k) Plan under the Code and applicable Treasury Regulations.
Employee Retirement Income Security Act of 1974 (“ERISA”). The 401(k) Plan is an “individual account plan” other than a “money purchase pension plan” within the meaning of ERISA. As such, the 401(k) Plan is subject to all of the provisions of Title I (Protection of Employee Benefit Rights) and Title II (Amendments to the Code Relating to Retirement Plans) of ERISA, except to the funding requirements contained in Part 3 of Title I of ERISA which by their terms do not apply to an individual account plan (other than a money purchase plan). The 401(k) Plan is not subject to Title IV (Plan Termination Insurance) of ERISA. The funding requirements contained in Title IV of ERISA are not applicable to participants or beneficiaries under the 401(k) Plan.
Reference to Full Text of Plan. The following portions of this prospectus supplement summarize certain provisions of the 401(k) Plan. They are not complete and are qualified in their entirety by the full text of the 401(k) Plan. Copies of the 401(k) Plan are available to all employees by filing a request with the 401(k) Plan administrator c/o Third Federal Savings and Loan, 7007 Broadway Avenue, Cleveland, Ohio 44105. You are urged to read carefully the full text of the 401(k) Plan.
Each employee is eligible to participate in the 401(k) Plan upon reaching age 18 and completing one year of Eligibility Service. Participation begins on the next entry day, which is the first day of any calendar quarter. Notwithstanding the foregoing, however, employees are not eligible to become “Tier III” participants until reaching age 21, and then only if they are not earning benefits under the Third Federal Savings Retirement Plan.
For purposes of the 401(k) Plan, an employee is credited with a year of Eligibility Service if the employee completes at least 1,000 hours of service by the anniversary of date of hire. If an employee does not complete at least 1,000 hours of service during that period, the employee will be credited with a year of Eligibility Service for the first calendar year beginning after the employee’s date of hire in which 1,000 hours of service is completed. For purposes of making Tax-Deferred Contributions and receiving Matching Contributions, however, an employee is considered to meet the above eligibility requirement when the employee first completes 1,000
Table of Contents
hours of service in the most recent 12 months of employment (which may occur before the anniversary of the employee’s hire date).
As of December 31, 2006, there were 986 employees, former employees and beneficiaries eligible to participate in the Plan and 800 employees participating by making elective deferral contributions.
Contributions Under the 401(k) Plan
The 401(k) Plan provides for several kinds of contributions, including Tax-Deferred Contributions as elected by employees, Employer Matching Contributions made on behalf of employees electing Tax-Deferred Contributions (also referred to as “Tier I”), discretionary Profit-Sharing Contributions (also referred as “Tier II”), and discretionary Tier III Contributions. Each type is summarized below. In determining contribution amounts under the 401(k) Plan, an employee’s annual compensation in excess of $225,000 is disregarded, as are certain other amounts of executive compensation.
As an eligible employee you may elect to make Tax-Deferred Contributions by authorizing a reduction in the compensation you would otherwise receive by a specified amount. This amount is then deposited in your 401(k) Plan account. You may elect to contribute between 1% and 75% of your eligible compensation. If you will be at least age 50 by the end of any calendar year, you may elect to contribute up to an additional $5,000 annually in this manner. You may change the amount of your Tax-Deferred Contributions, including discontinuing or resuming them, by filing a form or by telephone or other electronic medium.
Employer Matching Contributions.
Employer Matching Contributions are provided at the rate of 100% to match your Tax-Deferred Contributions under the 401(k) Plan, up to the first four percent of your compensation contributed as a Tax-Deferred Contribution for each payroll period.
Profit-Sharing Contributions
Third Federal Savings and Loan may, in its discretion, make a Profit-Sharing Contribution for a particular year. If a Profit-Sharing Contribution is made, it is allocated among eligible employees who have completed 1,000 hours of service during the year and have not terminated employment as of the last day of the year. Allocations are in proportion to compensation for the year.
2
Table of Contents
Tier III Contributions
Third Federal Savings and Loan may, in its discretion, make a Tier III contribution for each Tier III eligible employee. You must complete 1,000 hours of service and remain employed on the last day of the year in order to be eligible to receive a Tier III contribution, unless you qualify for LTD benefits, retire after reaching age 65, or die during the year. For 2007, Tier III Contributions are being made at the rate of 2.5% of the eligible employee’s compensation.
You may elect to roll over qualified distributions from another plan or a rollover IRA into the 401(k) Plan. IRS rules govern whether a distribution from another plan or an IRA qualifies for rollover into the 401(k) Plan, and you may be required to provide information to show that the distribution you wish to roll over qualifies under IRS rules. Any rollover contribution is held in a separate account.
Limitations on Tax-Deferred Contributions. For the plan year beginning January 1, 2007, the amount of your Tax-Deferred Contributions may not exceed $15,500 per calendar year. This amount may be adjusted periodically by law, based on changes in the cost of living. Contributions in excess of this limit are known as excess deferrals. If you defer amounts in excess of this limitation, your gross income for federal income tax purposes will include the excess in the year of the deferral. In addition, unless the excess deferral is distributed before April 15 of the following year, it will be taxed again in the year distributed. Income on the excess deferral distributed by April 15 of the immediately succeeding year will be treated, for federal income tax purposes, as earned and received by you in the tax year in which the contribution is made.
Catch-up Contributions. If you have made the maximum amount of regular Tax-Deferred Contributions allowed by the 401(k) Plan or other legal limits and you have attained at least age 50 (or will reach age 50 prior to the end of the plan year), you are also eligible to make an additional catch-up contribution. You may authorize your employer to withhold a specified dollar amount of your compensation for this purposes. For 2007, the maximum catch-up contribution is $5,000.
Benefits Under the 401(k) Plan
Your vested account balance determines the amount of your benefit under the 401(k) Plan. Your account balance is subject to changes in value on a daily basis, depending on the investments selected, as further described below.
Vested benefits are distributed following retirement, death, or termination of employment. Generally you must request a distribution and indicate whether you wish to direct a rollover into an individual retirement account or other eligible retirement plan. Benefits are distributed in the form of cash, except that if you so elect any amount invested in the TFS
3
Table of Contents
Financial Corporation Stock Fund can be distributed in the form of shares of common stock TFS Financial Corporation (with any fractional share distributable in cash).
If you continue in employment with Third Federal Savings and Loan after reaching age 70-1/2, you may elect to begin receiving periodic installment payments from your account or a single sum payment. Distribution is also available if you become disabled within the meaning of the 401(k) Plan before you terminate from employment.
If your vested account balance is $5,000 or less, distribution will be made without your consent. However, if the distribution amount exceeds $1,000 and your have not given your consent, your account will be automatically rolled over into an individual retirement account established for your benefit.
In the event of your death, your vested account balance will be payable to your beneficiary in accordance with the terms of the 401(k) Plan. Your beneficiary may also choose to roll over the benefit.
Your vested interest in your Tax-Deferred Contributions and Rollover Contributions is always 100%. Your vested interest in any Profit-Sharing and Matching Contributions credited to your account after 2002 is also 100%. Profit-Sharing and Matching Contributions made for periods prior to 2003 become vested according to the following schedule:
| Years of Vesting Service |
Vested Interest |
||
| Less than 2 |
0 | % | |
| 2, but less than 3 |
25 | % | |
| 3, but less than 4 |
50 | % | |
| 4, but less than 5 |
75 | % | |
| 5 or more |
100 | % |
If you are a Tier III eligible employee, your vested interest in Tier III Contributions is 0% until you complete 5 years of Vesting Service, when it becomes 100%. Tier III Contributions made for 2007 and beyond, however, become vested according to the following schedule:
| Years of Vesting Service |
Vested Interest |
||
| Less than 2 |
0 | % | |
| 2, but less than 3 |
25 | % | |
| 3, but less than 4 |
50 | % | |
| 4, but less than 5 |
75 | % | |
| 5 or more |
100 | % |
If you are employed by an employer under the 401(k) Plan when you reach age 65, become disabled, or die, your vested interest in all accounts will be 100%
You are credited with a year of Vesting Service for each calendar year in which you complete 1,000 hours of service. Special rules apply to determine years of Vesting Service if
4
Table of Contents
you are rehired by Third Federal Savings and Loan and were not vested prior to your first termination of employment.
Withdrawals and Distributions from the 401(k) Plan
Applicable federal law requires the 401(k) Plan to impose substantial restrictions on the right of a Plan participant to withdraw amounts held for his or her benefit under the 401(k) Plan prior to the participant’s termination of employment with Third Federal Savings and Loan. A substantial federal tax penalty may also be imposed on withdrawals made prior to the participant’s attainment of age 59 1/2, regardless of whether such a withdrawal occurs during his or her employment with Third Federal Savings and Loan or after termination of employment.
Withdrawals from your Plan Account Prior to Termination of Employment.
Hardship Distributions. In certain circumstances, you may make a cash withdrawal from your Tax-Deferred Contribution account (not including earnings credited after December 31, 1988) while you are still employed by an employer under the 401(k) Plan. In particular, if you incur an immediate and heavy financial need you may apply for a hardship withdrawal. You may only make a hardship withdrawal if it is determined that the withdrawal is necessary to meet your financial need. Your hardship withdrawal may include amount necessary to pay any federal, state, or local income taxes or penalties expected to result from the withdrawal. The financial needs for which you can receive a hardship withdrawal are:
| • | medical expenses of you, your spouse, or your dependents for the diagnosis, cure, mitigation, treatment, or prevention of disease |
| • | purchase of your principal residence (not including mortgage payments) |
| • | tuition payments, related educational fees, and room and board expenses of post-secondary education for you, your spouse, or your dependents, |
| • | prevention of eviction from your principal residence or foreclosure on the mortgage of your principal residence |
| • | payment of funeral expenses for your parent, spouse, child, or dependent |
| • | expenses for the repair of damage to your principal residence that would qualify for a casualty loss deduction under the Internal Revenue Code. |
You must represent that you cannot meet the financial need through insurance, liquidation of your assets, ceasing your Tax-Deferred Contributions under the Plan, or obtaining other distributions or a loan from the 401(k) Plan. Alternatively, you must show that the amount does not exceed the amount you need to meet your financial need, you must have obtained all other distributions and non-taxable loans available to you under any employer plan, and you must suspend your Tax-Deferred Contributions for at least six months.
Dividend Withdrawals. If any portion of your account is invested in the TFS Financial Corporation Stock Fund and dividends are paid on that fund, you will have the opportunity to withdraw the dividend payment applicable to your account. If not withdrawn, the dividend will remain invested in the 401(k) Plan on a fully vested basis.
5
Table of Contents
You may name a beneficiary for your account under the 401(k) Plan. If you are married at the time of your death, your spouse will be your beneficiary unless prior to your death your spouse has consented to the naming of another beneficiary. If you have not named a beneficiary and you are not married at the time of your death, your estate will be your beneficiary. Your vested account balance will be distributed to your beneficiary as soon as practicable after an application for distribution has been made, and generally not more than five years following your death.
Loans under the 401(k) Plan
You may apply for a loan under the 401(k) Plan, subject to the rules and limitations imposed by the Internal Revenue Code and the 401(k) Plan document. The amount of any loan is limited to the lesser of $50,000 or 50 percent of the employee’s vested account balance, not including Profit-Sharing and Tier III Contribution amounts. Loans bear a reasonable rate of interest and cannot be for a term greater than five years (ten years, when used to acquire the employee’s principal residence) and are repaid on a level amortization basis through the payroll system. The minimum amount of any loan is $1,000, and not more than one loan is permitted at any time. If a loan is not repaid in accordance with its terms it may go into default, resulting in certain potential adverse tax consequences.
Investment of Contributions and Account Balances
All amounts credited to your accounts under the 401(k) Plan are held in the 401(k) Plan trust (the “Trust”), which is administered by the trustee appointed by Third Federal Savings and Loan’s Board of Directors.
Prior to the effective date of the stock offering, you were provided the opportunity to direct the investment of your account into one of the following funds:
| • | Third Federal CD Portfolio |
| • | Bond and Mortgage Separate Account |
| • | American Funds American Balanced R4 Fund |
| • | Principal LifeTime Strategic Income Separate Account |
| • | Principal LifeTime 2010 Separate Account |
| • | Principal LifeTime 2020 Separate Account |
| • | Principal LifeTime 2030 Separate Account |
| • | Principal LifeTime 2040 Separate Account |
| • | Principal LifeTime 2050 Separate Account |
| • | LargeCap Value Separate Account |
| • | American Century Equity Income Adv Fund |
| • | American Funds Fundamental Investors R4 Fund |
| • | Victory Stock Index A Fund |
| • | American Funds Growth Fund of America R4 Fund |
| • | LargeCap Growth I Separate Account |
6
Table of Contents
| • | Medium Company Blend Separate Account |
| • | MidCap Growth Separate Account |
| • | Small Company Value Separate Account Small Company Blend Separate Account |
| • | SmallCap Growth II Separate Account |
| • | American Funds EuroPacific Growth R3 Fund |
| • | Putnam International Equity A Fund |
You may change your investment directions once each business day. This may be done either by filing a form or by telephone or other electronic medium. You may also redirect the investment of your investment accounts such that a percentage or dollar amount of any one or more investment accounts may be transferred to any one or more other investment accounts either by filing a form or by telephone or other electronic medium.
In connection with the stock offering, the 401(k) Plan now provides that in addition to the funds specified above, you may direct the trustee, or its representative, to invest all or a portion of your account in the TFS Financial Corporation Stock Fund.
Pending investment in shares of common stock, amounts allocated towards the purchase of shares in the stock offering will be held in the Money Market Separate Account-Standard. In the event of an oversubscription that prevents you from purchasing all of the shares of common stock that you ordered in the stock offering, the amounts that you elected to invest but were unable to invest, plus any earnings on those amounts, will be reinvested among the other funds of the 401(k) Plan in accordance with your then existing investment election (in proportion to your investment direction for future contributions).
Following the stock offering, you may elect to have both past contributions and earnings, as well as future contributions to your account invested among the funds listed above and the TFS Financial Corporation Stock Fund.
7
Table of Contents
The following table provides performance data with respect to the investment funds available under the 401(k) Plan through December 31, 2006:
AVERAGE ANNUALIZED RETURNS AS OF DECEMBER 31, 2006
| Investment Funds |
Year to Date |
1-Year | 3-Year | 5-Year | 10-Year | ||||||||||
| Third Federal CD Portfolio |
3.93 | % | 3.93 | % | 2.59 | % | 2.53 | % | 3.87 | % | |||||
| Bond and Mortgage Separate Account1 |
4.62 | % | 4.62 | % | 4.01 | % | 5.29 | % | 6.31 | % | |||||
| American Funds American Balanced R4 Fund2 |
11.78 | % | 11.78 | % | 7.84 | % | 7.60 | % | 9.67 | % | |||||
| Principal LifeTime Strategic Income Separate Account3 |
8.96 | % | 8.96 | % | 7.90 | % | 7.23 | % | — | ||||||
| Principal LifeTime 2010 Separate Account3,12,13 |
11.86 | % | 11.86 | % | 9.58 | % | 8.27 | % | — | ||||||
| Principal LifeTime 2020 Separate Account3,12,13 |
14.04 | % | 14.04 | % | 11.20 | % | 9.15 | % | — | ||||||
| Principal LifeTime 2030 Separate Account3,12,13 |
15.14 | % | 15.14 | % | 11.96 | % | 9.19 | % | — | ||||||
| Principal LifeTime 2040 Separate Account3,12,13 |
15.44 | % | 15.44 | % | 12.28 | % | 8.95 | % | — | ||||||
| Principal LifeTime 2050 Separate Account3,12,13 |
15.97 | % | 15.97 | % | 12.72 | % | 8.72 | % | — | ||||||
| LargeCap Value Separate Account1,4,5 |
21.79 | % | 21.79 | % | 13.21 | % | 9.79 | % | — | ||||||
| American Century Equity Income Adv Fund2 |
19.30 | % | 19.30 | % | 11.03 | % | 9.95 | % | 12.05 | % | |||||
| American Funds Fundamental Investors R4 Fund2 |
19.12 | % | 19.12 | % | 14.82 | % | 10.53 | % | 11.10 | % | |||||
| Victory Stock Index A Fund6 |
15.76 | % | 15.76 | % | 9.97 | % | 5.63 | % | 7.74 | % | |||||
| American Funds Growth Fund of America R4 Fund2 |
10.91 | % | 10.91 | % | 12.35 | % | 8.00 | % | 12.93 | % | |||||
| LargeCap Growth I Separate Account1,4,7 |
5.99 | % | 5.99 | % | 7.54 | % | 2.14 | % | — | ||||||
| Medium Company Blend Separate Account1 |
14.04 | % | 14.04 | % | 13.52 | % | 12.08 | % | 11.27 | % | |||||
| MidCap Growth Separate Account1,8 |
6.33 | % | 6.33 | 9.78 | % | 5.85 | % | — | |||||||
| Small Company Value Separate Account1,9 |
19.62 | % | 19.62 | % | 16.77 | % | 17.79 | % | 11.86 | % | |||||
| Small Company Blend Separate Account1,9 |
14.79 | % | 14.79 | % | 14.21 | % | 11.90 | % | 10.00 | % | |||||
| SmallCap Growth II Separate Account1,4,9,10 |
8.86 | % | 8.86 | % | 8.93 | % | 7.13 | % | — | ||||||
| American Funds EuroPacific Growth R3 Fund2,11 |
21.43 | % | 21.43 | % | 20.46 | % | 14.77 | % | 10.89 | % | |||||
| Putnam International Equity A Fund11 |
28.24 | % | 28.24 | % | 18.83 | % | 12.27 | % | 11.35 | % |
| 1 |
For more information about this investment option, including its full name, please visit The Principal Retirement Service Center at www.principal.com or call 1-800-547-7754 for assistance from a retirement specialist. |
| 2 |
These calculated returns reflect the historical performance of the oldest share class of the fund, adjusted to reflect the fees and expenses of this share class. Please see the fund’s prospectus for more information on specific expenses, and the fund’s most recent shareholder report for actual date of first sale. Expenses are deducted from income earned by the fund. As a result, dividends and investment results will differ for each share class. |
| 3 |
This Separate Account invests directly in the institutional class shares of a Principal Investors LifeTime Fund. The mutual fund operating expenses for each Principal Investors LifeTime Fund are reflected in the Total Investment Expense of the Separate Account as well as the operating expenses of the underlying funds in which the Principal Investors LifeTime Fund invests. Based on the asset allocation of the Principal Investors LifeTime Funds as in the |
8
Table of Contents
| prospectus dated March 1, 2006, the weighted average operating expenses of the underling funds are: Principal LifeTime Strategic Income, 0.67%; Principal LifeTime 2010, 0.70%; Principal LifeTime 2020, 0.75%; Principal LifeTime 2030, 0.74%; Principal LifeTime 2040, 0.73%; Principal LifeTime 2050, 0.73%. For further information on all mutual fund expenses, see the prospectus of the underlying Principal Investors LifeTime Fund. All voting rights associated with ownership of shares in the mutual fund are the rights of the Separate Account, not of contract holders investing in the Separate Account. |
| 4 |
This Separate Account invests solely in the Institutional class shares of the Principal Investors Fund. All voting rights associated with ownership of shares in the mutual fund are the rights of the Separate Account, not of contract holders investing in the Separate Account. For further information on the underlying mutual fund, see the prospectus of the fund. |
| 5 |
Effective March 1, 2006, Bank of New York is listed as a sub-advisor for managing the cash portion of this investment option. |
| 6 |
Each index-based investment option is invested in the stocks of the index it tracks. Performance of indexes reflects the unmanaged result for the market segment the selected stocks represent. There is no assurance an index-based investment option will match the performance of the index tracked. |
| 7 |
Effective August 24, 2004, this portfolio is sub-advised by T. Rowe Price Associates, Inc. Prior to August 24, 2004, the portfolio was sub-advised by Morgan Stanley Investment Management Inc. |
| 8 |
This Separate Account invests solely in the Institutional class shares of the Principal Investors Fund. All voting rights associated with ownership of shares in the mutual fund are the rights of the Separate Account, not of contract holders investing in the Separate Account. For further information on the underlying mutual fund, see the prospectus of the fund. |
| 9 |
This investment option is subject to more fluctuation in value than other investment options with stocks of larger, more stable companies. |
| 10 |
Effective May 1, 2002, this portfolio is sub-advised by UBS Global Asset Management. Effective September 1, 2004, Emerald Advisers was added as an additional sub-advisor. Effective June 30, 2006, Essex was added as an additional sub-advisor. Performance results displayed reflect all sub-advisors managing this portfolio during the time periods displayed. |
| 11 |
This investment option is subject to additional risk due to fluctuating exchange rates, foreign accounting and financial policies, and other economic and political environments. |
| 12 |
Equity investment options involve greater risk, including heightened volatility, than fixed-income investment options. Fixed-income investments options are subject to interest rate risk, and their value will decline as interest rates rise. |
| 13 |
Asset allocation does not guarantee a profit or protect against loss. Investing in real estate, small-cap, international, and high-yield investment options are subject to interest rate risk, and their value will decline as interest rates rise. |
The following is a brief description of each of the 401(k) Plan’s investment funds. For more complete information with respect to a particular fund, you should request a prospectus for that fund. You may request a prospectus for a particular fund by contacting The Principal Retirement Service Center at www.principal.com or by calling 1-800-547-7754 for assistance from a retirement specialist.
Third Federal CD Portfolio. The Third Federal CD Portfolio invests in certificates of deposit issued by Third Federal Savings and Loan. The portfolio consists of certificates of deposit of varying maturities, as determined by the Investment Committee.
Bond and Mortgage Separate Account. The Principal Bond and Mortgage Separate Account invests primarily in intermediate-term, fixed-income investments such as public and private corporate bonds, commercial and residential mortgages, asset-backed securities, and
9
Table of Contents
U.S. Government and agency-backed securities. Value is added primarily through sector allocation and security selection. The Separate Account may enter into reverse repurchase agreements to attempt to enhance portfolio return and income.
American Funds American Balanced R4 Fund. The investment seeks capital preservation, current income, and long-term growth of capital and income. The fund normally invests in a broad range of equities, debt, and cash instruments. It typically maintains at least 50% of assets in equities and at least 25% in bonds. Fixed-income securities must be rated investment-grade at the time of purchase. The fund may invest up to 10% of assets in foreign securities. Management primarily seeks securities that it believes are undervalued and provide long-term opportunities.
Principal LifeTime Strategic Income Separate Account. Principal LifeTime Strategic Income Separate Account seeks current income. It primarily invests in shares of the Principal Investors Funds. The underlying funds are intended to give the portfolio moderate exposure to the domestic and foreign equity and fixed income markets. In deciding how to allocate the Separate Account’s assets among the underlying funds, the sub-advisor considers long-term asset class returns and volatility assumptions. There are no minimum or maximum percentages in which the portfolio must invest in any underlying fund.
Principal LifeTime 2010 Separate Account. Principal LifeTime 2010 Separate Account seeks total return. It primarily invests in shares of other Principal Investors Funds. The underlying funds are intended to give the portfolio broad exposure to the domestic and foreign equity and fixed income markets. Over time, the fund’s management will shift the allocations to the underlying funds to accommodate investors progressing from asset accumulation years to income-generation years. The sub-advisor intends to allocate assets so that approximately five to ten years after the year 2010, the Separate Account’s assets invested in the underlying funds match the asset allocation of the Principal LifeTime Strategic Income Separate Account.
Principal LifeTime 2020 Separate Account. Principal LifeTime 2020 Separate Account seeks total return. It primarily invests in shares of the Principal Investors Funds. The underlying funds are intended to give the portfolio broad exposure to the domestic and foreign equity and fixed income markets. Over time, the fund’s management will shift the allocations to the underlying funds to accommodate investors progressing from asset accumulation years to income-generation years. The sub-advisor intends to allocate assets so that approximately five to ten years after the year 2020, the Separate Account’s assets invested in the underlying funds match the asset allocation of the Principal LifeTime Strategic Income Separate Account.
Principal LifeTime 2030 Separate Account. Principal LifeTime 2030 Separate Account seeks total return. It primarily invests in shares of the Principal Investors Funds. The underlying funds are intended to give the portfolio broad exposure to the domestic and foreign equity and fixed income markets. Over time, the fund’s management will shift the allocations to the underlying funds to accommodate investors progressing from asset accumulation years to income-generation years. The sub-advisor intends to allocate assets so that approximately five to ten years after the year 2030, the Separate Account’s assets invested in the underlying funds match the asset allocation of the Principal LifeTime Strategic Income Separate Account.
10
Table of Contents
Principal LifeTime 2040 Separate Account. Principal LifeTime 2040 Separate Account seeks total return. It primarily invests in shares of the Principal Investors Funds. The underlying funds are intended to give the portfolio broad exposure to the domestic and foreign equity and fixed income markets. Over time, the fund’s management will shift the allocations to the underlying funds to accommodate investors progressing from asset accumulation years to income-generation years. The sub-advisor intends to allocate assets so that approximately five to ten years after the year 2040, the Separate Account’s assets invested in the underlying funds match the asset allocation of the Principal LifeTime Strategic Income Separate Account.
Principal LifeTime 2050 Separate Account. Principal LifeTime 2050 Separate Account seeks total return. It primarily invests in shares of the Principal Investors Funds. The underlying funds are intended to give the portfolio broad exposure to the domestic and foreign equity and fixed income markets. Over time, the fund’s management will shift the allocations to the underlying funds to accommodate investors progressing from asset accumulation years to income-generation years. The sub-advisor intends to allocate assets so that approximately five to ten years after the year 2050, the Separate Account’s assets invested in the underlying funds match the asset allocation of the Principal LifeTime Strategic Income Separate Account.
LargeCap Value Separate Account. Principal Partners LargeCap Value Separate Account seeks long-term growth of capital. It invests primarily in undervalued equity securities of large-capitalization companies that the sub-advisor believes offer above-average potential for growth in future earnings. It normally invests at least 80% of assets in companies with market capitalizations similar to those of companies in the Russell 1000 Value Index. It may invest up to 25% of assets in foreign securities.
American Century Equity Income Adv Fund. The investment seeks current income; capital appreciation is secondary. The fund invests in equity securities of companies with a favorable income-paying history and with the potential for an increase in share price.
American Funds Fundamental Investors R4 Fund. The investment seeks growth of capital and income. The fund invests primarily in shares of common stocks or securities convertible into common stocks of large, established companies that offer growth potential at reasonable prices. It may invest significantly in securities of issuers domiciled outside of the U.S. and not included in the S&P 500 index. The fund may also hold cash or money market instruments.
Victory Stock Index A Fund. The investment seeks investment results that match the performance of the S&P 500 index. The fund invests primarily in the common stocks that comprise the S&P 500 index. The fund typically invests in all stocks that comprise the index. To compensate for the omission of certain stocks, the fund may purchase similar stocks not included on the index, or engage in futures transactions. The fund may invest in derivative instruments, including futures and options. Previously, the fund was named Society Stock Index Fund.
American Funds Growth Fund of America R4 Fund. The investment seeks capital growth. The fund invests primarily in common stocks. Management selects securities that it
11
Table of Contents
believes are reasonably priced and represent solid long-term investment opportunities. The fund may invest up to 15% of assets in securities of issuers domiciled outside of the U.S. and Canada, and not included in the S&P 500 index. If may also invest up to 10% of assets in debt securities rated below investment-grade.
LargeCap Growth I Separate Account. Principal Partners Large-Cap Growth I Separate Account seeks long-term growth of capital. It normally invests in growth-oriented equity securities of U.S. and, to a limited extent, foreign companies that exhibit strong, free cash flow potential. It normally invests at least 80% of assets in companies with market capitalizations larger than the median market cap of the companies in the Russell 1000 Growth Index. The sub-advisor generally looks for companies with an above-average rate of earnings and cash flow growth. It may invest up to 25% of assets in foreign securities.
Medium Company Blend Separate Account. The Principal Medium Company Blend Separate Account invests primarily in common stocks and other equity securities of medium capitalization companies. It normally invests the majority of assets in companies with market capitalizations assets in companies with market capitalizations similar to those companies in the Russell MidCap Index. Management’s securities selection is based on stocks with value and or growth characteristics, and management constructs an investment portfolio that has a blend of stocks with these characteristics. It may invest up to 25% of assets in foreign securities.
MidCap Growth Separate Account. Principal Partners Mid-Cap Growth Separate Account seeks long-term growth of capital. It invests primarily in common stocks and other equity securities of U.S. companies with strong earnings-growth potential. It normally invests at least 80% of assets in companies with market capitalizations similar to those of companies in the Russell MidCap Growth Index. Management attempts to maintain sector concentrations that approximate those of the index, but management does not limit investments to the securities of the index. It may invest up to 256% of assets in foreign securities.
Small Company Value Separate Account. The Principal Small Company value Separate Account seeks long-term growth of capital and invests primarily in common stocks of small capitalization companies. It normally invests the majority of assets in companies with market capitalizations similar to those companies in the Russell 2000 Value Index. Management focuses on stocks of small-sized companies that are undervalued at the time of purchase. These companies are often characterized by below-average stock price earnings ratios and above-average dividend yields. The Separate Account may invest up to 25% of assets in foreign securities.
Small Company Blend Separate Account. The Principal Small Company Blend Separate Account seeks long-term growth of capital and primarily invests in common stock of small capitalization companies. It normally invests the majority of assets in companies with market capitalizations similar to those of companies in the Russell 2000 Index. Management looks at stocks with value and or growth characteristics and constructs an investment portfolio that has a blend of stocks with these characteristics. Management does not have a policy of preferring one of these styles to the other. The Separate Account may invest up to 25% of assets in foreign securities.
12
Table of Contents
SmallCap Growth II Separate Account. Principal Partners Small-Cap Growth II Separate Account seeks long-term growth of capital. It invests primarily in equity securities of companies offering superior prospects for earnings growth. It normally invests at lest 80% of assets in companies with median market capitalizations similar to those of companies in the Russell 2000 Index. When selecting securities, management evaluates product positioning, management quality and sustainability of current growth trends. It may invest up to 25% of assets in foreign securities.
American Funds EuroPacific Growth R3 Fund. The investment seeks long-term growth of capital. The fund normally invests at least 80% of assets in securities of issuers located in Europe and the Pacific Basin. It considers a country to be part of the Pacific Basin if any of the country’s borders touch the Pacific Ocean. The fund may also hold cash, money market instruments and fixed-income securities.
Putnam International Equity A Fund. The investment seeks capital appreciation. The fund normally invests at least 80% of assets in equity securities. It may invest in companies of any size that management judges to be in a strong growth trend or undervalued. The fund may invest in both developed and emerging markets. It may also engage in various hedging strategies.
An investment in any of the funds listed above is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. As with any mutual fund investment, there is always a risk that you may lose money on your investment in any of the funds listed above.
Investment in Common Stock of TFS Financial Corporation
In connection with the stock offering, the 401(k) Plan now offers the TFS Financial Corporation Stock Fund as an additional choice to the investment options described above. The TFS Financial Corporation Stock Fund invests primarily in the shares of common stock of TFS Financial Corporation In connection with the stock offering, you may in the manner described earlier direct the trustee to invest up to 100% of your plan account in the TFS Financial Corporation Stock Fund as a one-time special election. Subsequent to the stock offering, you may elect to invest all or a portion of your payroll deduction contributions or matching contributions in the TFS Financial Corporation Stock Fund; you may also elect to transfer into the TFS Financial Corporation Stock Fund all or a portion of your accounts currently invested in other funds under the 401(k) Plan.
The TFS Financial Corporation Stock Fund consists primarily of investments in the shares of common stock of TFS Financial Corporation. After the stock offering, the trustee of the 401(k) Plan will use all amounts held by it in the TFS Financial Corporation Stock Fund to purchase additional shares of common stock of TFS Financial Corporation.
As of the date of this prospectus supplement, shares of TFS Financial Corporation common stock have been issued only to Third Federal Savings and Loan Association of
13
Table of Contents
Cleveland, MHC. There is no established market for TFS Financial Corporation common stock. Accordingly, there is no record of the historical performance of the TFS Financial Corporation Stock Fund. Performance of the TFS Financial Corporation Stock Fund depends on a number of factors, including the financial condition and profitability of TFS Financial Corporation and Third Federal Savings and Loan and market conditions for shares of TFS Financial Corporation common stock generally.
Investments in the TFS Financial Corporation Stock Fund involve special risks common to investments in the shares of common stock of TFS Financial Corporation.
For a discussion of material risks you should consider, see “Risk Factors” beginning on page 20 of the attached prospectus.
Administration of the 401(k) Plan
The Trustee and Custodian. Principal Trust Company, a subsidiary of Principal Financial Group, serves as trustee for all of the investments funds under the 401(k) Plan.
Plan Administrator. Pursuant to the terms of the 401(k) Plan, the 401(k) Plan is administered by the 401(k) Plan administrator. The address of the 401(k) Plan administrator is Third Federal Savings and Loan, Attention: Faye Pennyman, 7007 Broadway Avenue, Cleveland, Ohio 44105, telephone (216) 429-5248. The 401(k) Plan administrator is responsible for the administration of the 401(k) Plan, interpretation of the provisions of the 401(k) Plan, prescribing procedures for filing applications for benefits, preparation and distribution of information explaining the 401(k) Plan, maintenance of Plan records, books of account and all other data necessary for the proper administration of the 401(k) Plan, preparation and filing of all returns and reports relating to the 401(k) Plan which are required to be filed with the U.S. Department of Labor and the Internal Revenue Service, and for all disclosures required to be made to participants, beneficiaries and others under Sections 104 and 105 of ERISA.
Reports to Plan Participants. The 401(k) Plan administrator will furnish you a statement at least quarterly showing the balance in your account as of the end of that period, the amount of contributions allocated to your account for that period, any withdrawal or distribution activity and any adjustments to your account to reflect earnings or losses (if any).
It is the intention of Third Federal Savings and Loan to continue the 401(k) Plan indefinitely. Nevertheless, Third Federal Savings and Loan may terminate the 401(k) Plan at any time. If the 401(k) Plan is terminated in whole or in part, then regardless of other provisions in the 401(k) Plan, you will have a fully vested interest in your accounts. Third Federal Savings and Loan reserves the right to make any amendment or amendments to the 401(k) Plan which do not cause any part of the trust to be used for, or diverted to, any purpose other than the exclusive benefit of participants or their beneficiaries; provided, however, that Third Federal Savings and Loan may make any amendment it determines necessary or desirable, with or without retroactive effect, to comply with ERISA.
14
Table of Contents
Merger, Consolidation or Transfer
In the event of the merger or consolidation of the 401(k) Plan with another plan, or the transfer of the trust assets to another plan, the 401(k) Plan requires that you would, if either the 401(k) Plan or the other plan terminates, receive a benefit immediately after the merger, consolidation or transfer which is equal to or greater than the benefit you would have been entitled to receive immediately before the merger, consolidation or transfer, if the 401(k) Plan had then terminated.
Federal Income Tax Consequences
The following is a brief summary of the material federal income tax aspects of the 401(k) Plan. You should not rely on this summary as a complete or definitive description of the material federal income tax consequences relating to the 401(k) Plan. Statutory provisions change, as do their interpretations, and their application may vary in individual circumstances. Finally, the consequences under applicable state and local income tax laws may not be the same as under the federal income tax laws. Please consult your tax advisor with respect to any distribution from the 401(k) Plan and transactions involving the 401(k) Plan.
As a “tax-qualified retirement plan,” the Code affords the 401(k) Plan special tax treatment, including:
(1) the sponsoring employer is allowed an immediate tax deduction for the amount contributed to the 401(k) Plan each year;
(2) participants pay no current income tax on amounts contributed by the employer on their behalf; and
(3) earnings of the 401(k) Plan are tax-deferred, thereby permitting the tax-free accumulation of income and gains on investments.
Third Federal Savings and Loan will administer the 401(k) Plan to comply with the requirements of the Code as of the applicable effective date of any change in the law.
Lump-Sum Distribution. A distribution from the 401(k) Plan to a participant or the beneficiary of a participant will qualify as a lump-sum distribution if it is made within one taxable year, on account of the participant’s death, disability or separation from service, or after the participant attains age 59 1/2, and consists of the balance credited to participants under the 401(k) Plan and all other profit sharing plans (and in some cases all other stock bonus plans), if any, maintained by Third Federal Savings and Loan. The portion of any lump-sum distribution required to be included in your taxable income for federal income tax purposes consists of the entire amount of the lump-sum distribution, less the amount of after-tax contributions, if any, you have made to this Plan and any other profit sharing plans maintained by Third Federal Savings and Loan, which is included in the distribution.
TFS Financial Corporation Common Stock Included in Lump-Sum Distribution. If a lump-sum distribution includes TFS Financial Corporation common stock, the distribution
15
Table of Contents
generally will be taxed in the manner described above, except that the total taxable amount may be reduced by the amount of any net unrealized appreciation with respect to TFS Financial Corporation common stock, that is, the excess of the value of TFS Financial Corporation common stock at the time of the distribution over its cost or other basis of the securities to the trust. The tax basis of TFS Financial Corporation common stock, for purposes of computing gain or loss on its subsequent sale, equals the value of TFS Financial Corporation common stock at the time of distribution, less the amount of net unrealized appreciation. Any gain on a subsequent sale or other taxable disposition of TFS Financial Corporation common stock, to the extent of the amount of net unrealized appreciation at the time of distribution, will constitute long-term capital gain, regardless of the holding period of TFS Financial Corporation common stock. Any gain on a subsequent sale or other taxable disposition of TFS Financial Corporation common stock, in excess of the amount of net unrealized appreciation at the time of distribution, will be considered long-term capital gain. The recipient of a distribution may elect to include the amount of any net unrealized appreciation in the total taxable amount of the distribution, to the extent allowed by regulations to be issued by the Internal Revenue Service.
Distributions: Rollovers and Direct Transfers to Another Qualified Plan or to an IRA. You may roll over virtually all distributions from the 401(k) Plan to another qualified plan or to an individual retirement account in accordance with the terms of the other plan or account.
Notice of Your Rights Concerning Employer Securities. There has been an important change in Federal law that provides specific rights concerning investments in employer securities, such as TFS Financial Corporation common shares. Because you may in the future have investments in TFS Financial Corporation Stock Fund under the 401(k) Plan, you should take the time to read the following information carefully.
Your Rights Concerning Employer Securities. Beginning in 2007, the 401(k) Plan must allow you to elect to move any portion of your account that is invested in the TFS Financial Corporation Stock Fund from that investment into other investment alternatives under the 401(k) Plan. You may contact the Plan Administrator shown above for specific information regarding this new right, including how to make this election. In deciding whether to exercise this right, you will want to give careful consideration to the information below that describes the importance of diversification. All of the investment options under the 401(k) Plan are available to you if you decide to diversify out of the TFS Financial Corporation Stock Fund.
The Importance of Diversifying Your Retirement Savings. To help achieve long-term retirement security, you should give careful consideration to the benefits of a well-balanced and diversified investment portfolio. Spreading your assets among different types of investments can help you achieve a favorable rate of return, while minimizing your overall risk of losing money. This is because market or other economic conditions that cause one category of assets, or one particular security, to perform very well often cause another asset category, or another particular security, to perform poorly. If you invest more than 20% of your retirement savings in any one company or industry, your savings may not be properly diversified. Although diversification is not a guarantee against loss, it is an effective strategy to help you manage investment risk.
In deciding how to invest your retirement savings, you should take into account all of your assets, including any retirement savings outside of the 401(k) Plan. No single approach is right for everyone because, among other factors, individuals have different financial goals,
16
Table of Contents
different time horizons for meeting their goals, and different tolerances for risk. Therefore, you should carefully consider the rights described here and how these rights affect the amount of money that you invest in TFS Financial Corporation common stock through the 401(k) Plan.
It is also important to periodically review your investment portfolio, your investment objectives, and the investment options under the Plan to help ensure that your retirement savings will meet your retirement goals.
Additional ERISA Considerations
As noted above, the 401(k) Plan is subject to certain provisions of ERISA, including special provisions relating to control over the 401(k) Plan’s assets by participants and beneficiaries. The 401(k) Plan’s feature that allows you to direct the investment of your account balances is intended to satisfy the requirements of Section 404(c) of ERISA relating to control over plan assets by a participant or beneficiary. The effect of this is two-fold. First, you will not be deemed a “fiduciary” because of your exercise of investment discretion. Second, no person who otherwise is a fiduciary, such as Third Federal Savings and Loan, the 401(k) Plan administrator, or the 401(k) Plan’s trustee is liable under the fiduciary responsibility provision of ERISA for any loss which results from your exercise of control over the assets in your 401(k) Plan account.
Because you will be entitled to invest all or a portion of your account balance in the 401(k) Plan in TFS Financial Corporation common stock, the regulations under Section 404(c) of the ERISA require that the 401(k) Plan establish procedures that ensure the confidentiality of your decision to purchase, hold, or sell employer securities, except to the extent that disclosure of such information is necessary to comply with federal or state laws not preempted by ERISA. These regulations also require that your exercise of voting and similar rights with respect to the common stock be conducted in a way that ensures the confidentiality of your exercise of these rights.
Securities and Exchange Commission Reporting and Short-Swing Profit Liability
Section 16 of the Securities Exchange Act of 1934, as amended, imposes reporting and liability requirements on officers, directors, and persons beneficially owning more than 10% of public companies such as TFS Financial Corporation. Section 16(a) of the Securities Exchange Act of 1934 requires the filing of reports of beneficial ownership. Within 10 days of becoming an officer, director or person beneficially owning more than 10% of the shares of TFS Financial Corporation, a Form 3 reporting initial beneficial ownership must be filed with the Securities and Exchange Commission. Changes in beneficial ownership, such as purchases, sales and gifts generally must be reported periodically, either on a Form 4 within two business days after the change occurs, or annually on a Form 5 within 45 days after the close of TFS Financial Corporation’s fiscal year. Discretionary transactions in and beneficial ownership of the common stock through the TFS Financial Corporation Stock Fund of the 401(k) Plan by officers, directors and persons beneficially owning more than 10% of the common stock of TFS Financial Corporation generally must be reported to the Securities and Exchange Commission by such individuals.
17
Table of Contents
In addition to the reporting requirements described above, Section 16(b) of the Securities Exchange Act of 1934, as amended, provides for the recovery by TFS Financial Corporation of profits realized by an officer, director or any person beneficially owning more than 10% of TFS Financial Corporation’s common stock resulting from non-exempt purchases and sales of TFS Financial Corporation common stock within any six-month period.
The Securities and Exchange Commission has adopted rules that provide exemptions from the profit recovery provisions of Section 16(b) for all transactions in employer securities within an employee benefit plan, provided certain requirements are met. These requirements generally involve restrictions upon the timing of elections to acquire or dispose of employer securities for the accounts of Section 16(b) persons.
Except for distributions of common stock due to death, disability, retirement, termination of employment or under a qualified domestic relations order, persons affected by Section 16(b) are required to hold shares of common stock distributed from the 401(k) Plan for six months following such distribution and are prohibited from directing additional purchases within the TFS Financial Corporation stock fund for six months after receiving such a distribution.
Financial Information Regarding Plan Assets
Audited financial statements representing the net assets available for plan benefits at December 31, 2004 and December 31, 2005 and changes in net assets available for benefits for the years ended December 31, 2004 and December 31, 2005 are available upon written request to the Plan Administrator at the address shown above.
The validity of the issuance of the common stock has been passed upon by Luse Gorman Pomerenk & Schick, A Professional Corporation, Washington, D.C., which firm acted as special counsel to TFS Financial Corporation in connection with TFS Financial Corporation’s stock offering.
18
Table of Contents
PROSPECTUS
Holding Company for Third Federal Savings and Loan Association of Cleveland
87,130,102 Shares of Common Stock
TFS Financial Corporation, a federally chartered corporation, is offering for sale 87,130,102 shares of its common stock, $0.01 par value, on a best efforts basis. The shares being offered represent up to 30.08% of our shares of common stock that will be outstanding upon completion of the stock offering. Upon completion of the stock offering, up to 68.19% of our outstanding shares of common stock will be owned by Third Federal Savings and Loan Association of Cleveland, MHC, our federally chartered mutual holding company parent. In addition, Third Federal Savings and Loan Association of Cleveland intends to contribute cash in the amount of $5.0 million and we intend to issue up to 2% of our outstanding shares of common stock to a charitable foundation we will establish in connection with the stock offering. The contribution and issuance of cash and shares of common stock will total $47.9 million at the minimum of the offering range, up to a maximum contribution of $55.0 million.
We must sell a minimum of 64,400,510 shares in order to complete the stock offering, and we will terminate the stock offering if we do not sell the minimum number of shares. We may sell up to 100,199,618 shares because of changes in market conditions without resoliciting subscribers. The stock offering is scheduled to terminate at 4:00 p.m., Cleveland, Ohio time, on March 26, 2007. We may extend the termination date without notice to you, until May 14, 2007, unless the Office of Thrift Supervision approves a later date, which may not be beyond February 12, 2009.
Depositors of Third Federal Savings and Loan Association of Cleveland with aggregate deposit account balances of $50 or more as of April 30, 2005 will have first priority rights to subscribe for our shares of common stock. The minimum purchase is 25 shares of common stock. Generally, the maximum purchase that an individual may make through a single deposit account is 50,000 shares, and no person by himself, or with an associate or group of persons acting in concert, may purchase more than 75,000 shares. For further information concerning the limitations on purchases of shares of common stock, see “The Stock Offering—Limitations on Purchase of Shares.” Once submitted, orders are irrevocable unless the stock offering is terminated or extended beyond May 14, 2007. If the stock offering is extended beyond May 14, 2007, subscribers will have the right to modify or rescind their purchase orders. Funds received prior to the completion of the stock offering up to the minimum of the offering range will be held by Third Federal Savings and Loan Association of Cleveland. Funds received in excess of the minimum of the offering range may be maintained at Third Federal Savings and Loan Association of Cleveland or, at our discretion, at another federally insured depository institution. However, in no event will we maintain more than one escrow account. All subscriptions received will bear interest at Third Federal Savings and Loan Association of Cleveland’s passbook savings rate, which is currently 0.80% per annum. If the stock offering is terminated, subscribers will have their funds returned promptly, with interest.
Sandler O’Neill & Partners, L.P. will use its best efforts to assist us in selling our shares of common stock, but is not obligated to purchase any of the shares of common stock that are being offered for sale. Subscribers will not pay any commissions to purchase shares of common stock in the stock offering. There is currently no public market for the shares of common stock. Sandler O’Neill & Partners, L.P. has advised us that it intends to make a market in our shares of common stock, but is under no obligation to do so. We expect that our shares of common stock will be quoted on the Nasdaq Global Select Market under the symbol “TFSL.”
This investment involves risk, including the possible loss of principal.
Please read the “ Risk Factors” beginning on page 20.
OFFERING SUMMARY
Price: $10.00 per share
| Minimum |
Midpoint |
Maximum |
Adjusted | |||||
| Number of shares |
64,400,510 | 75,765,306 | 87,130,102 | 100,199,618 | ||||
| Estimated stock offering expenses excluding selling agent |
$ 3,560,000 | $ 3,560,000 | $ 3,560,000 | $ 3,560,000 | ||||
| Selling agent commissions and expenses (1) |
$ 3,656,000 | $ 4,298,000 | $ 4,942,000 | $ 5,683,000 | ||||
| Net proceeds |
$ 636,789,100 | $ 749,795,060 | $ 862,799,020 | $ 992,753,180 | ||||
| Net proceeds per share |
$ 9.89 | $ 9.90 | $ 9.90 | $ 9.91 |
| (1) | Based on 0.65% of the aggregate dollar amount of the shares of common stock sold in the subscription and community offerings, excluding shares sold to the employee stock ownership plan, the 401(k) plan, the charitable foundation and to our officers, employees and directors and members of their immediate families. For a description of the calculation of Sandler O’Neill & Partners, L.P.’s compensation for the stock offering, please see “The Stock Offering—Marketing Arrangements.” |
These securities are not deposits or savings accounts and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other governmental agency.
Neither the Securities and Exchange Commission, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, nor any state securities regulator has approved or disapproved these securities or has determined if this prospectus is accurate or complete. Any representation to the contrary is a criminal offense.
The date of this prospectus is February 12, 2007
Table of Contents
Table of Contents
| 1 | ||
| 20 | ||
| 29 | ||
| 31 | ||
| 36 | ||
| 37 | ||
| 39 | ||
| 40 | ||
| 41 | ||
| 43 | ||
| 45 | ||
| COMPARISON OF VALUATION AND PRO FORMA INFORMATION WITH AND WITHOUT THE CHARITABLE FOUNDATION |
52 | |
| MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
53 | |
| 73 | ||
| 74 | ||
| BUSINESS OF THIRD FEDERAL SAVINGS AND LOAN ASSOCIATION OF CLEVELAND |
74 | |
| 98 | ||
| 99 | ||
| 108 | ||
| 120 | ||
| 136 | ||
| 139 | ||
| 141 | ||
| 143 | ||
| 143 | ||
| 143 | ||
| 143 | ||
| 144 | ||
| F-1 |
i
Table of Contents
The following summarizes material information regarding the offering of shares of common stock by TFS Financial Corporation and the business of TFS Financial Corporation and Third Federal Savings and Loan Association of Cleveland. However, this summary may not contain all the information that may be important to you. For additional information, you should read this entire prospectus carefully, including the consolidated financial statements and the notes to the consolidated financial statements of TFS Financial Corporation.
Our Organization
In May 1997, Third Federal Savings and Loan Association of Cleveland (which we will refer to as “Third Federal Savings and Loan”) reorganized into the two-tier mutual holding company structure. As part of the reorganization, Third Federal Savings and Loan formed TFS Financial Corporation and Third Federal Savings and Loan Association of Cleveland, MHC, a federally chartered mid-tier stock holding company and mutual holding company, respectively. As a result of the reorganization, Third Federal Savings and Loan became a federally chartered capital stock savings and loan association, and a wholly-owned subsidiary of TFS Financial Corporation, and TFS Financial Corporation became the wholly-owned subsidiary of Third Federal Savings and Loan Association of Cleveland, MHC. The same directors and certain officers who manage Third Federal Savings and Loan manage TFS Financial Corporation and Third Federal Savings and Loan Association of Cleveland, MHC. In addition, in 1998 TFS Financial Corporation organized Third Capital, Inc. as a wholly-owned Delaware subsidiary corporation.
Our current ownership structure is as follows:
The Companies
Third Federal Savings and Loan Association of Cleveland, MHC
Third Federal Savings and Loan Association of Cleveland, MHC is a federally chartered mutual holding company and currently owns 100% of the outstanding common stock of TFS Financial Corporation. Third Federal Savings and Loan Association of Cleveland, MHC has not engaged in any significant business activity other than owning the common stock of TFS Financial Corporation, and does not intend to expand its business activities after the stock offering. Upon completion of the stock offering, Third Federal Savings and Loan Association of Cleveland, MHC is expected to own up to 68.34% of the outstanding shares of common stock of TFS Financial Corporation. So long as Third Federal Savings and Loan Association of Cleveland, MHC exists, it is required to own a majority of the voting stock of TFS Financial Corporation. The executive office of Third
1
Table of Contents
Federal Savings and Loan Association of Cleveland, MHC, is located at 103 Foulk Road, Suite 104, Wilmington, Delaware 19803, and its telephone number is (302) 661-2009. Third Federal Savings and Loan Association of Cleveland, MHC is subject to comprehensive regulation and examination by the Office of Thrift Supervision.
TFS Financial Corporation
TFS Financial Corporation is a federally chartered mid-tier stock holding company and currently owns 100% of the outstanding common stock of Third Federal Savings and Loan. TFS Financial Corporation also owns 100% of the common stock of Third Capital, Inc. (as described below). TFS Financial Corporation’s executive office is located at 103 Foulk Road, Suite 104, Wilmington, Delaware 19803, and its telephone number is (302) 661-2009. TFS Financial Corporation is subject to comprehensive regulation and examination by the Office of Thrift Supervision. At September 30, 2006, TFS Financial Corporation had consolidated assets of $8.6 billion, consolidated deposits of $7.4 billion and consolidated shareholder’s equity of $1.0 billion. Its net income for the fiscal year ended September 30, 2006 was $43.5 million.
Third Federal Savings and Loan Association of Cleveland
Third Federal Savings and Loan is a federally chartered savings and loan association headquartered in Cleveland, Ohio. Third Federal Savings and Loan was organized in 1938 by Ben S. and Gerome R. Stefanski, the parents of our current Chairman, President and Chief Executive Officer, Marc A. Stefanski. In May 1997, Third Federal Savings and Loan reorganized into the two-tier mutual holding company structure. In 1999, Third Federal Savings and Loan established its first branch offices in Florida, and currently operates from 14 branch offices in that state. Third Federal Savings and Loan conducts business from its main office located at 7007 Broadway Avenue, Cleveland, Ohio, 40 branch offices located in Ohio and Florida and eight loan production offices located in Ohio. The branch offices are located in the Ohio counties of Cuyahoga, Lake, Lorain, Medina and Summit and in the Florida counties of Collier, Hillsborough, Lee, Miami-Dade, Palm Beach, Pasco, Pinellas and Sarasota. The telephone number at Third Federal Savings and Loan’s main office is (216) 441-6000.
Third Federal Savings and Loan’s principal business consists of originating one- to four-family residential real estate mortgage loans, home equity loans and home equity lines of credit. Third Federal Savings and Loan also offers residential construction loans. To a lesser extent, Third Federal Savings and Loan also invests in mortgage-backed securities, U.S. Government and federal agency obligations and other investment securities. Third Federal Savings and Loan offers a variety of deposit accounts, including certificates of deposit, NOW accounts and passbook savings accounts. Deposits are Third Federal Savings and Loan’s primary source of funds for its lending and investing activities. Third Federal Savings and Loan has also used borrowed funds as a source of funds, principally from the Federal Home Loan Bank of Cincinnati. In addition to traditional banking services, Third Federal Savings and Loan offers insurance and investment products through ThirdFed Investments, a division of Third Federal Savings and Loan. Through a wholly-owned subsidiary, FBE, Inc., Third Federal Savings and Loan has acquired real properties as part of its commitment to revitalize the community surrounding its main office. Third Federal Savings and Loan is the indirect owner of a second-tier real estate investment trust, Broadway Realty Holdings Co., which holds mortgage loans and other investments. Third Federal Savings and Loan is subject to comprehensive regulation and examination by the Office of Thrift Supervision.
Third Federal Savings and Loan prices its loan and deposit products to encourage home ownership, attract borrowers and promote savings by its customers. Although this strategy does not enable Third Federal Savings and Loan to generate the highest returns, Third Federal Savings and Loan believes this strategy is the primary reason it has grown to become the nation’s largest mutually-owned savings and loan association based on total assets.
2
Table of Contents
Third Capital, Inc.
Third Capital, Inc. is a Delaware corporation that was organized in 1998 as a wholly-owned subsidiary of TFS Financial Corporation. Third Capital, Inc. is a holding company for operating subsidiaries, and is also a minority investor or partner in other entities and partnerships. Through its subsidiaries, Third Capital, Inc. engages in net lease transactions for commercial properties, and offers escrow and settlement services and reinsures private mortgage insurance. At September 30, 2006, Third Capital, Inc. had consolidated assets of $63.1 million. For further information, see “Business of Third Capital, Inc.”
Business Strategy
Our business strategy is:
| • | Following our mission of creating value for our customers, our communities and our company; |
| • | Encouraging home ownership by offering competitive interest rates and attractive product features on mortgage loans and home equity loans and lines of credit in our primary market areas; |
| • | Promoting savings by our customers by offering competitive rates on certificates of deposit and other deposit products; |
| • | Controlling and managing operating expenses; and |
| • | Growing through de novo branching. |
See “Business of Third Federal Savings and Loan Association of Cleveland” for a full description of our products and services. See also “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Strategy” for a discussion of our business strategy.
The Stock Offering
Federal regulations require that as long as Third Federal Savings and Loan Association of Cleveland, MHC exists, it must own a majority of our outstanding shares of common stock. Accordingly, the shares that we are permitted to sell in the stock offering must represent a minority of our outstanding shares of common stock. Based on these restrictions, our board of directors has decided to offer up to 30.15% of our shares of common stock for sale in the stock offering. In addition, Third Federal Savings and Loan intends to contribute cash of $5.0 million and we intend to contribute up to 2% of our shares of common stock to a charitable foundation we will establish. The contribution of cash and shares of common stock will total $47.9 million at the minimum of the offering range, up to a maximum contribution of $55.0 million. Our remaining outstanding shares of common stock will be held by Third Federal Savings and Loan Association of Cleveland, MHC.
3
Table of Contents
The following chart shows our structure following the stock offering:
Third Federal Savings and Loan Association of Cleveland, MHC has no plans, understandings or agreements, whether written or oral, to sell or otherwise dispose of its shares of common stock of TFS Financial Corporation. Third Federal Savings and Loan Association of Cleveland, MHC may convert to stock form in the future by offering its interest in TFS Financial Corporation for sale to depositors and others in a subscription offering. However, Third Federal Savings and Loan Association of Cleveland, MHC has no current plans to convert to stock form.
Reasons for the Stock Offering
The primary reasons for our decision to conduct the stock offering and raise capital are to:
| • | support our internal growth through lending in communities we serve or may serve in the future; |
| • | support the expansion of our branch network; |
| • | enhance our existing products and services and to support the development of new products and services; |
| • | enable us to compete more effectively in the financial services marketplace; |
| • | offer our depositors, employees, management and directors an equity ownership interest in TFS Financial Corporation and thereby obtain an economic interest in any future success that we may have; and |
| • | support our local communities through a contribution to the charitable foundation. |
The stock offering also will allow us to establish stock benefit plans for management and employees, which will help us to attract and retain qualified personnel.
Terms of the Stock Offering
We are offering between 64,400,510 and 87,130,102 shares of common stock to qualified depositors and borrowers, tax-qualified employee plans and to the public to the extent shares remain available. The maximum number of shares that we sell in the stock offering may increase up to 100,199,618 shares, as a result of positive changes in financial markets in general and with respect to financial institution stocks in particular. Unless our estimated pro forma market value decreases below $2.15 billion or increases above $3.32 billion, you will not
4
Table of Contents
have the opportunity to change or cancel your stock order. The offering price of the shares of common stock is $10.00 per share. Sandler O’Neill & Partners, L.P., our marketing advisor in connection with the stock offering, will use its best efforts to assist us in selling our shares of common stock, but Sandler O’Neill & Partners, L.P. is not obligated to purchase any shares in the stock offering.
Third Federal Savings and Loan also intends to contribute cash in the amount of $5.0 million and we intend to issue up to 2% of our outstanding shares to a charitable foundation we will establish. The contribution and issuance of cash and shares of common stock will total $47.9 million at the minimum of the offering range, up to a maximum contribution of $55.0 million.
Persons Who May Order Stock in the Stock Offering
We are offering the shares of common stock in a “subscription offering” in the following descending order of priority:
| (1) | Depositors who had accounts at Third Federal Savings and Loan with aggregate balances of at least $50.00 as of the close of business on April 30, 2005; |
| (2) | The tax-qualified employee benefit plans of Third Federal Savings and Loan (including our employee stock ownership plan); |
| (3) | Depositors who had accounts at Third Federal Savings and Loan with aggregate balances of at least $50.00 as of the close of business on December 31, 2006; and |
| (4) | Depositors who had accounts at Third Federal Savings and Loan with aggregate balances of at least $50.00 as of the close of business on January 31, 2007, and borrowers from Third Federal Savings and Loan as of January 17, 1996 who maintain such borrowings as of the close of business on January 31, 2007. |
If any shares of our common stock remain unsold in the subscription offering, we will offer such shares for sale in a community offering. Natural persons residing in the State of Ohio, the Kentucky counties of Boone, Kenton and Campbell, and the Florida counties of Broward, Charlotte, Citrus, Collier, Hernando, Hillsborough, Lake, Lee, Manatee, Martin, Miami-Dade, Orange, Osceola, Palm Beach, Pasco, Pinellas, Polk, Sarasota, Seminole, St. Lucie and Volusia, will have a purchase preference in any community offering. Shares of common stock also may be offered to the general public. The community offering, if any, may commence concurrently with, during or promptly after, the subscription offering. We also may offer shares of common stock not purchased in the subscription offering or the community offering through a syndicate of brokers in what is referred to as a syndicated community offering. The syndicated community offering, if necessary, would be managed by Sandler O’Neill & Partners, L.P. We have the right to accept or reject, in our sole discretion, any orders received in the community offering or the syndicated community offering.
To ensure a proper allocation of stock, each eligible account holder must list on his or her stock order form all deposit accounts in which he or she had an ownership interest at April 30, 2005, December 31, 2006 or January 31, 2007, as applicable. Failure to list an account, or providing incorrect information, could result in the loss of all or part of a subscriber’s stock allocation. Our interpretation of the terms and conditions of the stock issuance plan and of the acceptability of the order forms will be final.
How We Determined to Offer Between 64,400,510 Shares and 87,130,102 Shares and the $10.00 Price Per Share
The decision to offer between 64,400,510 shares and 87,130,102 shares, subject to adjustment, which is our offering range, is based on an independent appraisal of our pro forma market value prepared by FinPro, Inc., a firm experienced in appraisals of financial institutions. FinPro, Inc. is of the opinion that as of January 31, 2007,
5
Table of Contents
the estimated pro forma market value of the shares of common stock of TFS Financial Corporation on a fully- converted basis was between $2.15 billion and $2.90 billion, with a midpoint of $2.53 billion. The term “fully converted” assumes that 100% of our common stock had been sold to the public, as opposed to the 30.0% to 30.15% that will be sold in the stock offering.
In preparing its appraisal, FinPro, Inc. considered the information contained in this prospectus, including our consolidated financial statements. FinPro, Inc. also considered the following factors, among others:
| • | our present and projected operating results and financial condition and the economic and demographic conditions in our existing market areas; |
| • | historical, financial and other information relating to TFS Financial Corporation and Third Federal Savings and Loan; |
| • | a comparative evaluation of our operating and financial statistics with those of other similarly situated publicly traded thrifts and mutual holding companies; |
| • | the impact of the stock offering on our shareholders’ equity and earnings potential; |
| • | our proposed dividend policy; and |
| • | the trading market for securities of comparable institutions and general conditions in the market for such securities. |
FinPro, Inc. also considered the contribution of cash and issuance of shares of common stock to Third Federal Foundation, a charitable foundation we will establish. The contribution of cash and shares of common stock to the charitable foundation will have the effect of reducing our estimated pro forma value. See “Comparison of Valuation and Pro Forma Information with and without the Charitable Foundation.”
In reviewing the appraisal prepared by FinPro, Inc., the board of directors considered the methodologies and the appropriateness of the assumptions used by FinPro, Inc. in addition to the factors listed above, and the board of directors believes that these assumptions are reasonable.
The board of directors determined that the common stock should be sold at $10.00 per share, that up to 30.15% of the shares of common stock should be offered for sale in the stock offering and up to 68.34% should be held by Third Federal Savings and Loan Association of Cleveland, MHC, after giving effect to the issuance of shares of common stock to Third Federal Foundation. Based on the estimated valuation range and the purchase price, the number of shares of common stock that will be outstanding upon completion of the stock offering will range from 214,668,367 to 289,625,000 (subject to adjustment to 332,318,750), and the number of shares of common stock that will be sold in the stock offering will range from 64,400,510 shares to 87,130,102 shares (subject to adjustment up to 100,199,618), with a midpoint of 75,765,306 shares. The number of shares that Third Federal Savings and Loan Association of Cleveland, MHC will own after the stock offering will range from 145,974,490 to 197,494,898 (subject to adjustment to 227,119,132). The number of shares of common stock that Third Federal Foundation will own after the stock offering will range from 4,293,367 to 5,000,000. The estimated valuation range may be amended with the approval of the Office of Thrift Supervision, or if necessitated by subsequent developments in the financial condition of Third Federal Savings and Loan or market conditions generally.
The appraisal will be updated before we complete the stock offering. If the estimated pro forma market value of the shares of common stock at that time is either below $2.15 billion or above $3.32 billion, then we may, after consulting with the Office of Thrift Supervision:
| • | terminate the stock offering and return all funds promptly with interest; |
| • | extend the stock offering or hold a new subscription or community offering, or both; |
6
Table of Contents
| • | establish a new offering range and commence a resolicitation of subscribers; or |
| • | take such other actions as may be permitted by the Office of Thrift Supervision. |
Under such circumstances, we will notify you, and you will have the opportunity to change or cancel your order within a specified time period. In any event, the stock offering must be completed by no later than February 12, 2009.
Two measures investors use to evaluate an issuer’s stock are the ratio of the offering price to the pro forma tangible book value and the ratio of the offering price to the issuer’s pro forma net income. FinPro, Inc. considered these ratios, among other factors, in preparing its appraisal. Book value is the same as total equity, and represents the difference between the issuer’s assets and liabilities. The following table presents the ratio of the offering price to our pro forma tangible book value and earnings per share at or for the period indicated. See “Pro Forma Data” for a description of the assumptions used in making these calculations.
| At or For the Fiscal Year Ended September 30, 2006 | ||||||||||||
| 64,400,510 Shares Sold at $10.00 Per Share |
75,765,306 Shares Sold at $10.00 Per Share |
87,130,102 Shares Sold at $10.00 Per Share |
100,199,618 Shares Sold at $10.00 Per Share |
|||||||||
| Pro forma price-to-tangible book value ratio |
140.06 | % | 155.28 | % | 168.63 | % | 182.48 | % | ||||
| Pro forma price-to-earnings ratio |
45.45x | 52.63x | 58.82x | 66.67x | ||||||||
The following table compares our pricing ratios to the pricing ratios of our peer group companies on a non-fully converted basis, each at or for the twelve months ended September 30, 2006. Compared to the median pricing ratios of the peer group, our pro forma pricing ratios at the maximum of the offering range, indicated a discount of 30.12% on a price-to-core earnings basis and a discount of 30.83% on a price-to-tangible book basis.
| Non-Fully Converted Price-to-Core |
Non-Fully Converted Price-to-Tangible |
||||
| TFS Financial Corporation |
|||||
| Maximum |
35.71x | 168.63 | % | ||
| Minimum |
27.03x | 140.06 | % | ||
| Valuation of peer group companies as of January 31, 2007 |
|||||
| Averages |
75.10x | 242.28 | % | ||
| Medians |
51.10x | 243.80 | % |
The following table presents a summary of selected pricing ratios for the peer group companies and for us, each at or for the twelve months ended September 30, 2006, with the ratios adjusted to the hypothetical case of our being a fully converted stock holding company. Compared to the median fully converted pricing ratios of the peer group, our pro forma fully converted pricing ratios at the maximum of the offering range indicated a discount of 31.39% on a price-to-core earnings basis and a discount of 19.63% on a price-to-tangible book basis.
| Fully Converted Equivalent Pro Forma Price-to-Core Earnings Multiple |
Fully Converted Equivalent Pro Forma Price-to-Tangible Book Value Ratio |
||||
| TFS Financial Corporation |
|||||
| Maximum |
22.73x | 82.71 | % | ||
| Minimum |
18.87x | 75.30 | % | ||
| Valuation of peer group companies as of January 31, 2007 |
|||||
| Averages |
36.35x | 105.19 | % | ||
| Medians |
33.13x | 102.91 | % |
7
Table of Contents
As shown in the above tables, our pro forma fully converted and non-fully converted price-to-book value ratios are discounted compared to the average trading price-to-book value of the peer group companies.
The pro forma fully-converted calculations for the peer group companies include the following assumptions:
| • | 8.0% of the shares sold in a second-step stock offering would be purchased by an employee stock ownership plan, with the expense to be amortized over 30 years; |
| • | 4.0% of the shares sold in the second-step stock offering would be purchased by a stock-based benefit plan, with the expense to be amortized over five years; |
| • | Options equal to 10% of the shares sold in the second-step stock offering would be granted under a stock-based benefit plan, with option expense of $3.37 per option, and with the expense to be amortized over five years; and |
| • | stock offering expenses would equal 2.5% of the stock offering amount. |
With respect to TFS Financial Corporation, the pro forma fully-converted calculations use the same assumptions as applied to the peer group companies, but also assume: the impact of the establishment of our charitable foundation; the expense of the employee stock ownership plan would be amortized over 30 years; and that we would recognize expense with respect to stock options granted under a stock-based benefit plan over a five-year period. See “Comparison of Valuation and Pro Forma Information with and without the Charitable Foundation” for a discussion of the impact of our charitable foundation on our appraised value.
The independent appraisal does not indicate after-market trading value. Do not assume or expect that the valuation as indicated above means that our shares of common stock will trade at or above the $10.00 purchase price after the stock offering.
8
Table of Contents
After-Market Performance Information
The following table presents stock price performance information for all mutual holding company initial public offerings completed between January 1, 2006 and January 31, 2007. The offerings are presented in reverse chronological order, which means that the most recent offerings appear first.
| Price Performance from Initial Trading Date | ||||||||||||
| Transaction |
One Day Percentage Change |
One Week Percentage Change |
One Month Percentage Change |
Through Percentage |
||||||||
| Oritani Financial Corp. |
59.70 | % | 54.30 | % | N/A | 53.50 | % | |||||
| Polonia Bancorp |
1.00 | 1.50 | N/A | 1.00 | ||||||||
| MSB Financial Corp. |
23.00 | 21.20 | N/A | 20.00 | ||||||||
| MainStreet Financial Corporation |
10.00 | 10.00 | (2.50 | ) | — | |||||||
| Ben Franklin Financial, Inc. |
7.00 | 6.50 | 6.50 | 8.00 | ||||||||
| ViewPoint Financial Group |
49.90 | 52.50 | 53.90 | 71.20 | ||||||||
| Fox Chase Bancorp, Inc. |
29.50 | 27.90 | 30.10 | 38.20 | ||||||||
| Roma Financial Corporation |
41.00 | 45.00 | 46.60 | 57.10 | ||||||||
| Seneca-Cayuga Bancorp, Inc. |
— | (1.50 | ) | (7.00 | ) | (5.00 | ) | |||||
| Northeast Community Bancorp, Inc. |
10.00 | 12.00 | 12.00 | 19.20 | ||||||||
| Mutual Federal Bancorp, Inc. |
11.30 | 10.00 | 14.00 | 44.10 | ||||||||
| Lake Shore Bancorp, Inc. |
7.00 | 5.50 | 2.90 | 25.40 | ||||||||
| United Community Bancorp |
8.00 | 8.40 | 5.50 | 22.50 | ||||||||
| Magyar Bancorp, Inc. |
6.50 | 5.00 | 6.00 | 37.50 | ||||||||
| Greenville Federal Financial Corporation |
2.50 | 2.50 | — | 3.50 | ||||||||
| Average |
17.76 | 17.39 | 14.00 | 26.41 | ||||||||
| Median |
10.00 | 10.00 | 6.25 | 22.50 | ||||||||
The table above presents only short-term historical information on stock price performance, which may not be indicative of the longer-term performance of such stock prices. The data presented in the table are not intended to predict how our shares of common stock may perform following the stock offering. The historical information in the table may not be meaningful to you because the data were calculated using a small sample.
The market price of any particular company’s stock is subject to various factors, including the amount of proceeds a company raises and management’s ability to deploy proceeds (such as through investments, the acquisition of other financial institutions or other businesses, the payment of dividends and common stock repurchases). In addition, stock prices may be affected by general market conditions, market interest rates, the market for financial institutions, merger or takeover transactions, the presence of professional and other investors who purchase stock on speculation, as well as other unforeseeable events not necessarily within the control of management or the board of directors.
FinPro, Inc. advised the board of directors that the appraisal was prepared in conformance with the appraisal methodology set forth in Office of Thrift Supervision regulatory guidelines and policy. That methodology requires a valuation based on an analysis of the trading prices of comparable public companies whose stocks have traded for at least one year prior to the valuation date. FinPro, Inc. also advised the board of directors that the aftermarket trading experience of recent transactions was considered in the appraisal as a general indicator of current market conditions, but was not relied upon as a primary valuation methodology.
Our board of directors carefully reviewed the information provided by FinPro, Inc. in its appraisal, but did not make any determination regarding whether prior mutual holding company stock offerings have been valued
9
Table of Contents
fairly, nor did the board draw any conclusions regarding how the historical data reflected above may affect the appraisal. Instead, the board of directors engaged FinPro, Inc. to help it understand the regulatory process as it applies to the appraisal and to advise the board of directors how much capital would need to be raised under the regulatory guidelines.
There can be no assurance that our stock price will not trade below $10.00 per share. As noted in the above table, two of the 15 initial public mutual holding company stock offerings since January 1, 2006 referenced in the table have traded below their initial offering price at the dates indicated. Before you make an investment decision, we urge you to carefully read this prospectus, including the section entitled “Risk Factors.”
Our Officers, Directors and Employees Will Receive Additional Compensation and Benefit Plans After the Stock Offering
Third Federal Savings and Loan has established an employee stock ownership plan, and we intend to implement one or more stock-based benefit plans that will provide for grants of stock options and shares of common stock. Our tax-qualified employee benefit plans, including our employee stock ownership plan and our 401(k) savings plan, may purchase in the stock offering up to 4.9% of our outstanding shares of common stock (including shares issued to Third Federal Foundation). However, it is expected that our employee stock ownership plan will purchase 3.92% of our outstanding shares of common stock (including shares issued to Third Federal Savings and Loan Association of Cleveland, MHC and to Third Federal Foundation).
In addition to shares purchased by the employee stock ownership plan, we intend to grant options and stock awards under one or more stock-based benefit plans that we intend to implement no sooner than six months after the completion of the stock offering, subject to the approval of our shareholders. Under current Office of Thrift Supervision regulations, the number of options granted or shares of common stock awarded under our stock-based benefit plans may not exceed 4.90% and 1.96%, respectively, of our total outstanding shares (including shares issued to Third Federal Savings and Loan Association of Cleveland, MHC and to Third Federal Foundation), exclusive of shares acquired in the secondary market to fund such plans in excess of the foregoing amounts. The number of options granted or shares awarded under our stock-based benefit plans that we may implement following the stock offering, when aggregated with any subsequently adopted stock-based benefit plans (exclusive of any shares held by our employee stock ownership plan), may not exceed 25% of the shares of common stock held by persons other than Third Federal Savings and Loan Association of Cleveland, MHC.
The stock-based benefit plans will comply with all applicable regulations of the Office of Thrift Supervision in effect at the time such plans are adopted. Under Office of Thrift Supervision regulations, the stock-based benefit plans cannot be established sooner than six months after the stock offering, and would require the approval of a majority of votes cast by our shareholders (under Nasdaq rules) and by a majority of the total votes eligible to be cast (excluding votes eligible to be cast by Third Federal Savings and Loan Association of Cleveland, MHC), unless we obtain a waiver from the Office of Thrift Supervision that would allow the stock-based benefit plans to be approved by a majority of votes cast by our shareholders (excluding shares voted by Third Federal Savings and Loan Association of Cleveland, MHC). We currently intend to request such a waiver from the Office of Thrift Supervision. Unless a waiver is obtained from the Office of Thrift Supervision, the following additional Office of Thrift Supervision restrictions would apply to our stock-based benefit plans:
| • | non-employee directors in the aggregate may not receive more than 30% of the options and stock awards authorized under the plans; |
| • | any one non-employee director may not receive more than 5% of the options and stock awards authorized under the plans; |
| • | any officer or employee may not receive more than 25% of the options or stock awards authorized under the plans; |
10
Table of Contents
| • | the options and stock awards may not vest more rapidly than 20% per year, beginning on the first anniversary of shareholder approval of the plans; and |
| • | accelerated vesting of awards is not permitted except for death, disability or upon a change in control of Third Federal Savings and Loan or TFS Financial Corporation. |
We may obtain the shares needed for our stock-based benefit plans by issuing additional shares of common stock from authorized but unissued shares or through stock repurchases.
The Office of Thrift Supervision has proposed amendments to its existing regulations regarding stock-based benefit plans that are intended to clarify and simplify such regulations. Specifically, the amendments would clarify that we may grant options and award shares of common stock under one or more stock-based benefit plans in excess of 4.90% and 1.96%, respectively, of our total outstanding shares if the stock-based benefit plans are adopted more than one year following the stock offering, provided shares used to fund the plans in excess of these amounts are obtained through stock repurchases. The proposed amendments would also require that, if the stock-based benefit plans are adopted less than one year following the stock offering, the stock-based benefit plans must be approved by a majority of the votes of TFS Financial Corporation shareholders cast at an annual or special meeting of shareholders, excluding votes eligible to be cast by Third Federal Savings and Loan Association of Cleveland, MHC. Under the proposed amendments, there would be no separate vote required of minority shareholders if the stock-based benefit plans are adopted more than one year following the stock offering. The proposed amendments would further clarify that the current regulatory restrictions set forth above regarding the amount of individual and group awards, and restrictions on accelerated vesting of awards, would not apply if the stock-based benefit plans are adopted more than one year following the stock offering.
In the event the Office of Thrift Supervision adopts these regulations as proposed, or otherwise changes its existing regulations or policies, we may implement stock-based benefit plans that exceed the current limits applicable to the overall size of such plans and individual awards thereunder, and otherwise grant awards with terms that are different than those required by current Office of Thrift Supervision regulations and policy. Moreover, to the extent that any new regulations or policies contain a more flexible voting standard for shareholder approval than that currently required, we intend to use the more flexible voting standard, which could result in the vote of Third Federal Savings and Loan Association of Cleveland, MHC controlling the outcome of a shareholder vote on stock-based benefit plans.
The employee stock ownership plan and the stock-based benefit plans will increase our future compensation costs, thereby reducing our earnings. Public companies are required to expense the grant-date fair value of stock options and other stock awards granted to officers, directors and employees. In addition, public companies must revalue their estimated compensation costs at each subsequent reporting date and may be required to recognize additional compensation expense at those dates. Any additional compensation expense due to variances in actual vesting or stock price experience compared to assumptions in the table below will increase our compensation costs over the vesting period of the options. Additionally, shareholders will experience a reduction in their ownership interest if newly issued shares of common stock are used to fund stock options and stock awards. See “Risk Factors—Our Stock Based Benefit Plans Will Increase Our Costs, Which Will Reduce Our Income. Our Directors, Officers and Employees are Eligible to Participate in These Stock-Based Benefit Plans,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Anticipated Increase in Non-Interest Expense” and “Management—Stock Benefit Plans.”
The following three tables summarize the stock benefits that our officers, directors and employees may receive following the stock offering at the maximum of the offering range, assuming that we initially implement one or more stock-based benefit plans granting options to purchase 4.90% of the shares outstanding at the completion of the stock offering (including shares issued to Third Federal Foundation) and awarding shares of common stock equal to 1.96% of the shares outstanding at the completion of the stock offering (including shares issued to Third Federal Foundation). Proposed Office of Thrift Supervision regulations would clarify that the
11
Table of Contents
amount of stock options and stock awards available for grant under the stock-based benefit plans may be greater than the amounts set forth in the following three tables, provided shares used to fund the stock-based benefit plans in excess of these amounts are obtained through stock repurchases.
In the table below, it is assumed that, at the maximum of the offering range, a total of 87,130,102 shares will be sold to the public, and a total of 92,130,102 shares will be issued and outstanding to the public and the charitable foundation. This table assumes that Third Federal Savings and Loan’s tangible capital ratio is 10% or more following the stock offering.
| Plan/Awards |
Individuals |
Number of Shares |
Percent of Outstanding Shares (1) |
Percent of Shares Sold |
Value of Benefits Based on Maximum of Offering Range (2) | ||||||||
| (In thousands) | |||||||||||||
| Employee stock ownership plan |
All officers and employees | 11,353,300 | 3.92 | % | 13.03 | % | $ | 113,533 | |||||
| Stock awards |
Directors, officers and employees | 5,676,650 | 1.96 | 6.52 | 56,767 | ||||||||
| Stock options |
Directors, officers and employees | 14,191,625 | 4.90 | 16.29 | 47,826 | ||||||||
| 10.78 | % | 35.84 | % | $ | 218,126 | ||||||||
| (1) | Amounts are based on current Office of Thrift Supervision regulations and policy, exclusive of shares acquired in the secondary market to fund stock awards and stock options. Proposed Office of Thrift Supervision regulations would clarify that the amount of stock options and stock awards available for grant under the stock-based benefit plans may be greater than the amounts set forth in the table, provided shares used to fund the stock-based benefit plans in excess of these amounts are obtained through stock repurchases. |
| (2) | The actual value of the stock awards will be determined based on their fair value as of the date the grants are made. For purposes of this table, fair value is assumed to be the offering price of $10.00 per share. The fair value of stock options has been estimated at $3.37 per option using the Black-Scholes option pricing model with the following assumptions: a grant-date share price and option exercise price of $10.00; dividend yield of 0%; expected option life of 7.5 years; risk-free interest rate of 4.56% (based on the seven-year Treasury Note rate); and a volatility rate of 16.34% based on an index of publicly traded mutual holding companies. The actual expense of the stock options will be determined by the grant-date fair value of the options, which will depend on a number of factors, including the valuation assumptions used in the option pricing model ultimately adopted. |
12
Table of Contents
The value of the shares of common stock will be based on the price per share of our common stock at the time those shares are granted, which, subject to shareholder approval, cannot occur until at least six months after the stock offering. The following table presents the total value of all shares of common stock to be available for award and issuance under the stock-based benefit plans, assuming the stock-based benefit plans award shares of common stock equal to 1.96% of the outstanding shares after the stock offering and the shares for the plans are purchased or issued in a range of market prices from $8.00 per share to $16.00 per share.
| Share Price |
4,207,499 Shares Awarded at Minimum of Offering Range |
4,949,000 Shares Awarded at Midpoint of Offering Range |
5,676,650 Shares Awarded at Maximum of Offering Range |
6,513,447
Shares As Adjusted | ||||||||
| (In thousands, except per share data) | ||||||||||||
| $ 8.00 |
$ | 33,660 | $ | 39,592 | $ | 45,413 | $ | 52,108 | ||||
| $10.00 |
$ | 42,075 | $ | 49,490 | $ | 56,767 | $ | 65,134 | ||||
| $12.00 |
$ | 50,490 | $ | 59,388 | $ | 68,120 | $ | 78,161 | ||||
| $14.00 |
$ | 58,905 | $ | 69,286 | $ | 79,473 | $ | 91,188 | ||||
| $16.00 |
$ | 67,320 | $ | 79,184 | $ | 90,826 | $ | 104,215 | ||||
The grant-date fair value of the options granted under the stock-based benefit plans will be based in part on the price per share of our common stock at the time the options are granted, which, subject to shareholder approval, cannot occur until at least six months after the stock offering. The value will also depend on the various assumptions used in the option pricing model ultimately adopted. The following table presents the total estimated value of the options to be available for grant under the stock-based benefit plans, assuming the stock-based benefit plans award options equal to 4.9% of the outstanding shares of common stock after the stock offering, the market price and exercise price for the stock options are equal and the range of market prices for the shares are $8.00 per share to $16.00 per share.
| Market/Exercise Price |
Grant-Date Fair Value Per Option |
10,518,749 Options at Minimum of Offering Range |
12,372,500 Options at Midpoint of Offering Range |
14,191,625 Options at Maximum of Offering Range |
16,283,618 As Adjusted | ||||||||||
| (In thousands, except per share data) | |||||||||||||||
| $ 8.00 |
$ | 2.70 | $ | 28,401 | $ | 33,406 | $ | 38,317 | $ | 43,966 | |||||
| $10.00 |
$ | 3.37 | $ | 35,448 | $ | 41,695 | $ | 47,826 | $ | 54,876 | |||||
| $12.00 |
$ | 4.05 | $ | 42,601 | $ | 50,109 | $ | 57,476 | $ | 65,949 | |||||
| $14.00 |
$ | 4.72 | $ | 49,648 | $ | 58,398 | $ | 66,984 | $ | 76,859 | |||||
| $16.00 |
$ | 5.40 | $ | 56,801 | $ | 66,812 | $ | 76,635 | $ | 87,932 | |||||
Limits on Your Purchase of Shares of Common Stock
The minimum purchase is 25 shares of common stock. Generally, no individual, or individuals acting through a single account, may purchase more than $500,000 (50,000 shares) of common stock. If any of the following persons purchase shares of common stock, their purchases, when combined with your purchases, cannot exceed $750,000 (75,000 shares) of common stock:
| • | your spouse, or relatives of you or your spouse living in your house; |
| • | companies or other entities in which you have a 10% or greater equity or substantial beneficial interest or in which you serve as a senior officer or partner; |
| • | a trust or other estate if you have a substantial beneficial interest in the trust or estate or you are a trustee or fiduciary for the trust or estate; or |
| • | other persons who may be acting together with you (including, but not limited to, persons who file jointly a Schedule 13G or Schedule 13D Beneficial Ownership Report with the Securities and Exchange Commission). |
13
Table of Contents
A detailed discussion of the limitations on purchases of common stock by an individual and persons acting together is set forth under the caption “The Stock Offering—Limitations on Purchase of Shares.”
Subject to Office of Thrift Supervision approval, we may increase or decrease the purchase limitations in the stock offering at any time. In addition, in any community offering or syndicated community offering, we will first fill orders for our shares of common stock up to a maximum of 1,000 shares. Thereafter, we will allocate any remaining shares of common stock on an equal number of shares per order basis, until we fill all orders. Our tax-qualified benefit plans, including our employee stock ownership plan, are authorized to purchase up to 4.9% of the shares to be outstanding immediately following the stock offering (including shares issued to Third Federal Savings and Loan Association of Cleveland, MHC and Third Federal Foundation) without regard to these purchase limitations. The employee stock ownership plan may purchase shares of common stock in the stock offering, in the open market following consummation of the stock offering, from authorized but unissued shares of common stock, or from treasury shares following consummation of the stock offering.
Our Issuance of Shares of Common Stock to the Charitable Foundation
To further our commitment to the communities we serve, we intend to establish a charitable foundation as part of the stock offering. Third Federal Savings and Loan will contribute cash in the amount of $5.0 million and we will issue up to 2% of our outstanding shares of common stock to the charitable foundation, ranging from 4,293,367 shares at the minimum of the valuation range to 5,000,000 shares at the maximum of the valuation range, which shares will have a value of $42.9 million at the minimum of the valuation range and $50.0 million at the maximum of the valuation range, based on the $10.00 per share offering price, up to a maximum contribution of $55.0 million of cash and shares of common stock. As a result of the issuance of shares to the charitable foundation and the contribution of $5.0 million in cash, we will record an after-tax expense of approximately $31.2 million at the minimum of the valuation range and of approximately $35.8 million at the maximum of the valuation range, during the quarter in which the stock offering is completed.
Under the Internal Revenue Code, an entity is permitted to deduct up to 10% of its taxable income (income before income taxes) in any one year for charitable contributions. Any contribution in excess of the 10% limit may be deducted for federal income tax purposes over each of the five years following the year in which the charitable contribution was made. Accordingly, a charitable contribution by an entity to a charitable foundation could, if necessary, be deducted over a six-year period. Based on $61.7 million of income before income tax expense for the fiscal year ended September 30, 2006, and assuming that our income before income tax expense remained at that level in future years following the stock offering, we estimate that we would only be able to deduct for federal income tax purposes $37.0 million of the contribution to the charitable foundation. This would result in after-tax expense of $42.1 million at the midpoint of the offering range, and not $35.8 million as we currently estimate.
The charitable foundation will be governed by a board of directors, initially consisting of two of our current directors and one individual who is not affiliated with us. None of these individuals will receive compensation for their service as a director of the charitable foundation. We intend to hire an executive director for the charitable foundation who is not affiliated with us. This individual will receive compensation that we believe will be competitive in our marketplace for executive directors of similar charitable foundations. In addition, some of our employees will serve as executive officers of the charitable foundation. None of these individuals will receive compensation for their service as an executive officer of the charitable foundation.
The charitable foundation will be dedicated exclusively to supporting charitable causes and community development activities in the communities in which we operate. In addition to traditional community contributions and community reinvestment initiatives, the charitable foundation is expected to emphasize grants or donations to support housing assistance, local education and other types of organizations or civic-minded
14
Table of Contents
projects. During the fiscal years ended September 30, 2006 and 2005, we made charitable contributions of $931,000 and $1.3 million, respectively. The charitable foundation is expected to make contributions totaling approximately $2.8 million in its first year of operation, assuming we sell our shares of common stock at the midpoint of the offering range. However, the charitable foundation is not expected to limit the size of its contributions to any one program or aggregate amount in any one year.
Issuing shares of common stock to the charitable foundation will:
| • | dilute the voting interests of purchasers of shares of our common stock in the stock offering; and |
| • | result in an expense, and a reduction in earnings during the quarter in which the contribution is made, equal to the full amount of the contribution to the charitable foundation, offset in part by a corresponding tax benefit. |
The establishment and funding of the charitable foundation has been approved by the boards of directors of TFS Financial Corporation and Third Federal Savings and Loan Association of Cleveland, MHC.
See “Risk Factors—The Contribution of Shares to the Charitable Foundation Will Dilute Your Ownership Interests and Adversely Affect Net Income in Fiscal 2007,” “Comparison of Valuation and Pro Forma Information With and Without the Charitable Foundation” and “Third Federal Foundation.”
How You May Pay for Your Shares
In the subscription offering and the community offering you may pay for your shares only by:
| (1) | personal check, bank check or money order; or |
| (2) | authorizing us to withdraw money from your deposit account(s) maintained with Third Federal Savings and Loan. |
If you wish to use your Third Federal Savings and Loan individual retirement account to pay for your shares, please be aware that federal law requires that such funds first be transferred to a self-directed retirement account with a trustee other than Third Federal Savings and Loan. The transfer of such funds to a new trustee takes time, so please make arrangements as soon as possible or contact the Stock Information Center for further information. Also, please be aware that Third Federal Savings and Loan is not permitted to lend funds to anyone for the purpose of purchasing shares of common stock in the stock offering.
You can subscribe for shares of common stock in the stock offering by delivering to Third Federal Savings and Loan a signed and completed original stock order form and certification form, together with full payment, provided we receive the stock order form and certification form before the end of the stock offering. Funds received prior to the completion of the stock offering up to the minimum of the offering range will be held by Third Federal Savings and Loan. Funds received in excess of the minimum of the offering range may be maintained at Third Federal Savings and Loan, or, at our discretion, at another federally insured depository institution. However, in no event will we maintain more than one escrow account. We will pay interest at Third Federal Savings and Loan’s passbook savings rate, currently 0.80% per annum, from the date funds are received until completion or termination of the stock offering. Withdrawals from certificates of deposit at Third Federal Savings and Loan for the purpose of purchasing shares of common stock in the stock offering may be made without incurring an early withdrawal penalty. All funds authorized for withdrawal from deposit accounts with Third Federal Savings and Loan must be in the deposit accounts at the time the stock order form is received. However, funds will not be withdrawn from the accounts until the stock offering is completed and will continue to earn interest at the applicable deposit account rate until the completion of the stock offering. A hold will be placed on those funds when your stock order is received, making the designated funds unavailable to you. After we receive an order, the order cannot be revoked or changed, except with our consent. Payment may not be made by wire transfer or any other electronic transfer of funds. In addition, we will not be required to accept copies or facsimiles of order forms.
15
Table of Contents
For a further discussion regarding the stock ordering procedures, see “The Stock Offering—Prospectus Delivery and Procedure for Purchasing Shares.”
You May Not Sell or Transfer Your Subscription Rights
Federal law prohibits the transfer of subscription rights. If you order shares of common stock in the subscription offering, you will be required to state that you are purchasing the shares of common stock for yourself and that you have no agreement or understanding to sell or transfer your subscription rights. We intend to take legal action, including reporting persons to federal or state regulatory agencies, against anyone who we believe sells or in any way transfers his or her subscription rights. We will not accept your stock order if we have reason to believe that you sold or transferred your subscription rights. With the exception of purchases through individual retirement accounts, Keogh accounts and 401(k) plan accounts, shares purchased in the subscription offering must be registered in the names of all depositors on the qualifying account(s). Deleting names of depositors or adding non-depositors or otherwise altering the form of beneficial ownership of a qualifying account will result in the loss of your subscription rights.
Deadline for Orders of Common Stock
If you wish to purchase shares of common stock, we must receive at the Stock Information Center (not simply have post-marked) your properly completed stock order form, together with payment for the shares, no later than 4:00 p.m., Cleveland, Ohio time, on March 26, 2007, unless we extend this deadline. You may submit your stock order form by mail using the return envelope provided, by overnight courier to the indicated address on the stock order form, or by bringing your stock order form to our main office. A postmark prior to March 26, 2007 will not entitle you to purchase shares of common stock unless we receive the envelope by March 26, 2007.
Although we will make reasonable efforts to provide a prospectus and stock offering materials to holders of subscription rights, the subscription offering and all subscription rights will expire at 4:00 p.m., Cleveland, Ohio time, on March 26, 2007, regardless of whether we have been able to locate each person entitled to subscription rights.
Termination of the Stock Offering
The subscription offering will terminate at 4:00 p.m., Cleveland, Ohio time, on March 26, 2007. We may extend this expiration date without notice to you, until May 14, 2007, unless the Office of Thrift Supervision approves a later date. If the subscription offering and/or community offerings extend beyond May 14, 2007, we will be required to resolicit subscriptions before proceeding with the stock offering. In such event, if you choose not to subscribe for the shares of common stock, your funds will be returned promptly to you with interest. All further extensions, in the aggregate, may not last beyond February 12, 2009.
Steps We May Take If We Do Not Receive Orders for the Minimum Number of Shares
If we do not receive orders for at least 64,400,510 shares of common stock, we may take several steps in order to sell the minimum number of shares of common stock in the stock offering range. Specifically, we may:
| (i) | increase the maximum number of shares that may be purchased by any subscriber (including our subscribing directors and officers); and/or |
| (ii) | seek regulatory approval to extend the stock offering beyond the May 14, 2007 expiration date, provided that any such extension will require us to resolicit subscriptions received in the stock offering. |
16
Table of Contents
Our Policy Regarding Dividends
Following completion of the stock offering, our board of directors will have the authority to declare dividends on our common stock, subject to statutory and regulatory requirements. While our board of directors currently intends to declare dividends, it has not yet determined the amount and timing of any dividend payments. The payment and amount of any dividend payments will depend upon a number of factors, including the following:
| • | regulatory capital requirements; |
| • | our financial condition and results of operations; |
| • | tax considerations; |
| • | statutory and regulatory limitations; and |
| • | general economic conditions. |
If we pay dividends to our shareholders, we also will be required to pay dividends to Third Federal Savings and Loan Association of Cleveland, MHC, unless Third Federal Savings and Loan Association of Cleveland, MHC elects to waive the receipt of dividends. We anticipate that Third Federal Savings and Loan Association of Cleveland, MHC will waive any dividends we pay. Any decision to waive the receipt of dividends will be subject to the non-objection of the Office of Thrift Supervision.
Market for the Shares of Common Stock
We anticipate that the shares of common stock sold in the stock offering will be quoted on the Nasdaq Global Select Market under the symbol “TFSL.” Sandler O’Neill & Partners, L.P. currently intends to make a market in the shares of common stock, but it is under no obligation to do so.
How We Intend to Use the Proceeds We Raise from the Stock Offering
Assuming we sell 87,130,102 shares of common stock in the stock offering, and we have net proceeds of $862.8 million, we intend to distribute the net proceeds as follows:
| • | $436.4 million (50.6% of the net proceeds) will be contributed to Third Federal Savings and Loan; |
| • | $104.4 million (12.1% of the net proceeds) will be loaned to our employee stock ownership plan to fund its purchase of our shares of common stock; and |
| • | $322.0 million (37.3% of the net proceeds) will be retained by us. |
We may use the net proceeds of the stock offering to invest in securities, to deposit funds in Third Federal Savings and Loan, to finance the possible acquisition of other financial institutions or financial service businesses, to pay dividends or for other general corporate purposes, including repurchasing shares of our common stock. Third Federal Savings and Loan may use the proceeds it receives to make loans, to purchase securities, to expand its banking franchise internally through branching or through acquisitions, and for general corporate purposes. See “How We Intend to Use the Proceeds from the Stock Offering.” Neither Third Federal Savings and Loan nor TFS Financial Corporation has plans to conduct any specific material acquisition transaction or branch expansion at this time.
17
Table of Contents
Tax Consequences of the Stock Offering
The stock offering will result in no taxable gain or loss to Third Federal Savings and Loan Association of Cleveland, MHC, TFS Financial Corporation or Third Federal Savings and Loan, or to depositors or borrowers who have a priority right to subscribe for shares of common stock in the stock offering, or to our employees, officers or directors, except to the extent that the nontransferable subscription rights to purchase shares of common stock in the stock offering may be determined to have value. Luse Gorman Pomerenk & Schick, P.C. has opined as to federal law that it is more likely than not that the fair market value of such subscription rights is zero. In that case, no taxable gain or loss will need to be recognized by depositors or borrowers who receive nontransferable subscription rights. See “The Stock Offering—Tax Effects of the Stock Offering.”
Once Submitted, Your Purchase Order May Not Be Revoked Unless the Stock Offering is Terminated or Extended Beyond May 14, 2007.
Funds that you use to purchase shares of our common stock in the stock offering will be held in an interest-bearing account until the termination or completion of the stock offering, including any extension of the expiration date. The Office of Thrift Supervision approved the stock offering on February 12, 2007; however, because completion of the stock offering will be subject to an update of the independent appraisal, among other factors, there may be one or more delays in the completion of the stock offering. Any orders that you submit to purchase shares of our common stock in the stock offering are irrevocable, and you will not have access to subscription funds unless the stock offering is terminated, or extended beyond May 14, 2007.
Restrictions on the Acquisition of TFS Financial Corporation and Third Federal Savings and Loan
Federal regulations, as well as provisions contained in the charter and bylaws of Third Federal Savings and Loan and TFS Financial Corporation, restrict the ability of any person, firm or entity to acquire TFS Financial Corporation, Third Federal Savings and Loan, or their respective capital stock. These restrictions include the requirement that a potential acquirer obtain the prior approval of the Office of Thrift Supervision before acquiring in excess of 10% of the stock of TFS Financial Corporation or Third Federal Savings and Loan. Because a majority of the outstanding shares of common stock of TFS Financial Corporation must be owned by Third Federal Savings and Loan Association of Cleveland, MHC, any acquisition of TFS Financial Corporation must be approved by Third Federal Savings and Loan Association of Cleveland, MHC, and Third Federal Savings and Loan Association of Cleveland, MHC would not be required to pursue or approve a sale of TFS Financial Corporation even if such a sale were favored by a majority of TFS Financial Corporation’s public shareholders.
Possible Conversion of Third Federal Savings and Loan Association of Cleveland, MHC to Stock Form
In the future, Third Federal Savings and Loan Association of Cleveland, MHC may convert from the mutual to capital stock form of organization in a transaction commonly known as a “second-step conversion.” In a second-step conversion, depositors and borrowers of Third Federal Savings and Loan would have subscription rights to purchase shares of common stock of TFS Financial Corporation’s successor, and our public shareholders would be entitled to exchange their shares of common stock for an equal percentage of shares of the stock holding company resulting from the conversion. This percentage may be adjusted to reflect any assets owned by Third Federal Savings and Loan Association of Cleveland, MHC.
Our board of directors has no current plan to undertake a second-step conversion transaction. Any second-step conversion transaction would require the approval of our shareholders and depositor and borrower members of Third Federal Savings and Loan Association of Cleveland, MHC.
18
Table of Contents
Proposed Stock Orders by Management
Our directors and executive officers and their associates are expected to subscribe for approximately 649,000 shares of common stock in the stock offering, which represents 0.9% of the shares to be sold to the public and 0.3% of the total shares to be outstanding after the stock offering at the midpoint of the offering range. Directors and executive officers will pay the same $10.00 per share price paid by all other persons who purchase shares in the stock offering. These shares will be counted in determining whether the minimum of the range of the stock offering is reached.
How You May Obtain Additional Information Regarding the Stock Offering
If you have any questions regarding the stock offering, please call the Stock Information Center at (877) 513-2318, Monday through Friday between 9:00 a.m. and 4:00 p.m., Cleveland, Ohio time. The Stock Information Center is located at our main office at 7007 Broadway Avenue, Cleveland, Ohio 44105.
19
Table of Contents
You should consider carefully the following risk factors in evaluating an investment in our shares of common stock.
Risks Related to Our Business
Our Lending Activities and Pricing Strategies for Loans and Deposits Provide Lower Rates of Return than Financial Institutions that Originate More Commercial Loans or Who are Less Aggressive in Pricing Loan and Deposit Products.
Our principal business consists of originating one- to four-family residential real estate mortgage loans and home equity loans and lines of credit. As of September 30, 2006, these loans and lines of credit totaled $7.4 billion, or 85.7% of our assets as of that date. We are one of the largest mortgage lenders in the State of Ohio and we price our loan products to encourage home ownership and attract borrowers, and not to generate the highest return or create the greatest difference between our cost of funds and the yield on our interest-earning assets (interest rate spread). For example, we advertise that we will match the interest rate, or offer lower interest rates than those offered by our competitors on certain types of mortgage loans. In addition, we price our deposit products very competitively, and deposits are our primary source of funds for our lending and investment activities. We intend to continue our focus on this type of lending and this pricing strategy for loans and deposits following the stock offering.
Residential real estate mortgage loans and home equity loans and lines of credit generally have lower interest rates than commercial business loans and commercial real estate loans. As a result, we may generate lower interest rate spreads and rates of return when compared to our competitors who originate more commercial loans, or who originate residential real estate loans at higher interest rates than we do or who offer deposit products with lower interest rates than we do. For the fiscal year ended September 30, 2006, our return on average equity (net income divided by average equity) was 4.34%, compared to a median return on average equity of 4.72% for a peer group of publicly traded savings institutions. In addition, our net interest margin was 2.37%, compared to a median of 2.83% for a peer group of publicly traded savings institutions during that time period. Each of these factors may reduce the value of our shares of common stock.
Future Changes in Interest Rates Could Reduce Our Net Income.
Our net income largely depends on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between:
| • | the interest income we earn on our interest-earning assets, such as loans and securities; and |
| • | the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. |
Although interest rates recently have been at historically low levels, from June 30, 2004 to September 30, 2006 the Federal Reserve Board increased its target for the federal funds rate from 1.0% to 5.25%. While these short-term market interest rates (which we use as a guide to price our deposits) have increased, longer-term market interest rates (which we use as a guide to price our longer-term loans) have not increased to the same degree. This “flattening” of the yield curve has had a negative impact on our interest rate spread and net interest margin. Our interest rate spread decreased to 2.01% for the fiscal year ended September 30, 2006 from 2.09% for the fiscal year ended September 30, 2005, and our net interest margin decreased to 2.37% for the fiscal year ended September 30, 2006 from 2.38% for the fiscal year ended September 30, 2005. Based upon contractual rates, our interest rate spread was 1.70% at September 30, 2006. If short-term interest rates continue to rise, and if rates on our deposits and borrowings continue to reprice upwards faster than the rates on our long-term loans and investments, we would continue to experience compression of our interest rate spread and net interest margin, which would have a negative effect on our profitability.
20
Table of Contents
In addition, changes in interest rates can affect the average life of loans and mortgage-backed and related securities. A reduction in interest rates normally results in increased prepayments of loans and mortgage-backed and related securities, as borrowers refinance their debt in order to reduce their borrowing costs. This creates reinvestment risk, which is the risk that we may not be able to reinvest the proceeds of loan and securities prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities. Additionally, increases in interest rates may decrease loan demand and/or make it more difficult for borrowers to repay adjustable rate loans.
Changes in interest rates also affect the current market value of our interest-earning securities portfolio. Generally, the value of securities moves inversely with changes in interest rates. At September 30, 2006, the fair value of our available-for-sale agency securities, mortgage-backed securities and corporate debt obligations totaled $63.7 million. Unrealized net losses on these available-for-sale securities totaled $1.1 million at September 30, 2006 and are reported as a separate component of shareholder’s equity. Further decreases in the fair value of securities available-for-sale in future periods would further reduce shareholder’s equity.
As of September 30, 2006, we were servicing $6.7 billion of loans sold to third parties, and the mortgage servicing rights associated with such loans had an estimated fair value, at such date, of $61.2 million. Generally, the value of mortgage servicing rights increases as interest rates rise and decreases as interest rates fall, because the estimated life and estimated income from the underlying loans increase with rising interest rates and decrease with falling interest rates.
In addition to our own model, we evaluate interest rate sensitivity using a model prepared by the Office of Thrift Supervision. These models estimate the change in Third Federal Savings and Loan’s net portfolio value over a range of interest rate scenarios. Net portfolio value is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts. At September 30, 2006, in the event of an immediate 200 basis point increase in interest rates, the Office of Thrift Supervision model projects that we would experience a $269.3 million, or 25%, decrease in net portfolio value, and our internal model projects that we would experience a $354.8 million, or 31%, decrease in net portfolio value. Our internal calculations further project that, at September 30, 2006, in the event of an immediate 200 basis point increase in interest rates, we would expect our projected net interest income for the twelve months ended September 30, 2007 to decrease by 10%. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Management of Market Risk.”
Loans Originated Through Our Home Today Program Have Higher Delinquency Rates than the Remainder of Our Loan Portfolio.
Through our Home Today program, we offer loans with our standard terms to borrowers who might not otherwise qualify for such loans. To qualify for our Home Today program, a borrower must complete financial management education and counseling and must be referred to us by a sponsoring organization with whom we have partnered as part of the program. Because we apply less stringent underwriting and credit standards to these loans, loans originated under the Home Today program have greater credit risk than traditional one- to four-family residential real estate mortgage loans. As of September 30, 2006, we had $285.2 million of outstanding loans that were originated through our Home Today program, 24.3% of which were delinquent 30 days or more, compared to 1.1% for our entire loan portfolio as of that date. During the fiscal year ended September 30, 2006, we incurred net charge-offs of $162,000 on loans originated through our Home Today program, compared to $3.9 million of net charge-offs for our entire loan portfolio.
The Federal Deposit Insurance Corporation has Issued New Rules that Will Increase Our Deposit Insurance Assessments and Reduce Our Income.
Under prior rules, the Federal Deposit Insurance Corporation did not assess deposit insurance premiums on financial institutions, such as Third Federal Savings and Loan, that were, among other criteria, well-capitalized.
21
Table of Contents
On November 2, 2006, the Federal Deposit Insurance Corporation adopted final regulations that assess insurance premium based on risk. As a result, the new regulation will enable the Federal Deposit Insurance Corporation to more closely tie each financial institution’s deposit insurance premiums to the risk it poses to the deposit insurance fund. Under the new rules, the Federal Deposit Insurance Corporation will evaluate the risk of each financial institution based on its supervisory rating, its financial ratios, and its long-term debt issuer rating. The new rates for nearly all banks and savings institutions vary between five and seven cents for every $100 of domestic deposits. If this rule were in effect September 30, 2006, we would have paid an annual deposit insurance assessment to the Federal Deposit Insurance Corporation of approximately $5.0 million, which would reduce our net income.
A Downturn in the Economy May Adversely Affect Our Business.
Our success depends on the general economic conditions in the States of Ohio and Florida, and surrounding areas. In addition, many of the loans in our loan portfolio are secured by real estate located in our primary market areas. Negative conditions in the real estate markets where collateral for a mortgage loan is located could adversely affect a borrower’s ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various other factors, including supply and demand, changes in general or regional economic conditions, interest rates, governmental rules or policies and natural disasters. Adverse changes in the regional and general economy could also reduce our growth rate, impair our ability to collect loans and generally have a negative effect on our financial condition and results of operations.
Hurricanes or Other Adverse Weather Events Could Negatively Affect the Economy in Our Florida Market Area or Cause Disruptions to Our Branch Office Locations, Which Could Have an Adverse Effect on Our Business or Results of Operations.
A significant portion of our operations are conducted in the State of Florida, a geographic region with coastal areas that are susceptible to hurricanes and tropical storms. Such weather events can disrupt our operations, result in damage to our branch office locations and negatively affect the local economy in which we operate. We cannot predict whether or to what extent damage caused by future hurricanes or tropical storms will affect our operations or the economy in our market area, but such weather events could result in fewer loan originations and greater delinquencies, foreclosures or loan losses. These and other negative effects of future hurricanes or tropical storms may adversely affect our business or results of operations.
The Stock Offering Will Reduce Our Return on Average Equity.
Following the stock offering, we expect our consolidated equity to increase from $1.0 billion to between $1.5 billion at the minimum of the offering range and $1.8 billion at the adjusted maximum of the offering range. Our return on equity will be further reduced by the higher expenses of being a public company and added expenses associated with our employee stock ownership plan and the stock-based benefit plans we intend to adopt. As a result, we expect our return on equity to remain below the industry average following the stock offering, which may reduce the value of our common stock.
Strong Competition Within Our Market Areas May Limit Our Growth and Profitability.
Competition in the banking and financial services industry is intense. In our market areas, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, money market funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Some of our competitors have greater name recognition and market presence that benefit them in attracting business, and offer certain services that we do not or cannot provide. In addition, larger competitors may be able to price loans and deposits more aggressively than we do. Our profitability depends upon our continued ability to successfully compete in our market areas. For additional information see “Business of Third Federal Savings and Loan Association of Cleveland—Competition.”
22
Table of Contents
If Our Allowance for Loan Losses is Not Sufficient to Cover Actual Loan Losses, Our Earnings Could Decrease.
We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to our allowance. Our allowance for loan losses was 0.27% of total loans and 25.98% of non-performing loans at September 30, 2006, each of which is lower than the average for our peer group of financial institutions. Material additions to our allowance could materially decrease our net income.
In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our allowance for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our financial condition and results of operations.
Risks Related to the Stock Offering
The Future Price of the Shares of Our Common Stock May Be Less Than the Purchase Price in the Stock Offering.
We cannot assure you that if you purchase shares of common stock in the stock offering you will later be able to sell them at or above the purchase price. The purchase price in the stock offering is determined by an independent, third-party appraisal, pursuant to federal banking regulations and subject to review and approval by the Office of Thrift Supervision as part of Office of Thrift Supervision review and approval of our application to conduct the stock offering. The appraisal is not intended, and should not be construed, as a recommendation of any kind as to the advisability of purchasing shares of our common stock. The Office of Thrift Supervision attempts to ensure that the aftermarket appreciation of standard conversion and mutual holding company stocks is not excessive. In recent years, the final independent valuation as approved by the Office of Thrift Supervision typically has been at the adjusted maximum of the offering range as long as total subscriptions exceed the adjusted maximum of the offering range. However, the adjusted maximum of the offering range is approximately 32% higher than the fair market value of a company’s stock as determined by the independent appraisal. Accordingly, our aggregate pro forma market value as reflected in the final, approved independent appraisal may exceed the market price of our shares of common stock after the completion of the offering, which may result in our stock trading below the initial offering price of $10.00 per share.
Based on market trading data in “Summary—After-Market Performance Information,” two of the 15 mutual holding company initial public offerings that initiated trading between January 1, 2006 and January 31, 2007 have traded below their initial offering price at the dates indicated.
We Will Need to Implement Additional Finance and Accounting Systems, Procedures and Controls in Order to Satisfy Our New Public Company Reporting Requirements, Which Will Increase Our Operating Expenses.
Upon completion of the stock offering, we will become a public reporting company. Federal securities laws and regulations require that we file annual, quarterly and current reports with the Securities and Exchange Commission and that we maintain effective disclosure controls and procedures and internal control over financial reporting. We expect that the obligations of being a public company, including substantial public reporting obligations, will require significant expenditures and place additional demands on our management team. These obligations will increase our operating expenses and could divert our management’s attention from our operations. In addition, compliance with the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the Securities and Exchange Commission will require us to certify as to the adequacy of our internal controls and procedures, which may require us to upgrade our accounting systems, which would also increase our operating costs.
23
Table of Contents
The Contribution of Shares to the Charitable Foundation Will Dilute Your Ownership Interests and Adversely Affect Net Income in Fiscal Year 2007.
We intend to establish a charitable foundation in connection with the stock offering. We will make a contribution to the charitable foundation in the form of shares of TFS Financial Corporation common stock and Third Federal Savings and Loan will contribute $5.0 million in cash. The contribution of cash and shares of common stock will total $47.9 million at the minimum of the offering range, up to a maximum contribution of $55.0 million. At the midpoint of the offering range, we will contribute 5,000,000 shares of common stock to the charitable foundation, which equals 1.98% of the shares of common stock to be outstanding upon completion of the stock offering. The aggregate contribution will also have an adverse effect on our net income for the quarter and year in which we make the issuance and contribution to the charitable foundation. The after-tax expense of the contribution will reduce net income in our 2007 fiscal year by approximately $35.8 million at the midpoint of the offering range. We had net income of $43.5 million for the fiscal year ended September 30, 2006. Persons purchasing shares in the stock offering will have their ownership and voting interests in TFS Financial Corporation diluted by up to 2% due to the issuance of shares of common stock to the charitable foundation.
Under the Internal Revenue Code, an entity is permitted to deduct up to 10% of its taxable income (income before income taxes) in any one year for charitable contributions. Any contribution in excess of the 10% limit may be deducted for federal income tax purposes over each of the five years following the year in which the charitable contribution was made. Accordingly, a charitable contribution by an entity to a charitable foundation could, if necessary, be deducted over a six-year period. Based on $61.7 million of income before income tax expense for the fiscal year ended September 30, 2006, and assuming that our income before income tax expense remained at that level in future years following the stock offering, we estimate that we would only be able to deduct for federal income tax purposes $37.0 million of the contribution to the charitable foundation. This would result in after-tax expense of $42.1 million at the midpoint of the offering range, and not $35.8 million as we currently estimate.
Our Contribution to the Charitable Foundation May Not Be Tax Deductible, Which Could Reduce Our Profits.
We believe that the contribution to Third Federal Foundation will be deductible for federal income tax purposes. However, we cannot assure you that the Internal Revenue Service will grant tax-exempt status to the charitable foundation. If the contribution is not deductible, we would not receive any tax benefit from the contribution. In addition, even if the contribution is tax deductible, we may not have sufficient profits to be able to use the deduction fully. The value of the contribution would be $55.0 million in cash and shares of common stock at the adjusted maximum of the offering range, which would result in after-tax expense of approximately $35.8 million during the fiscal year ending September 30, 2007. In the event that the Internal Revenue Service does not grant tax-exempt status to the charitable foundation or the contribution to the charitable foundation is otherwise not tax deductible, we would recognize as after-tax expense the value of the entire contribution, or $55.0 million at the adjusted maximum of the offering range.
Our Stock-Based Benefit Plans Will Increase Our Costs, Which Will Reduce Our Income. Our Directors, Officers and Employees are Eligible to Participate in These Stock-Based Benefit Plans.
We have established an employee stock ownership plan in connection with the stock offering, and we intend to implement one or more stock-based benefit plans that will provide for grants of stock options and shares of common stock. During the fiscal year ending September 30, 2007, we expect that we will recognize $9.1 million in expense associated with the employee stock ownership plan, as we intend to repay a greater amount of principal than will be required by the terms of the employee stock ownership plan loan. In addition, as discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and based on certain assumptions discussed therein, we estimate the annual expense associated with the grant of shares of common stock and stock options under our stock-based benefit plans would be approximately $13.0 million and $11.0 million, respectively, on a pre-tax basis, assuming the adjusted maximum number of shares is sold in the stock offering.
24
Table of Contents
We anticipate that our employee stock ownership plan will use a $9.1 million cash contribution from Third Federal Savings and Loan that occurred during the quarter ended September 30, 2006 and borrow funds from TFS Financial Corporation to purchase in the stock offering 3.92% of our outstanding shares of common stock (including shares issued to Third Federal Foundation). Only employees, including our officers, are eligible to participate in the employee stock ownership plan. The cost of acquiring the shares of common stock for the employee stock ownership plan will be between $84.1 million at the minimum of the offering range and $130.3 million at the adjusted maximum of the offering range. We will record an annual employee stock ownership plan expense in an amount equal to the fair value of shares of common stock committed to be released to employees as a result of repayment of the loan. As a result, if our common stock appreciates in value over time, compensation expense relating to the employee stock ownership plan also will increase.
We also intend to adopt one or more stock-based benefit plans after the stock offering under which plans participants would be awarded shares of our common stock (at no cost to them) or options to purchase shares of our common stock. Our directors, officers and employees would be eligible to receive awards under the stock-based benefit plans. Under current Office of Thrift Supervision regulations, we may grant shares of common stock or stock options under our stock-based benefit plans for up to 1.96% and 4.90%, respectively, of our total outstanding shares (including shares issued to Third Federal Foundation and to Third Federal Savings and Loan Association of Cleveland, MHC), exclusive of shares acquired in the secondary market to fund such plans, provided such grants do not exceed 25% of the shares held by persons other than Third Federal Savings and Loan Association of Cleveland, MHC. Proposed Office of Thrift Supervision regulations would clarify that the amount of stock options and stock awards available for grant under the stock-based benefit plans may be greater than 1.96% and 4.90%, respectively, of our outstanding shares, provided shares used to fund the stock-based benefit plans in excess of these amounts are obtained through stock repurchases, which would, in turn, further increase our costs.
The shares of common stock granted under the stock-based benefit plans will be expensed by us over their vesting period at the fair market value of the shares on the date they are awarded. If the shares of common stock to be granted under the plans are repurchased in the open market (rather than issued directly from authorized but unissued shares of TFS Financial Corporation) and cost the same as the purchase price in the stock offering, the reduction to shareholders’ equity due to the plans would be between $42.1 million at the minimum of the offering range and $65.1 million at the adjusted maximum of the offering range. To the extent we repurchase shares of common stock in the open market to fund the grants of shares under the plans, and the price of such shares exceeds the offering price of $10.00 per share, the reduction to shareholders’ equity would exceed the range described above. Conversely, to the extent the price of such shares is below the offering price of $10.00 per share, the reduction to shareholders’ equity would be less than the range described above.
Public companies must expense the grant-date fair value of stock options. In addition, public companies must revalue their estimated compensation costs at each subsequent reporting period and may be required to recognize additional compensation expense at these dates. When we record an expense for the grant of stock options and other stock awards using the fair value method as described in the applicable accounting rules, we will incur significant compensation and benefits expense.
Proposed Office of Thrift Supervision Regulations May Permit Us to Adopt Stock-Based Benefit Plans that Exceed Limits Applicable Under Current Regulations, and May Permit Us to Approve Stock Benefit Plans Without a Separate Vote of Minority Shareholders.
The Office of Thrift Supervision has proposed amendments to its existing regulations regarding stock-based benefit plans that are intended to clarify and simplify such regulations. Specifically, the amendments would clarify that we may grant options and award shares of common stock under our stock-based benefit plans in excess of 4.90% and 1.96%, respectively, of our total outstanding shares if the stock-based benefit plans are adopted more than one year following the stock offering, provided shares used to fund the plans in excess of these amounts are obtained through stock repurchases. The proposed amendments would also require that, if the
25
Table of Contents
stock-based benefit plans are adopted less than one year following the stock offering, the stock-based benefit plans must be approved by a majority of the votes of TFS Financial Corporation shareholders cast at an annual or special meeting of shareholders, excluding votes eligible to be cast by Third Federal Savings and Loan Association of Cleveland, MHC. Under the proposed amendments, there would be no separate vote required of minority shareholders if the stock-based benefit plans are adopted more than one year following the stock offering. The proposed amendments would further clarify that the restrictions set forth above regarding the maximum amount of individual and group awards and restrictions on accelerated vesting of awards, would not apply if the stock-based benefit plans are adopted more than one year following the stock offering.
In the event the Office of Thrift Supervision adopts these regulations as proposed, or otherwise changes its existing regulations or policies, we may implement stock-based benefit plans that exceed the current limits applicable to the overall size of such plans, the relative amounts of stock options and stock awards and individual awards thereunder, and otherwise grant awards with terms that are different than those required by current Office of Thrift Supervision regulations and policy. Implementing stock-based benefit plans that exceed current limits could result in expense that exceeds the amounts estimated in “—Our Stock-Based Benefit Plans Will Increase Our Costs, Which Will Reduce Our Income. Our Directors, Officers and Employees are Eligible to Participate in These Stock-Based Benefit Plans.” However, until we implement our stock-based benefit plans, and until the proposed Office of Thrift Supervision regulations are adopted in final form, we cannot estimate the costs of stock-based benefit plans that we may adopt in the future.
Moreover, to the extent that any new regulations or policies contain a more flexible voting standard for shareholder approval than that currently required, we intend to use the more flexible voting standard, which could result in the vote of Third Federal Savings and Loan Association of Cleveland, MHC controlling the outcome of a shareholder vote on stock-based benefit plans.
The Implementation of Stock-Based Benefit Plans May Dilute Your Ownership Interest.
We intend to adopt one or more stock-based benefit plans following the stock offering. The stock-based benefit plans will be funded through either open market purchases of common stock or from the issuance of authorized but unissued shares of common stock. Shareholders would experience a reduction in ownership interest (including shares held by Third Federal Savings and Loan Association of Cleveland, MHC) totaling 6.4% in the event newly issued shares are used to fund stock options or awards of common stock under the plans in an amount equal to 4.90% and 1.96%, respectively, of our total outstanding shares, including shares held by Third Federal Foundation and to Third Federal Savings and Loan Association of Cleveland, MHC.
The Office of Thrift Supervision has proposed amendments to its existing regulations regarding stock-based benefit plans that would permit us to grant options and award shares of common stock under stock-based benefit plans in excess of 4.90% and 1.96%, respectively, of our total outstanding shares if the stock-based benefit plans are adopted more than one year following the stock offering, provided shares used to fund the plans in excess of these amounts are obtained through stock repurchases.
We Have Broad Discretion in Using the Proceeds of the Stock Offering. Our Failure to Effectively Use Such Proceeds May Reduce Our Net Income.
We will use a portion of the net proceeds to finance the purchase of shares of common stock in the stock offering by the employee stock ownership plan and may use the remaining net proceeds to pay dividends to shareholders, repurchase shares of common stock, purchase investment securities, deposit funds in Third Federal Savings and Loan, acquire other financial services companies and financial institutions or for other general corporate purposes. Third Federal Savings and Loan may use the proceeds it receives to fund new loans, establish or acquire new branches, purchase investment securities, or for general corporate purposes. In addition, we intend to expand our presence within and outside our primary market area through acquisitions and de novo branching, which may have a negative effect on our earnings until these branches achieve profitability. We have not, however, identified specific amounts of proceeds for any of these purposes and we will have significant
26
Table of Contents
flexibility in determining the amount of net proceeds we apply to different uses and the timing of such applications. Our failure to utilize these funds effectively could reduce our profitability. We have not established a timetable for the effective deployment of the proceeds and we cannot predict how long we will require to effectively deploy the proceeds.
Persons Who Purchase Stock in the Stock Offering Will Own a Minority of Our Shares of Common Stock and Will Not Be Able to Exercise Voting Control Over Most Matters Put to a Vote of Shareholders.
Public shareholders will own a minority of the outstanding shares of our common stock. As a result, shareholders other than Third Federal Savings and Loan Association of Cleveland, MHC will not be able to exercise voting control over most matters put to a vote of shareholders. Third Federal Savings and Loan Association of Cleveland, MHC will own a majority of our outstanding shares of common stock after the stock offering and, through its board of directors, will be able to exercise voting control over most matters put to a vote of shareholders. If a rule currently proposed by the Office of Thrift Supervision is adopted in its current form, this voting control will extend to stock-based benefit plans presented to shareholders for approval more than one year following completion of this stock offering. The same directors and certain officers who manage TFS Financial Corporation and Third Federal Savings and Loan also manage Third Federal Savings and Loan Association of Cleveland, MHC. Further, these same directors and officers are expected to purchase an aggregate of 0.9% of the shares sold at the midpoint of the offering range, thereby further reducing the voting control of public shareholders who own a minority of the outstanding shares. In addition, Third Federal Savings and Loan Association of Cleveland, MHC may exercise its voting control to prevent a sale or merger transaction in which shareholders could receive a premium for their shares.
Our Stock Value May be Affected Negatively by Federal Regulations Restricting Takeovers and Our Mutual Holding Company Structure.
The Mutual Holding Company Structure Will Impede Takeovers. Third Federal Savings and Loan Association of Cleveland, MHC, as our majority shareholder, will be able to control the outcome of virtually all matters presented to our shareholders for their approval, including any proposal to acquire us. Accordingly, Third Federal Savings and Loan Association of Cleveland, MHC may prevent the sale of control or merger of TFS Financial Corporation or its subsidiaries even if such a transaction were favored by a majority of the public shareholders of TFS Financial Corporation.
Federal Regulations Restricting Takeovers. For three years following the stock offering, Office of Thrift Supervision regulations prohibit any person from acquiring or offering to acquire more than 10% of our common stock without the prior written approval of the Office of Thrift Supervision. Moreover, current Office of Thrift Supervision policy prohibits the acquisition of a mutual holding company subsidiary by any person or entity other than a mutual holding company or a mutual institution. See “Restrictions on the Acquisition of TFS Financial Corporation and Third Federal Savings and Loan Association of Cleveland” for a discussion of applicable Office of Thrift Supervision regulations regarding acquisitions.
The Corporate Governance Provisions in Our Charter and Bylaws May Prevent or Impede the Holders of a Minority of Our Common Stock From Obtaining Representation on Our Board of Directors.
Provisions in our charter and bylaws also may prevent or impede holders of a minority of our shares of common stock from obtaining representation on our board of directors. For example, our charter provides that there will not be cumulative voting by shareholders for the election of our directors. This means that Third Federal Savings and Loan Association of Cleveland, MHC, as the holder of a majority of the shares eligible to be voted at a meeting of shareholders, may elect all of the directors to be elected at that meeting. In addition, our board of directors is divided into three staggered classes. A classified board makes it more difficult for shareholders to change a majority of the directors because it generally takes at least two annual elections of directors for this to occur. Our bylaws contain procedures and timetables for shareholders that wish to make
27
Table of Contents
nominations for the election of directors or propose new business at a meeting of shareholders, the effect of which may be to give our management time to solicit their own proxies to defeat any dissident slate of nominees. All of these provisions may prevent the sale of control or merger of TFS Financial Corporation, even if such transaction is favored by a majority of our public shareholders.
Office of Thrift Supervision Policy on Remutualization Transactions Could Prohibit the Acquisition of TFS Financial Corporation, Which May Lower Our Stock Price.
Current Office of Thrift Supervision regulations permit a mutual holding company subsidiary to be acquired by a mutual institution or a mutual holding company in a so-called “remutualization” transaction. The possibility of a remutualization transaction and the successful completion of a small number of remutualization transactions where significant premiums have been paid to minority shareholders has resulted in some takeover speculation for mutual holding companies, which may be reflected in the per share price of mutual holding companies’ common stock. However, the Office of Thrift Supervision has issued a policy statement indicating that it views remutualization transactions as raising significant issues concerning disparate treatment of minority shareholders and the mutual interests of the mutual holding company and the effect on the mutual interests of the acquiring entity. Under certain circumstances, the Office of Thrift Supervision intends to give these issues special scrutiny and to reject applications to complete remutualization transactions unless the applicant clearly demonstrates that the Office of Thrift Supervision’s concerns are not warranted in the particular case. Should the Office of Thrift Supervision prohibit or otherwise restrict these transactions in the future, our stock price may be adversely affected.
28
Table of Contents
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
The summary information presented below at or for each of the fiscal years presented is derived in part from our consolidated financial statements. The following information is only a summary, and should be read in conjunction with our consolidated financial statements and notes beginning on page F-1 of this prospectus. The information at September 30, 2006 and 2005 and for the fiscal years ended September 30, 2006, 2005 and 2004 is derived in part from the audited consolidated financial statements that appear in this prospectus. The information at September 30, 2004, 2003 and 2002 and for the fiscal years ended September 30, 2003 and 2002 is derived in part from audited consolidated financial statements of Third Federal Savings and Loan Association of Cleveland, MHC and subsidiaries that do not appear in this prospectus.
| At September 30, | ||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||
| (In thousands) | ||||||||||||||||
| Selected Financial Condition Data: |
||||||||||||||||
| Total assets |
$ | 8,595,567 | $ | 8,913,820 | $ | 8,529,358 | $ | 8,417,537 | $ | 8,167,514 | ||||||
| Cash and cash equivalents |
252,927 | 120,320 | 165,169 | 389,120 | 370,301 | |||||||||||
| Investment securities: |
||||||||||||||||
| Available for sale |
28,277 | 35,332 | 110,439 | 267,985 | 259,569 | |||||||||||
| Held to maturity |
12,003 | 12,000 | 2,589 | 14,511 | 2,553 | |||||||||||
| Trading |
— | — | — | 869 | 3,358 | |||||||||||
| Mortgage-backed securities: |
||||||||||||||||
| Available for sale |
35,378 | 59,166 | 89,853 | 147,951 | 323,549 | |||||||||||
| Held to maturity |
55,316 | 81,314 | 130,574 | 230,414 | 763,681 | |||||||||||
| Loans, net |
7,477,041 | 7,620,721 | 7,245,136 | 6,642,892 | 5,507,706 | |||||||||||
| Loans held for sale |
314,956 | 542,480 | 400,448 | 330,122 | 545,329 | |||||||||||
| Bank owned life insurance |
139,260 | 133,650 | 128,009 | 122,177 | 110,690 | |||||||||||
| Other assets |
35,962 | 77,602 | 35,725 | 50,160 | 36,971 | |||||||||||
| Deposits |
7,401,077 | 7,054,248 | 7,254,493 | 7,175,236 | 6,982,874 | |||||||||||
| Federal Home Loan Bank advances |
25,103 | 717,378 | 214,326 | 97,672 | 105,433 | |||||||||||
| Shareholder’s equity |
1,012,594 | 973,874 | 914,023 | 852,147 | 801,628 | |||||||||||
| For the Fiscal Years Ended September 30, | ||||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 | ||||||||||||
| (In thousands) | ||||||||||||||||
| Selected Data: |
||||||||||||||||
| Interest income |
$ | 485,804 | $ | 418,757 | $ | 395,896 | $ | 414,106 | $ | 445,613 | ||||||
| Interest expense |
289,137 | 227,620 | 226,215 | 253,196 | 306,846 | |||||||||||
| Net interest income |
196,667 | 191,137 | 169,681 | 160,910 | 138,767 | |||||||||||
| Provision for loan losses |
6,050 | 6,000 | 5,522 | 3,789 | 5,809 | |||||||||||
| Net interest income after provision for loan losses |
190,617 | 185,137 | 164,159 | 157,121 | 132,958 | |||||||||||
| Non-interest income (loss) |
(6,393 | ) | 35,081 | 51,145 | 77,679 | 38,927 | ||||||||||
| Non-interest expense |
122,515 | 123,208 | 133,511 | 159,436 | 141,995 | |||||||||||
| Income before income tax expense |
61,709 | 97,010 | 81,793 | 75,364 | 29,890 | |||||||||||
| Income tax expense |
18,170 | 32,502 | 26,326 | 23,378 | 8,053 | |||||||||||
| Net income |
$ | 43,539 | $ | 64,508 | $ | 55,467 | $ | 51,986 | $ | 21,837 | ||||||
29
Table of Contents
| At or For the Fiscal Years Ended September 30, | |||||||||||||||
| 2006 | 2005 | 2004 | 2003 | 2002 | |||||||||||
| Selected Financial Ratios and Other Data: |
|||||||||||||||
| Performance Ratios: |
|||||||||||||||
| Return on average assets |
0.50 | % | 0.77 | % | 0.66 | % | 0.62 | % | 0.27 | % | |||||
| Return on average equity |
4.34 | % | 6.83 | % | 6.29 | % | 6.31 | % | 2.74 | % | |||||
| Interest rate spread (1) |
2.01 | % | 2.09 | % | 1.82 | % | 1.73 | % | 1.50 | % | |||||
| Net interest margin (2) |
2.37 | % | 2.38 | % | 2.10 | % | 1.99 | % | 1.81 | % | |||||
| Efficiency ratio (3) |
64.39 | % | 54.46 | % | 60.46 | % | 66.82 | % | 79.91 | % | |||||
| Noninterest expense to average total assets |
1.41 | % | 1.47 | % | 1.59 | % | 1.89 | % | 1.77 | % | |||||
| Average interest-earning assets to average interest-bearing liabilities |
110.12 | % | 110.23 | % | 109.75 | % | 108.55 | % | 107.79 | % | |||||
| Asset Quality Ratios: |
|||||||||||||||
| Non-performing assets as a percent of total assets |
1.01 | % | 0.76 | % | 0.47 | % | 0.35 | % | 0.32 | % | |||||
| Non-performing loans as a percent of total loans |
1.05 | % | 0.78 | % | 0.52 | % | 0.40 | % | 0.43 | % | |||||
| Allowance for loan losses as a percent of non-performing loans |
25.98 | % | 30.42 | % | 39.34 | % | 44.43 | % | 42.71 | % | |||||
| Allowance for loan losses as a percent of total loans |
0.27 | % | 0.24 | % | 0.20 | % | 0.18 | % | 0.18 | % | |||||
| Capital Ratios: |
|||||||||||||||
| Total risk-based capital (to risk weighted assets) |
|||||||||||||||
| Third Federal Savings and Loan |
15.00 | % | 14.61 | % | 13.59 | % | 14.20 | % | 13.08 | % | |||||
| DeepGreen Bank |
— | — | 19.36 | % | 14.99 | % | 9.06 | % | |||||||
| Ohio Central Savings |
— | — | 13.80 | % | 14.17 | % | 11.83 | % | |||||||
| Tier 1 leverage (core) capital (to adjusted tangible assets) |
|||||||||||||||
| Third Federal Savings and Loan |
10.35 | % | 9.60 | % | 9.43 | % | 9.10 | % | 8.83 | % | |||||
| DeepGreen Bank |
— | — | 16.45 | % | 13.91 | % | 8.83 | % | |||||||
| Ohio Central Savings |
— | — | 6.74 | % | 7.43 | % | 7.16 | % | |||||||
| Tangible capital (to tangible assets) |
|||||||||||||||
| Third Federal Savings and Loan |
10.35 | % | 9.60 | % | 9.43 | % | 9.10 | % | 8.83 | % | |||||
| DeepGreen Bank |
— | — | 16.45 | % | 13.91 | % | 8.83 | % | |||||||
| Ohio Central Savings |
— | — | 6.74 | % | 7.43 | % | 7.16 | % | |||||||
| Tier 1 risk-based capital (to risk weighted assets) |
|||||||||||||||
| Third Federal Savings and Loan |
14.69 | % | 14.34 | % | 13.36 | % | 14.00 | % | 12.96 | % | |||||
| DeepGreen Bank |
— | — | 19.22 | % | 14.61 | % | 8.21 | % | |||||||
| Ohio Central Savings |
— | — | 13.00 | % | 13.39 | % | 11.06 | % | |||||||
| Average equity to average total assets |
11.52 | % | 11.26 | % | 10.48 | % | 9.79 | % | 9.96 | % | |||||
| Other Data: |
|||||||||||||||
| Number of full service offices |
|||||||||||||||
| Third Federal Savings and Loan |
40 | 40 | 41 | 41 | 43 | ||||||||||
| Ohio Central Savings |
— | — | 2 | 2 | 2 | ||||||||||
| Loan production offices |
8 | 8 | 8 | 8 | 8 | ||||||||||
| (1) | Represents the difference between the weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities for the fiscal year. |
| (2) | The net interest margin represents net interest income as a percent of average interest-earning assets for the fiscal year. |
| (3) | The efficiency ratio represents non-interest expense divided by the sum of net interest income and non-interest income. |
30
Table of Contents
The following tables set forth selected consolidated historical financial and other data of TFS Financial Corporation at the dates and for the periods indicated. The following information is only a summary, and should be read in conjunction with our consolidated financial statements and notes beginning on page F-1 of this prospectus. The information at September 30, 2006 is derived in part from the audited consolidated financial statements that appear in this prospectus. The information at December 31, 2006 and for the three months ended December 31, 2006 and 2005 is unaudited. However, in the opinion of management of TFS Financial Corporation, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the results of operations for the unaudited periods, have been made. The selected operating data presented below for the three months ended December 31, 2006, are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2007.
| At December 31, 2006 |
At September 30, 2006 | |||||
| (In thousands) | ||||||
| Selected Financial Condition Data: |
||||||
| Total assets |
$ | 8,733,145 | $ | 8,595,567 | ||
| Cash and cash equivalents |
455,698 | 252,927 | ||||
| Investment securities: |
||||||
| Available for sale |
33,461 | 28,277 | ||||
| Held to maturity |
12,003 | 12,003 | ||||
| Mortgage-backed securities: |
||||||
| Available for sale |
31,733 | 35,378 | ||||
| Held to maturity |
182,180 | 55,316 | ||||
| Loans, net |
7,464,193 | 7,477,041 | ||||
| Loans held for sale |
139,803 | 314,956 | ||||
| Bank owned life insurance |
140,825 | 139,260 | ||||
| Other assets |
25,587 | 35,962 | ||||
| Deposits |
7,520,494 | 7,401,077 | ||||
| Federal Home Loan Bank advances |
25,106 | 25,103 | ||||
| Shareholder’s equity |
1,028,648 | 1,012,594 | ||||
| For the Three Months Ended December 31, | ||||||
| 2006 | 2005 | |||||
| (In thousands) | ||||||
| Selected Data: |
||||||
| Interest income |
$ | 125,733 | $ | 116,099 | ||
| Interest expense |
81,107 | 66,680 | ||||
| Net interest income |
44,626 | 49,419 | ||||
| Provision for loan losses |
2,000 | 1,045 | ||||
| Net interest income after provision for loan losses |
42,626 | 48,374 | ||||
| Non-interest income |
12,421 | 1,449 | ||||
| Non-interest expense |
31,522 | 28,499 | ||||
| Income before income tax expense |
23,525 | 21,324 | ||||
| Income tax expense |
7,694 | 6,853 | ||||
| Net income |
$ | 15,831 | $ | 14,471 | ||
31
Table of Contents
| At or For the Three Months Ended December 31, |
||||||
| 2006 | 2005 | |||||
| Selected Financial Ratios and Other Data: |
||||||
| Performance Ratios: |
||||||
| Return on average assets (1) |
0.73 | % | 0.67 | % | ||
| Return on average equity (1) |
6.21 | % | 5.90 | % | ||
| Interest rate spread (2) |
1.64 | % | 2.07 | % | ||
| Net interest margin (1)(3) |
2.12 | % | 2.40 | % | ||
| Efficiency ratio (4) |
55.26 | % | 56.03 | % | ||
| Noninterest expense to average total assets (1) |
1.45 | % | 1.33 | % | ||
| Average interest-earning assets to average interest-bearing liabilities |
112.41 | % | 110.50 | % | ||
| Asset Quality Ratios: |
||||||
| Non-performing assets as a percent of total assets |
1.12 | % | 0.93 | % | ||
| Non-performing loans as a percent of total loans |
1.19 | % | 0.94 | % | ||
| Allowance for loan losses as a percent of non-performing loans |
23.50 | % | 26.23 | % | ||
| Allowance for loan losses as a percent of total loans |
0.28 | % | 0.25 | % | ||
| Capital Ratios: |
||||||
| Third Federal Savings and Loan: |
||||||
| Total risk-based capital (to risk weighted assets) |
15.54 | % | 15.39 | % | ||
| Tier 1 leverage (core) capital (to adjusted tangible assets) |
10.40 | % | 10.12 | % | ||
| Tangible capital (to tangible assets) |
10.40 | % | 10.12 | % | ||
| Tier 1 risk-based capital (to risk weighted assets) |
15.21 | % | 15.09 | % | ||
| TFS Financial Corporation: |
||||||
| Average equity to average total assets |
11.74 | % | 11.40 | % | ||
| Other Data: |
||||||
| Number of full service offices |
40 | 40 | ||||
| Loan production offices |
8 | 8 | ||||
| (1) | Annualized. |
| (2) | Represents the difference between the weighted-average yield on interest-earning assets and the weighted-average cost of interest-bearing liabilities for the period. |
| (3) | The net interest margin represents net interest income as a percent of average interest-earning assets for the period. |
| (4) | The efficiency ratio represents non-interest expense divided by the sum of net interest income and non-interest income. |
Comparison of Financial Condition at December 31, 2006 and September 30, 2006
Total assets increased $137.6 million, or 1.6%, to $8.7 billion at December 31, 2006 from $8.6 billion at September 30, 2006. Cash and cash equivalents (cash and due from banks, federal funds sold and interest-bearing deposits) increased $202.8 million, or 80.2%, to $455.7 million at December 31, 2006 from $252.9 million at September 30, 2006. In addition, mortgage-backed securities held to maturity increased $126.9 million to $182.2 million at December 31, 2006 from $55.3 million at September 30, 2006. Loan sales during the quarter ended December 31, 2006 totaled $467.8 million. The proceeds from these sales, as well as loan repayments and prepayments, exceeded the cash we needed to fund loan originations during the quarter. We maintained some of our excess cash in liquid assets, and we used the remainder to purchase mortgage-backed securities during a period of rising interest rates.
32
Table of Contents
Loans receivable (loans held for investment, net, and loans held for sale) decreased $188.0 million, or 2.4%, to $7.6 billion at December 31, 2006 from $7.8 billion at September 30, 2006. Loans held for sale decreased $175.2 million, or 55.6%, to $139.8 million at December 31, 2006 from $315.0 million at September 30, 2006, as we sold $467.8 million of loans during the quarter ended December 31, 2006. There were no material changes in the composition of our loan portfolio during the quarter ended December 31, 2006.
Deposits increased $119.4 million, or 1.6%, to $7.5 billion at December 31, 2006 from $7.4 billion at September 30, 2006. The increase in deposits was primarily the result of a $118.7 million, or 7.9%, increase in high-yield checking accounts (a subcategory of our NOW accounts), to $1.6 billion at December 31, 2006 from $1.5 billion at September 30, 2006. We have focused on promoting this type of deposit product since we believe it provides a stable source of funds. In addition, our high-yield checking accounts reprice in a manner similar to our equity loan products, and therefore assist us in managing interest rate risk. There were no material changes in the composition of our deposits during the quarter ended December 31, 2006.
Shareholder’s equity increased $16.1 million, or 1.6%, to $1.03 billion at December 31, 2006 from $1.01 billion at September 30, 2006. The increase primarily resulted from net income of $15.8 million during the quarter.
Comparison of Operating Results for the Three Months Ended December 31, 2006 and December 31, 2005
General. Net income increased $1.4 million, or 9.4%, to $15.8 million for the three months ended December 31, 2006 from $14.5 million for the three months ended December 31, 2005. The increase in net income was caused by an increase in non-interest income, partially offset by a decrease in net interest income and an increase in non-interest expense.
Interest Income. Interest income increased $9.6 million, or 8.3%, to $125.7 million for the three months ended December 31, 2006 from $116.1 million for the three months ended December 31, 2005. The increase in interest income resulted from an increase in interest income on federal funds sold and an increase in interest income on loans.
Interest income on federal funds sold was $5.8 million for the three months ended December 31, 2006, compared to $5,000 for the three months ended December 31, 2005. The increase resulted from our maintaining higher levels of liquid assets during the three months ended December 31, 2006, as our average balance of federal funds sold was $445.8 million for the three months ended December 31, 2006 compared to $485,000 for the three months ended December 31, 2005.
Interest and fee income on loans increased $3.2 million, or 2.9%, to $116.4 million for the three months ended December 31, 2006 from $113.2 million for the three months ended December 31, 2005. The increase resulted from an increase in the yield we earned on loans. The average yield on our loan portfolio increased 36 basis points to 6.04% for the three months ended December 31, 2006 from 5.68% for the three months ended December 31, 2005, primarily as a result of increases in the interest rates on our adjustable-rate loans and on newly-originated fixed-rate loans in response to increases in market interest rates. The average balance of loans decreased $263.2 million, or 3.3%, to $7.7 billion for the three months ended December 31, 2006 from $8.0 billion for the three months ended December 31, 2005, reflecting our sale of $2.2 billion of loans during the fiscal year ended September 30, 2006.
Interest Expense. Interest expense increased $14.4 million, or 21.6%, to $81.1 million for the three months ended December 31, 2006 from $66.7 million for the three months ended December 31, 2005. The increase in interest expense resulted from increases in interest expense on certificates of deposit and NOW accounts, partially offset by a decrease in interest expense on Federal Home Loan Bank advances.
33
Table of Contents
Interest expense on certificates of deposit increased $11.5 million, or 22.3%, to $63.1 million for the three months ended December 31, 2006 from $51.6 million for the three months ended December 31, 2005. The increase was caused primarily by a 70 basis point increase in the average rate we paid on certificates of deposit to 4.59% for the three months ended December 31, 2006 from 3.89% for the three months ended December 31, 2005. We increased rates on deposits in response to increases in market interest rates. In addition, the average balance of certificates of deposit increased by $192.5 million, or 3.6%, to $5.5 billion for the three months ended December 31, 2006 from $5.3 billion for the three months ended December 31, 2005. The increase in certificate of deposit accounts primarily reflects our customers seeking higher interest-paying deposit products during a period of rising market interest rates.
Interest expense on NOW accounts increased $6.5 million, or 61.5%, to $16.9 million for the three months ended December 31, 2006 from $10.5 million for the three months ended December 31, 2005. The increase was caused primarily by a 102 basis point increase in the average rate we paid on NOW accounts to 4.12% for the three months ended December 31, 2006 from 3.10% for the three months ended December 31, 2005. We increased rates on deposits in response to increases in market interest rates. In addition, the average balance of NOW accounts increased $291.5 million, or 21.5%, to $1.6 billion for the three months ended December 31, 2006 from $1.4 billion for the three months ended December 31, 2005. The increase in NOW accounts reflects our customers seeking higher interest-paying deposit products during a period of rising market interest rates. The increase also reflects our continued focus on high-yield checking accounts, since we believe this type of deposit provides a stable source of funds that reprices in a manner similar to our equity loan products, and therefore assists us in managing interest rate risk.
Interest expense on Federal Home Loan Bank advances decreased $3.3 million, or 91.3%, to $315,000 for the three months ended December 31, 2006 from $3.6 million for the three months ended December 31, 2005. The decrease was caused by a decrease in our average balance of Federal Home Loan Bank advances. The average balance decreased $348.0 million to $25.1 million for the three months ended December 31, 2006 from $373.1 million for the three months ended December 31, 2005. Throughout the fiscal year ended September 30, 2006, we repaid nearly all of our Federal Home Loan Bank advances, without incurring prepayment penalties.
Net Interest Income. Net interest income decreased by $4.8 million, or 9.7%, to $44.6 million for the three months ended December 31, 2006 from $49.4 million for the three months ended December 31, 2005. The decrease resulted solely from a further compression of our interest rate spread and our net interest margin, as our interest rate spread decreased 43 basis points to 1.64% for the three months ended December 31, 2006 from 2.07% for the three months ended December 31, 2005, and our net interest margin decreased 28 basis points to 2.12% for the three months ended December 31, 2006 from 2.40% for the three months ended December 31, 2005. The decreases in our interest rate spread and net interest margin are consistent with the inverting of the U.S. Treasury yield curve. From June 30, 2004 to December 31, 2006, the Federal Reserve Board increased its target for the federal funds rate from 1.0% to 5.25%. While these short-term market interest rates (which we use as a guide to price our deposits) have increased, longer-term market interest rates (which we use as a guide to price our longer-term loans) have not increased to the same degree. The compression in our interest rate spread and net interest margin was partially offset by an increase in net interest-earning assets of $148.6 million, or 19.0%, to $929.8 million for the three months ended December 31, 2006 from $781.2 million for the three months ended December 31, 2005.
Provision for Loan Losses. We establish provisions for loan losses, which are charged to operations, in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of nonperforming and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses on a quarterly basis and make provisions for loan losses in order to maintain the allowance.
34
Table of Contents
Based on our evaluation of the above factors, we recorded a provision for loan losses of $2.0 million for the three months ended December 31, 2006 and a provision for loan losses of $1.0 million for the three months ended December 31, 2005. The provisions recorded reflected net chargeoffs of $1.5 million and $249,000 for the three months ended December 31, 2006 and 2005, respectively. The allowance for loans losses was $21.2 million, or 0.28% of total loans receivable at December 31, 2006, compared to $19.4 million, or 0.25% of total loans receivable at December 31, 2005. We increased the allowance for loan losses to reflect an increase in non-performing loans from December 31, 2005 to December 31, 2006. Nonperforming loans increased by $16.4 million to $90.3 million, or 1.19% of total loans, at December 31, 2006 from $74.0 million, or 0.94% of total loans, at December 31, 2005. The increase in nonperforming loans occurred primarily in our one- to four-family residential real estate mortgage loan portfolio, and specifically a $14.3 million increase in non-performing loans originated through our Home Today program, which was established in 2000. See “Business of Third Federal Savings and Loan Association of Cleveland—Non-Performing Assets” and “—Delinquent Loans” for a discussion of the asset quality of this portion of our loan portfolio. We had one impaired loan with a principal balance of $2.3 million and $2.4 million at December 31, 2006 and 2005, respectively. We used the same general methodology in assessing the allowance at the end of the three-month periods. To the best of our knowledge, we have recorded all losses that are both probable and reasonable to estimate for the three months ended December 31, 2006 and 2005.
Non-Interest Income. Non-interest income increased $11.0 million to $12.4 million for the three months ended December 31, 2006 from $1.4 million for the three months ended December 31, 2005. The increase was primarily caused by our recognizing losses of $811,000 on loan sales for the three months ended December 31, 2006, compared to $8.3 million of such losses for the three months ended December 31, 2005. The increase was also caused by an increase in other non-interest income of $2.9 million, or 112.2%, to $5.5 million for the three months ended December 31, 2006 from $2.6 million for the three months ended December 31, 2005. This increase primarily reflected gains from private equity fund investments of Third Capital, Inc.
Non-Interest Expense. Non-interest expense increased $3.0 million, or 10.6%, to $31.5 million for the three months ended December 31, 2006 from $28.5 million for the three months ended December 31, 2005. Salaries and employee benefits expense increased $2.0 million, or 12.8%, to $17.3 million for the three months ended December 31, 2006 from $15.4 million for the three months ended December 31, 2005. This increase is due to our incurring benefits expense of $2.3 million (pre-tax) for the three months ended December 31, 2006 as a result of funding our employee stock ownership plan.
Income Tax Expense. The provision for income taxes was $7.7 million for the three months ended December 31, 2006, compared to $6.9 million for the three months ended December 31, 2005, reflecting an increase in pre-tax income between the three-month periods. Our effective tax rate was 32.7% for the three months ended December 31, 2006 compared to 32.1% for the three months ended December 31, 2005. Our effective tax rate is below the combined state and federal statutory rate because of our ownership of bank-owned life insurance.
35
Table of Contents
This prospectus 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 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, that are worse than expected; |
| • | adverse changes in the securities markets; |
| • | legislative or regulatory changes that adversely affect our business; |
| • | 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 and the Financial Accounting Standards Board; |
| • | inability of third-party providers to perform their obligations to us; and |
| • | changes in our organization, compensation and benefit plans. |
Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. We discuss these and other uncertainties in “Risk Factors.”
36
Table of Contents
HOW WE INTEND TO USE THE PROCEEDS FROM THE STOCK OFFERING
Although we will not be able to determine the amount of actual net proceeds we will receive from the sale of shares of common stock until the stock offering is completed, based upon the sale of our shares at $10.00 per share, we anticipate that the net proceeds will be between $636.8 million and $862.8 million, or $992.8 million if the stock offering is increased.
We intend to distribute the net proceeds from the stock offering as follows:
| 64,400,510 Shares at Offering Range |
75,765,306 Shares at Offering Range |
87,130,102 Shares at Offering Range |
100,199,618 Shares at Adjusted Maximum of Offering Range (1) |
|||||||||||||||||||||||||
| Amount | Percent of Net Proceeds |
Amount | Percent of Net Proceeds |
Amount | Percent of Net Proceeds |
Amount | Percent of Net Proceeds |
|||||||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||||||||||||||
| Stock offering proceeds |
$ | 644,005 | $ | 757,653 | $ | 871,301 | $ | 1,001,996 | ||||||||||||||||||||
| Less: |
||||||||||||||||||||||||||||
| Stock offering expenses, excluding sales agent commissions and expenses |
(3,560 | ) | (3,560 | ) | (3,560 | ) | (3,560 | ) | ||||||||||||||||||||
| Sales agent commissions and expenses |
(3,656 | ) | (4,298 | ) | (4,942 | ) | (5,683 | ) | ||||||||||||||||||||
| Net stock offering proceeds |
636,789 | 100.0 | % | 749,795 | 100.0 | % | 862,799 | 100.0 | % | 992,753 | 100.0 | % | ||||||||||||||||
| Less: |
||||||||||||||||||||||||||||
| Proceeds contributed to Third Federal Savings and Loan |
(323,395 | ) | (50.8 | ) | (379,898 | ) | (50.7 | ) | (436,400 | ) | (50.6 | ) | (501,377 | ) | (50.5 | ) | ||||||||||||
| Proceeds used for loan to employee stock ownership plan |
(75,050 | ) | (11.8 | ) | (89,880 | ) | (12.0 | ) | (104,433 | ) | (12.1 | ) | (121,169 | ) | (12.2 | ) | ||||||||||||
| Proceeds retained by TFS Financial Corporation |
$ | 238,344 | 37.4 | % | $ | 280,017 | 37.3 | % | $ | 321,966 | 37.3 | % | $ | 370,207 | 37.3 | % | ||||||||||||
| (1) | As adjusted to give effect to an increase in the number of shares of common stock outstanding after the stock offering which could occur due to an increase in the maximum of the independent valuation as a result of regulatory considerations, demand for the shares, or changes in market conditions or general economic conditions following the commencement of the stock offering. |
The net proceeds may vary because total expenses relating to the stock offering may be more or less than our estimates. For example, our expenses would increase if a syndicated community offering were used to sell shares of common stock not purchased in the subscription offering and any community offering. Payments for shares made through withdrawals from existing deposit accounts will not result in the receipt of new funds for investment but will result in a reduction of Third Federal Savings and Loan’s deposits. In all instances, Third Federal Savings and Loan will receive at least 50% of the net proceeds of the stock offering.
We are undertaking the stock offering at this time in order to increase our capital and have the capital resources available to expand our business. For further information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Business Strategy.” The stock offering proceeds will increase our capital resources and the amount of funds available to us for lending and investment purposes. The proceeds will also give us greater flexibility to expand our branch network and expand the products and services we offer to our customers.
37
Table of Contents
TFS Financial Corporation may use the proceeds it retains from the stock offering:
| • | to finance the purchase of shares of common stock in the stock offering by the employee stock ownership plan; |
| • | to invest in securities; |
| • | to deposit funds in Third Federal Savings and Loan; |
| • | to repurchase its shares of common stock; |
| • | to pay dividends to our shareholders; |
| • | to finance acquisitions of financial institutions or branches and other financial services businesses, although no material transactions are being considered at this time; and |
| • | for general corporate purposes. |
Under current Office of Thrift Supervision regulations, we may not repurchase shares of our common stock during the first year following the stock offering, except when extraordinary circumstances exist and with prior regulatory approval. The loan that will be used to fund the purchases by the employee stock ownership plan will accrue interest.
Third Federal Savings and Loan intends to contribute $5.0 million in cash to the Third Federal Foundation, and invest the remaining proceeds it receives from the stock offering initially in short-term, liquid investments. Over time, Third Federal Savings and Loan may use the proceeds that it receives from the stock offering as follows:
| • | to expand its retail banking franchise by establishing de novo branches, by acquiring existing branches, or by acquiring other financial institutions or other financial services companies, although no material acquisitions or branch expansion are specifically being considered at this time; |
| • | to fund new loans; |
| • | to support new products and services; |
| • | to invest in securities; and |
| • | for general corporate purposes. |
The use of the proceeds outlined above may change based on changes in interest rates, equity markets, laws and regulations affecting the financial services industry, our relative position in the financial services industry, the attractiveness of potential acquisitions to expand our operations, and overall market conditions. We expect our return on equity to decrease as compared to our performance in recent years until we are able to utilize effectively the additional capital raised in the stock offering. Until we can increase our net interest income and non-interest income, we expect our return on equity to remain below the industry average, which may negatively affect the value of our common stock. See “Risk Factors.”
38
Table of Contents
OUR POLICY REGARDING DIVIDENDS
Following completion of the stock offering, our board of directors will have the authority to declare dividends on our shares of common stock, subject to statutory and regulatory requirements. While our board of directors currently intends to declare dividends, it has not yet determined the amount and timing of any dividend payments. The amount of any dividend payments will depend upon a number of factors, including capital requirements, our consolidated financial condition and results of operations, tax considerations, statutory and regulatory limitations and general economic conditions. No assurances can be given that any dividends will be paid or that, if paid, such dividends will not be reduced or eliminated in the future. Special cash dividends, stock dividends or returns of capital, to the extent permitted by Office of Thrift Supervision policy and regulations, may be paid in addition to, or in lieu of, regular cash dividends. We will file a consolidated tax return with Third Federal Savings and Loan. Accordingly, it is anticipated that any cash distributions made by TFS Financial Corporation to its shareholders would be treated as cash dividends and not as a non-taxable return of capital for federal and state tax purposes.
Pursuant to our charter, we are authorized to issue preferred stock. If we issue preferred stock, the holders thereof may have a priority over the holders of our shares of common stock with respect to the payment of dividends. For a further discussion concerning the payment of dividends on our shares of common stock, see “Description of Capital Stock of TFS Financial Corporation—Common Stock—Distributions.” Dividends we can declare and pay will depend, in large part, upon the net proceeds of the stock offering we retain and, to a lesser extent, on the receipt of dividends from Third Federal Savings and Loan and Third Capital, Inc. Initially, we will have no additional sources of income to support dividend payments, other than earnings from the investment of proceeds from the stock offering, and interest payments received on our loan to the employee stock ownership plan. A regulation of the Office of Thrift Supervision imposes limitations on “capital distributions” by savings institutions. See “Supervision and Regulation—Federal Banking Regulation—Capital Distributions.”
Pursuant to Office of Thrift Supervision regulations, any payment of dividends by Third Federal Savings and Loan to TFS Financial Corporation that would be deemed to be drawn from Third Federal Savings and Loan’s bad debt reserves would require a payment of taxes at the then-current tax rate by Third Federal Savings and Loan on the amount of earnings deemed to be removed from the reserves for such distribution. Third Federal Savings and Loan does not intend to make any distribution to TFS Financial Corporation that would create such a federal tax liability. See “Federal and State Taxation.”
Additionally, pursuant to Office of Thrift Supervision regulations, during the three-year period following the stock offering, we will not take any action to declare an extraordinary dividend to shareholders that would be treated by recipients as a tax-free return of capital for federal income tax purposes.
If we pay dividends to our shareholders, we also will be required to pay dividends to Third Federal Savings and Loan Association of Cleveland, MHC, unless Third Federal Savings and Loan Association of Cleveland, MHC elects to waive the receipt of dividends. We anticipate that Third Federal Savings and Loan Association of Cleveland, MHC will waive any dividends we pay. Any decision to waive dividends will be subject to regulatory approval. Under Office of Thrift Supervision regulations, public shareholders would not be diluted for any dividends waived by Third Federal Savings and Loan Association of Cleveland, MHC in the event Third Federal Savings and Loan Association of Cleveland, MHC converts to stock form. See “Supervision and Regulation—Holding Company Regulation.”
39
Table of Contents
We have never issued capital stock (except for the 1,000 shares issued to Third Federal Savings and Loan Association of Cleveland, MHC in connection with the mutual holding company reorganization completed in 1997). We anticipate that our shares of common stock will be quoted on the Nasdaq Global Select Market under the symbol “TFSL.” We will try to have at least four market makers to make a market in our common stock. Sandler O’Neill & Partners, L.P. has advised us that it intends to make a market in our common stock following the stock offering, but it is under no obligation to do so. While we will attempt before completion of the stock offering to obtain commitments from at least three other broker-dealers to make a market in our common stock, there can be no assurance that we will be successful in obtaining such commitments.
The development of an active trading market depends on the existence of willing buyers and sellers, the presence of which is not within our control, or that of any market maker. The number of active buyers and sellers of our common stock at any particular time may be limited. Under such circumstances, you could have difficulty selling your shares of common stock on short notice and, therefore, you should not view the purchase of our common stock as a short-term investment. We cannot assure you that an active trading market for the common stock will develop or that, if it develops, it will continue. Nor can we assure you that if you purchase shares of our common stock, you will be able to sell them at or above $10.00 per share.
40
Table of Contents
At September 30, 2006, Third Federal Savings and Loan exceeded all regulatory capital requirements. The following table sets forth our compliance, as of September 30, 2006, with the regulatory capital standards, on a historical and pro forma basis, assuming that the indicated number of shares of common stock were sold as of such date at $10.00 per share, Third Federal Savings and Loan received 50% of the estimated net proceeds and the cash to contribute to the charitable foundation, and approximately 50% of the net proceeds were retained by TFS Financial Corporation. Accordingly, proceeds received by Third Federal Savings and Loan have been assumed to equal $323.4 million, $379.9 million, $436.4 million and $501.4 million at the minimum, midpoint, maximum and adjusted maximum of the offering range, respectively. For a discussion of the applicable capital requirements, see “Supervision and Regulation—Federal Banking Regulation—Capital Requirements.”
| Pro Forma at September 30, 2006, Based Upon the Sale of | ||||||||||||||||||||||||||||||||||
| Historical at September 30, 2006 |
64,400,510 Shares at Minimum of |
75,765,306 Shares Offering Range |
87,130,102 Shares at Maximum of Offering Range |
100,199,618 Shares at Adjusted |
||||||||||||||||||||||||||||||
| Amount | Percent of Assets |
Amount | Percent of Assets |
Amount | Percent of Assets |
Amount | Percent of Assets |
Amount | Percent of Assets |
|||||||||||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||||||||||||||||||||
| GAAP capital |
$ | 891,545 | 10.44 | % | $ | 1,094,565 | 12.52 | % | $ | 1,128,823 | 12.86 | % | $ | 1,163,495 | 13.20 | % | $ | 1,203,369 | 13.59 | % | ||||||||||||||
| Tangible capital: |
||||||||||||||||||||||||||||||||||
| Tangible capital (3)(4) |
$ | 883,510 | 10.35 | % | $ | 1,086,530 | 12.43 | % | $ | 1,120,788 | 12.78 | % | $ | 1,155,460 | 13.12 | % | $ | 1,195,334 | 13.51 | % | ||||||||||||||
| Requirement |
128,028 | 1.50 | 131,073 | 1.50 | 131,587 | 1.50 | 132,107 | 1.50 | 132,705 | 1.50 | ||||||||||||||||||||||||
| Excess |
$ | 755,482 | 8.85 | % | $ | 955,457 | 10.93 | % | $ | 989,201 | 11.28 | % | $ | 1,023,353 | 11.62 | % | $ | 1,062,629 | 12.01 | % | ||||||||||||||
| Core capital: |
||||||||||||||||||||||||||||||||||
| Core capital (3)(4) |
$ | 883,510 | 10.35 | % | $ | 1,086,530 | 12.43 | % | $ | 1,120,788 | 12.78 | % | $ | 1,155,460 | 13.12 | % | $ | 1,195,334 | 13.51 | % | ||||||||||||||
| Requirement (5) |
341,407 | 4.00 | 349,528 | 4.00 | 350,898 | 4.00 | 352,285 | 4.00 | 353,880 | 4.00 | ||||||||||||||||||||||||
| Excess |
$ | 542,103 | 6.35 | % | $ | 737,002 | 8.43 | % | $ | 769,890 | 8.78 | % | $ | 803,175 | 9.12 | % | $ | 841,454 | 9.51 | % | ||||||||||||||
| Tier I risk based capital: |
||||||||||||||||||||||||||||||||||
| Tier I risk based capital (3)(4) |
$ | 883,510 | 14.69 | % | $ | 1,086,530 | 17.95 | % | $ | 1,120,788 | 18.49 | % | $ | 1,155,460 | 19.04 | % | $ | 1,195,334 | 19.67 | % | ||||||||||||||
| Requirement (5) |
240,561 | 4.00 | 242,185 | 4.00 | 242,459 | 4.00 | 242,736 | 4.00 | 243,055 | 4.00 | ||||||||||||||||||||||||
| Excess |
$ | 642,949 | 10.69 | % | $ | 844,345 | 13.95 | % | $ | 878,329 | 14.49 | % | $ | 912,724 | 15.04 | % | $ | 952,279 | 15.67 | % | ||||||||||||||
| Risk-based capital: |
||||||||||||||||||||||||||||||||||
| Risk-based capital (4)(6) |
$ | 902,401 | 15.00 | % | $ | 1,105,421 | 18.26 | % | $ | 1,139,679 | 18.80 | % | $ | 1,174,351 | 19.35 | % | $ | 1,214,225 | 19.98 | % | ||||||||||||||
| Requirement |
481,121 | 8.00 | 484,370 | 8.00 | 484,918 | 8.00 | 485,472 | 8.00 | 486,110 | 8.00 | ||||||||||||||||||||||||
| Excess |
$ | 421,280 | 7.00 | % | $ | 621,051 | 10.26 | % | $ | 654,761 | 10.80 | % | $ | 688,879 | 11.35 | % | $ | 728,115 | 11.98 | % | ||||||||||||||
| Reconciliation of capital infused into Third Federal Savings and Loan: |
||||||||||||||||||||||||||||||||||
| Net proceeds |
$ | 323,395 | $ | 379,898 | $ | 436,400 | $ | 501,377 | ||||||||||||||||||||||||||
| Less: |
||||||||||||||||||||||||||||||||||
| Cash contribution to charitable foundation (after-tax) |
(3,250 | ) | (3,250 | ) | (3,250 | ) | (3,250 | ) | ||||||||||||||||||||||||||
| Common stock acquired by employee stock ownership plan |
(75,050 | ) | (89,880 | ) | (104,433 | ) | (121,169 | ) | ||||||||||||||||||||||||||
| Common stock acquired by stock-based benefit plans |
(42,075 | ) | (49,490 | ) | (56,767 | ) | (65,134 | ) | ||||||||||||||||||||||||||
| Pro forma increase in GAAP and regulatory capital |
$ | 203,020 | $ | 237,278 | $ | 271,950 | $ | 311,824 | ||||||||||||||||||||||||||
(footnotes on following page)
41
Table of Contents
| (1) | As adjusted to give effect to an increase in the number of shares of common stock outstanding after the stock offering which could occur due to an increase in the maximum of the independent valuation as a result of changes in market conditions following the commencement of the stock offering. |
| (2) | Based on pre-stock offering adjusted total assets of $8.5 billion for purposes of the tangible and core capital requirements, and risk-weighted assets of $6.0 billion for purposes of the risk-based capital requirement. |
| (3) | Tangible capital levels are shown as a percentage of tangible assets. Core capital levels are shown as a percentage of total adjusted assets. Risk-based capital levels are shown as a percentage of risk-weighted assets. |
| (4) | Pro forma capital levels assume that we fund the stock-based benefit plans with purchases in the open market of 1.96% of the outstanding shares of common stock following the stock offering (including shares issued to Third Federal Foundation and to Third Federal Savings and Loan Association of Cleveland, MHC) at a price equal to the price for which the shares of common stock are sold in the stock offering, and that the employee stock ownership plan purchases 3.92% of the shares of common stock to be outstanding immediately following the stock offering (including shares issued to Third Federal Foundation) with a $9.1 million contribution that occurred during the quarter ended September 30, 2006 and with funds we lend. Third Federal Savings and Loan’s pro forma GAAP and regulatory capital have been reduced by the amount required to fund both of these plans and the cash contribution to Third Federal Foundation. See “Management” for a discussion of the stock-based benefit plans and employee stock ownership plan. The Office of Thrift Supervision has proposed amendments to its existing regulations regarding stock-based benefit plans that would clarify that we may award shares of common stock under one or more stock-based benefit plans in excess of 1.96% of our total outstanding shares if the stock-based benefit plans are adopted more than one year following the stock offering, provided shares used to fund the plans in excess of this amount are obtained through stock repurchases. In the event the Office of Thrift Supervision adopts these regulations as proposed, or otherwise changes its regulations or policies regarding stock-based benefit plans, including any regulations or policies restricting the aggregate amount of awards, we may increase the awards beyond current regulatory restrictions and beyond the amounts reflected in this table. |
| (5) | The current core capital requirement for savings banks that receive the highest supervisory rating for safety and soundness is 3% of total adjusted assets and 4% to 5% of total adjusted assets for all other savings banks. See “Supervision and Regulation—Federal Banking Regulation—Standards for Safety and Soundness” and “Capital Requirements,” respectively. |
| (6) | Assumes net proceeds are invested in assets that carry a 20% risk-weighting. |
42
Table of Contents
The following table presents our historical consolidated capitalization at September 30, 2006, and our pro forma consolidated capitalization after giving effect to the stock offering, based upon the sale of the number of shares of common stock indicated in the table and the other assumptions set forth under “Pro Forma Data.”
| Historical Consolidated |
Pro Forma Consolidated Capitalization Based Upon the Sale for $10.00 Per Share of |
|||||||||||||||||||
| 64,400,510 Range |
75,765,306 Range |
87,130,102 Range |
100,199,618 Shares at Adjusted Maximum of Offering Range (1) |
|||||||||||||||||
| (Dollars in Thousands) | ||||||||||||||||||||
| Deposits (2) |
$ | 7,401,077 | $ | 7,401,077 | $ | 7,401,077 | $ | 7,401,077 | $ | 7,401,077 | ||||||||||
| Federal Home Loan Bank advances (3) |
25,103 | 25,103 | 25,103 | 25,103 | 25,103 | |||||||||||||||
| Total deposits and borrowings |
$ | 7,426,180 | $ | 7,426,180 | $ | 7,426,180 | $ | 7,426,180 | $ | 7,426,180 | ||||||||||
| Shareholders’ equity: |
||||||||||||||||||||
| Preferred stock, $0.01 par value per share, 100,000,000 shares authorized; none to be issued |
$ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
| Common stock, $0.01 par value per share, 700,000,000 shares authorized; shares to be issued as reflected |
— | 2,147 | 2,525 | 2,896 | 3,323 | |||||||||||||||
| Additional paid-in capital (4) |
627,979 | 1,262,621 | 1,375,249 | 1,487,882 | 1,617,409 | |||||||||||||||
| Retained earnings |
395,892 | 395,892 | 395,892 | 395,892 | 395,892 | |||||||||||||||
| Plus: |
||||||||||||||||||||
| Contribution to charitable foundation |
— | 42,934 | 50,000 | 50,000 | 50,000 | |||||||||||||||
| Less: |
||||||||||||||||||||
| After-tax expense of contribution to charitable foundation (5) |
— | (31,157 | ) | (35,750 | ) | (35,750 | ) | (35,750 | ) | |||||||||||
| Common stock acquired by employee stock ownership plan (6) |
— | (77,325 | ) | (92,155 | ) | (106,708 | ) | (123,444 | ) | |||||||||||
| Common stock acquired by stock-based benefit plans (7) |
— | (42,075 | ) | (49,490 | ) | (56,767 | ) | (65,134 | ) | |||||||||||
| Accumulated other comprehensive loss |
(11,277 | ) | (11,277 | ) | (11,277 | ) | (11,277 | ) | (11,277 | ) | ||||||||||
| Total shareholders’ equity (8) |
$ | 1,012,594 | $ | 1,541,760 | $ | 1,634,994 | $ | 1,726,168 | $ | 1,831,019 | ||||||||||
| Pro forma shares outstanding: |
||||||||||||||||||||
| Total shares outstanding (9) |
214,668,367 | 252,500,000 | 289,625,000 | 332,318,750 | ||||||||||||||||
| Shares issued to Third Federal Savings and Loan Association of Cleveland, MHC (9) |
145,974,490 | 171,734,694 | 197,494,898 | 227,119,132 | ||||||||||||||||
| Shares offered for sale |
64,400,510 | 75,765,306 | 87,130,102 | 100,199,618 | ||||||||||||||||
| Shares issued to charitable foundation |
4,293,367 | 5,000,000 | 5,000,000 | 5,000,000 | ||||||||||||||||
| Total shareholders’ equity as a percentage of pro forma total assets |
11.78 | % | 16.90 | % | 17.74 | % | 18.54 | % | 19.45 | % | ||||||||||
| (1) | As adjusted to give effect to an increase in the number of shares of common stock outstanding after the stock offering which could occur due to an increase in the maximum of the independent valuation as a result of changes in market conditions following the commencement of the stock offering. |
| (2) | Does not reflect withdrawals from deposit accounts for the purchase of shares of common stock in the stock offering. Such withdrawals would reduce pro forma deposits by the amount of such withdrawals. |
(footnotes continued on following page)
43
Table of Contents
(continued from previous page)
| (3) | Includes securities sold under agreements to repurchase. See “Business of Third Federal Savings and Loan Association of Cleveland—Sources of Funds—Borrowings.” |
| (4) | The sum of the par value of the total shares outstanding and additional paid-in capital equals the net stock offering proceeds plus the market value of the shares issued to the charitable foundation at the offering price of $10.00 per share. No effect has been given to the issuance of additional shares of common stock pursuant to stock options granted under one or more stock-based benefit plans that we intend to adopt. The stock issuance plan permits us to adopt one or more stock-based benefit plans, subject to shareholder approval, that may award stock or stock options in an aggregate amount up to 25% of the number of shares of common stock held by persons other than Third Federal Savings and Loan Association of Cleveland, MHC. The stock-based benefit plans will not be implemented for at least six months after the stock offering and until they have been approved by our shareholders. |
| (5) | Represents the expense of the contribution to the charitable foundation based on a 35.0% tax rate. The realization of the deferred tax benefit is limited annually to a maximum deduction for charitable foundations equal to 10% of our annual taxable income, subject to our ability to carry forward any unused portion of the deduction for five years following the year in which the contribution is made. |
| (6) | Assumes that 3.92% of the shares of common stock to be outstanding immediately following the stock offering (including shares issued to Third Federal Foundation) will be purchased by the employee stock ownership plan with a $9.1 million contribution that occurred during the quarter ended September 30, 2006 and with funds that we will lend to acquire the remaining shares. The shares of common stock acquired by the employee stock ownership plan are reflected as a reduction of shareholders’ equity. Third Federal Savings and Loan will provide the funds to repay the employee stock ownership plan loan. See “Management—Benefit Plans.” |
| (7) | Assumes that subsequent to the stock offering, 1.96% of the outstanding shares of common stock (including shares issued to Third Federal Foundation and to Third Federal Savings and Loan Association of Cleveland, MHC) are purchased (with funds we provide) by the stock-based benefit plans in the open market at a price equal to the price for which the shares are sold in the stock offering. The shares of common stock to be purchased by the stock-based benefit plans are reflected as a reduction of shareholders’ equity. See “Pro Forma Data” and “Management.” The stock issuance plan permits us to adopt one or more stock-based benefit plans that award stock or stock options, in an aggregate amount up to 25% of the number of shares of common stock held by persons other than Third Federal Savings and Loan Association of Cleveland, MHC. The stock-based benefit plans will not be implemented for at least six months after the stock offering and until they have been approved by shareholders. See “Pro Forma Data” for a discussion of the potential dilutive impact of the award of shares under these plans. The Office of Thrift Supervision has proposed amendments to its existing regulations regarding stock-based benefit plans that would clarify that we may award shares of common stock under one or more stock-based benefit plans in excess of 1.96% of our total outstanding shares if the stock-based benefit plans are adopted more than one year following the stock offering, and the shares used to fund the plans in excess of this amount are obtained through stock repurchases. In the event the Office of Thrift Supervision adopts these regulations as proposed, or otherwise changes its regulations or policies to permit larger stock-based benefit plans, greater amounts of stock awards as compared to stock options or faster acceleration of vesting of benefits, we may increase the awards beyond current regulatory restrictions and beyond the amounts reflected in this table. |
| (8) | Total shareholders’ equity equals GAAP capital. |
| (9) | We issued 1,000 shares of our common stock to Third Federal Savings and Loan Association of Cleveland, MHC in connection with our mutual holding company reorganization in 1997. |
44
Table of Contents
We cannot determine the actual net proceeds from the sale of the shares of common stock until the stock offering is completed. However, based upon the following assumptions, we estimate that net proceeds will be between $636.8 million and $862.8 million, or $992.8 million if the offering range is increased:
| • | we will sell all shares of common stock in the subscription offering; |
| • | our employee stock ownership plan will purchase 3.92% of the shares of common stock to be outstanding upon the completion of the stock offering (including shares issued to Third Federal Foundation) with a $9.1 million contribution that occurred during the quarter ended September 30, 2006 and a loan from TFS Financial Corporation. Third Federal Savings and Loan intends to repay $9.1 million of the loan for the employee stock ownership plan during the calendar year ended December 31, 2007. After December 31, 2007, Third Federal Savings and Loan’s total annual payment of the employee stock ownership plan debt is based upon equal annual installments of principal and interest based upon the remaining term of the loan; |
| • | Third Federal Savings and Loan will contribute $5.0 million in cash to the Third Federal Foundation; |
| • | expenses of the stock offering, other than fees to be paid to Sandler O’Neill & Partners, L.P., are estimated to be $3.6 million; |
| • | 649,000 shares of common stock will be purchased by our executive officers and directors, and their immediate families; and |
| • | Sandler O’Neill & Partners, L.P. will receive a fee equal to 0.65% of the aggregate purchase price of the shares sold in the stock offering, excluding any shares purchased by any employee benefit plans, the charitable foundation and any of our directors, officers or employees or members of their immediate families. |
We calculated our pro forma consolidated net income and shareholders’ equity for the fiscal year ended September 30, 2006 as if the shares of common stock had been sold at the beginning of the fiscal year and the net proceeds had been invested at 4.90% for the entire fiscal year, which assumes reinvestment of the net proceeds at a rate equal to the one year United States Treasury yield for the period. We believe this rate more accurately reflects a pro forma reinvestment rate than the arithmetic average method, which assumes reinvestment of the net proceeds at a rate equal to the average of the yield on our interest-earning assets and the cost of deposits for these periods. We assumed a tax rate of 35.0% for the fiscal year. This results in an annualized after-tax yield of 3.19% for the fiscal year ended September 30, 2006.
We calculated historical and pro forma per share amounts by dividing historical and pro forma amounts of consolidated net income and shareholders’ equity by the indicated number of shares of common stock. We adjusted these figures to give effect to the shares of common stock purchased by the employee stock ownership plan. We computed per share amounts for the fiscal year as if the shares of common stock were outstanding at the beginning of the fiscal year, but we did not adjust per share historical or pro forma shareholders’ equity to reflect the earnings on the estimated net proceeds.
The pro forma tables give effect to the implementation of stock-based benefit plans. Subject to the receipt of shareholder approval, we have assumed that the stock-based benefit plans will acquire an amount of shares of common stock equal to 1.96% of our outstanding shares of common stock (including shares issued to Third Federal Foundation and to Third Federal Savings and Loan Association of Cleveland, MHC) at the same price for which they were sold in the stock offering. We assume that shares of common stock are granted under the plans in awards that vest over a five-year period. The stock issuance plan provides that we may grant awards of stock or options under one or more stock-based benefit plans in an aggregate amount up to 25% of the number of shares of common stock held by persons other than Third Federal Savings and Loan Association of Cleveland, MHC. However, any awards of stock in excess of 1.96% of the outstanding shares (including shares issued to
45
Table of Contents
Third Federal Foundation and to Third Federal Savings and Loan Association of Cleveland, MHC) exclusive of shares acquired in the secondary market to fund such stock-based benefit plans, currently would require prior approval of the Office of Thrift Supervision.
We have also assumed that the stock-based benefit plans will grant options to acquire shares of common stock equal to 4.90% of our outstanding shares of common stock (including shares of common stock issued to Third Federal Savings and Loan Association of Cleveland, MHC and to Third Federal Foundation). In preparing the tables below, we assumed that shareholder approval was obtained, that the exercise price of the stock options and the market price of the stock at the date of grant were $10.00 per share and that the stock options had a term of ten years and vested over five years. We applied the Black-Scholes option pricing model to estimate a grant-date fair value of $3.37 for each option. In addition to the terms of the options described above, the Black-Scholes option pricing model incorporated an estimated volatility rate of 16.34% for the shares of common stock based on an index of publicly traded mutual holding companies, a dividend yield of 0%, an expected option life of 7.5 years and a risk free interest rate of 4.56%. Finally, we assumed that 25% of the stock options were non-qualified options granted to directors, resulting in a tax benefit (at an assumed tax rate of 35.0%) for a deduction for compensation expense equal to the grant-date fair value of the options. The stock issuance plan provides that we may grant awards of stock options under one or more stock-based benefit plans in an amount up to 25% of the number of shares of common stock held by persons other than Third Federal Savings and Loan Association of Cleveland, MHC. However, any awards of options in excess of 4.90% of our outstanding shares (including shares issued to Third Federal Foundation and to Third Federal Savings and Loan Association of Cleveland, MHC) would require prior approval of the Office of Thrift Supervision. It is expected that TFS Financial Corporation will fund the cost of any proposed stock-based benefit plans.
The Office of Thrift Supervision has proposed amendments to its existing regulations regarding stock-based benefit plans that are intended to clarify and simplify such regulations. Specifically, the amendments would clarify that we may grant options and award shares of common stock under one or more stock-based benefit plans in excess of 4.90% and 1.96%, respectively, of our total outstanding shares if the stock-based benefit plans are adopted more than one year following the stock offering and shares used to fund the plans in excess of the foregoing amounts are obtained through stock repurchases. In the event the Office of Thrift Supervision adopts these regulations as proposed, or otherwise changes its existing regulations or policies to permit larger stock-based benefit plans, greater amounts of stock awards as compared to stock options, or faster acceleration of vesting of benefits, the restrictions described above may not apply to any stock-based benefit plans that we adopt, and we may exceed the current limits applicable to the overall size of such plans and individual awards thereunder, and otherwise grant awards with terms that are different than those required by current Office of Thrift Supervision regulations and policy.
As discussed under “How We Intend to Use the Proceeds from the Stock Offering,” we intend to contribute at least 50% of the net proceeds from the stock offering to Third Federal Savings and Loan, and we will retain the remainder of the net proceeds from the stock offering. We will use a portion of the proceeds we retain for the purpose of making a loan to the employee stock ownership plan, and retain the rest of the proceeds for future use.
The pro forma table does not give effect to:
| • | withdrawals from deposit accounts for the purpose of purchasing shares of common stock in the stock offering; |
| • | our results of operations after the stock offering; or |
| • | changes in the market price of the shares of common stock after the stock offering. |
The following pro forma information may not represent the financial effects of the stock offering at the date on which the stock offering actually occurs and you should not use the table to indicate future results of operations. Pro forma shareholders’ equity represents the difference between the stated amount of our assets and liabilities, computed in accordance with accounting principles generally accepted in the United States of America
46
Table of Contents
(“GAAP”). We did not increase or decrease shareholders’ equity to reflect the difference between the carrying value of loans and other assets and their market value. Pro forma shareholders’ equity is not intended to represent the fair market value of the shares of common stock and may be different than the amounts that would be available for distribution to shareholders if we liquidated. Pro forma shareholders’ equity does not give effect to the impact of intangible assets or tax bad debt reserves in the event we are liquidated.
| At or For the Fiscal Year Ended September 30, 2006 Based Upon the Sale at $10.00 Per Share of |
||||||||||||||||
| 64,400,510 Shares at Minimum of Offering Range |
75,765,306 Shares at |
87,130,102 Shares at |
100,199,618 Shares at Adjusted Maximum of Offering Range (1) |
|||||||||||||
| (Dollars in Thousands, Except Per Share Amounts) | ||||||||||||||||
| Gross proceeds of stock offering |
$ | 644,005 | $ | 757,653 | $ | 871,301 | $ | 1,001,996 | ||||||||
| Plus: market value of shares issued to charitable foundation |
42,934 | 50,000 | 50,000 | 50,000 | ||||||||||||
| Market value of stock offering and charitable foundation shares |
$ | 686,939 | $ | 807,653 | $ | 921,301 | $ | 1,051,996 | ||||||||
| Gross proceeds of stock offering |
$ | 644,005 | $ | 757,653 | $ | 871,301 | $ | 1,001,996 | ||||||||
| Less: expenses |
(7,216 | ) | (7,858 | ) | (8,502 | ) | (9,243 | ) | ||||||||
| Estimated net proceeds |
636,789 | 749,795 | 862,799 | 992,753 | ||||||||||||
| Less: cash contribution to charitable foundation |
(5,000 | ) | (5,000 | ) | (5,000 | ) | (5,000 | ) | ||||||||
| Common stock acquired by employee stock ownership plan (2) |
(75,050 | ) | (89,880 | ) | (104,433 | ) | (121,169 | ) | ||||||||
| Common stock awarded under stock-based benefit plans (3) |
(42,075 | ) | (49,490 | ) | (56,767 | ) | (65,134 | ) | ||||||||
| Estimated net proceeds after adjustment for charitable foundation and stock benefit plans |
$ | 514,664 | $ | 605,425 | $ | 696,599 | $ | 801,450 | ||||||||
| For the Fiscal Year Ended September 30, 2006: |
||||||||||||||||
| Net income: |
||||||||||||||||
| Historical |
$ | 43,539 | $ | 43,539 | $ | 43,539 | $ | 43,539 | ||||||||
| Pro forma adjustments: |
||||||||||||||||
| Income on adjusted net proceeds |
16,418 | 19,313 | 22,222 | 25,566 | ||||||||||||
| Employee stock ownership plan (2) |
(1,479 | ) | (1,479 | ) | (1,479 | ) | (1,479 | ) | ||||||||
| Options awarded under stock-based benefit plans (5) |
(7,090 | ) | (8,339 | ) | (9,565 | ) | (10,975 | ) | ||||||||
| Shares awarded under stock-based benefit plans (3)(4) |
(5,470 | ) | (6,434 | ) | (7,380 | ) | (8,467 | ) | ||||||||
| Pro forma net income (6) |
$ | 45,918 | $ | 46,600 | $ | 47,337 | $ | 48,184 | ||||||||
| Net income per share: |
||||||||||||||||
| Historical |
$ | 0.21 | $ | 0.18 | $ | 0.16 | $ | 0.14 | ||||||||
| Pro forma adjustments: |
||||||||||||||||
| Income on adjusted net proceeds |
0.08 | 0.08 | 0.08 | 0.08 | ||||||||||||
| Employee stock ownership plan (2) |
(0.01 | ) | (0.01 | ) | (0.01 | ) | (0.01 | ) | ||||||||
| Options awarded under stock-based benefit plans (5) |
(0.03 | ) | (0.03 | ) | (0.03 | ) | (0.03 | ) | ||||||||
| Shares awarded under stock-based benefit plans (3)(4) |
(0.03 | ) | (0.03 | ) | (0.03 | ) | (0.03 | ) | ||||||||
| Pro forma net income per share (2)(3)(4)(5)(6) |
$ | 0.22 | $ | 0.19 | $ | 0.17 | $ | 0.15 | ||||||||
| Offering price to pro forma net income per share |
45.45x | 52.63x | 58.82x | 66.67x | ||||||||||||
| Shares considered outstanding in calculating historical and pro forma net income per share (7) |
207,163,368 | 243,512,000 | 279,181,700 | 320,201,855 | ||||||||||||
(Footnotes begin on second following page)
47
Table of Contents
| At or For the Fiscal Year Ended September 30, 2006 Based Upon the Sale at $10.00 Per Share of |
||||||||||||||||
| 64,400,510 Shares at Minimum of Offering Range |
75,765,306 Shares at |
87,130,102 Shares at |
100,199,618 Shares at Adjusted Maximum of Offering Range (1) |
|||||||||||||
| (Dollars in Thousands, Except Per Share Amounts) | ||||||||||||||||
| At September 30, 2006: |
||||||||||||||||
| Shareholders’ equity: |
||||||||||||||||
| Historical |
$ | 1,012,594 | $ | 1,012,594 | $ | 1,012,594 | $ | 1,012,594 | ||||||||
| Estimated net proceeds |
636,789 | 749,795 | 862,799 | 992,753 | ||||||||||||
| Contribution to charitable foundation |
42,934 | 50,000 | 50,000 | 50,000 | ||||||||||||
| Less: |
||||||||||||||||
| After-tax effect of contribution to charitable foundation |
(31,157 | ) | (35,750 | ) | (35,750 | ) | (35,750 | ) | ||||||||
| Common stock acquired by employee stock ownership plan (2) |
(77,325 | ) | (92,155 | ) | (106,708 | ) | (123,444 | ) | ||||||||
| Common stock awarded under stock-based benefit plans (3)(4) |
(42,075 | ) | (49,490 | ) | (56,767 | ) | (65,134 | ) | ||||||||
| Pro forma shareholders’ equity (8) |
$ | 1,541,760 | $ | 1,634,994 | $ | 1,726,168 | $ | 1,831,019 | ||||||||
| Shareholders’ equity per share: |
||||||||||||||||
| Historical |
$ | 4.72 | $ | 4.01 | $ | 3.50 | $ | 3.05 | ||||||||
| Estimated net proceeds |
2.97 | 2.97 | 2.98 | 2.99 | ||||||||||||
| Contributions issued to charitable foundation |
0.20 | 0.20 | 0.17 | 0.15 | ||||||||||||
| Less: |
||||||||||||||||
| After-tax effect of contribution to charitable foundation |
(0.15 | ) | (0.14 | ) | (0.12 | ) | (0.11 | ) | ||||||||
| Common stock acquired by employee stock ownership plan (2) |
(0.36 | ) | (0.36 | ) | (0.37 | ) | (0.37 | ) | ||||||||
| Common stock awarded under stock-based benefit plans (3)(4) |
(0.20 | ) | (0.20 | ) | (0.20 | ) | (0.20 | ) | ||||||||
| Pro forma shareholders’ equity per share (3)(4)(5)(6)(8) |
$ | 7.18 | $ | 6.48 | $ | 5.96 | $ | 5.51 | ||||||||
| Offering price as percentage of pro forma shareholders’ equity per share |
139.28 | % | 154.32 | % | 167.79 | % | 181.49 | % | ||||||||
| Shares considered outstanding in calculating offering price as a percentage of pro forma shareholders’ equity per share |
214,668,367 | 252,500,000 | 289,625,000 | 332,318,750 | ||||||||||||
| Charitable foundation ownership |
2.00 | % | 1.98 | % | 1.73 | % | 1.51 | % | ||||||||
| Public ownership |
30.00 | % | 30.01 | % | 30.08 | % | 30.15 | % | ||||||||
| Mutual holding company ownership |
68.00 | % | 68.01 | % | 68.19 | % | 68.34 | % | ||||||||
(Footnotes begin on following page)
48
Table of Contents
| (1) | As adjusted to give effect to an increase in the number of shares outstanding after the stock offering, which could occur due to an increase in the maximum of the independent valuation as a result of changes in market conditions following the commencement of the stock offering. |
| (2) | It is assumed that 3.92% of the shares to be outstanding upon completion of the stock offering (including shares issued to Third Federal Foundation) will be purchased by the employee stock ownership plan. For purposes of this table, $9.1 million of the funds used to acquire such shares were contributed by Third Federal Savings and Loan during the fiscal year ended September 30, 2006, for which Third Federal Savings and Loan Association recognized expense of $6.8 million during the fiscal year. The remaining funds used to acquire such shares are assumed to have been borrowed from us by the employee stock ownership plan with a loan with a 30-year term. The amount to be borrowed is reflected as a reduction of shareholders’ equity. Third Federal Savings and Loan intends to make annual contributions to the employee stock ownership plan in an amount at least equal to the principal and interest requirement of the debt. In addition, Third Federal Savings and Loan intends to repay $9.1 million of the loan for the employee stock ownership plan during the calendar year ending December 31, 2007. After December 31, 2007, Third Federal Savings and Loan’s total annual payment of the employee stock ownership plan debt is based upon equal annual installments of principal and interest based upon the remaining term of the loan. The pro forma net income information makes the following assumptions: |
| (i) | Third Federal Savings and Loan’s contribution to the employee stock ownership plan was made at the end of the period; |
| (ii) | 910,000 shares at the minimum, midpoint, maximum and adjusted maximum of the offering range, respectively were committed to be released during the fiscal year ended September 30, 2006, at an average fair value equal to the price for which the shares are sold in the stock offering in accordance with Statement of Position (“SOP”) 93-6; and |
| (iii) | only the employee stock ownership plan shares committed to be released were considered outstanding for purposes of the net income per share calculations. |
| (3) | Gives effect to one or more stock-based benefit plans expected to be adopted following the stock offering. We have assumed that the plans acquire a number of shares of common stock equal to 1.96% of the outstanding shares, including shares issued to Third Federal Foundation and to Third Federal Savings and Loan Association of Cleveland, MHC, through open market purchases at the beginning of the period presented for a purchase price equal to the price for which the shares are sold in the stock offering, and that 20% of the amount contributed was an amortized expense (based upon a five-year vesting period) during the fiscal year ended September 30, 2006. It is expected that TFS Financial Corporation will contribute the funds used by the stock-based benefit plans to purchase the shares. There can be no assurance that the actual purchase price of the shares granted under the stock-based benefit plans will be equal to the $10.00 subscription price. If shares are acquired from authorized but unissued shares of common stock or from treasury shares, our shareholders’ ownership interest would be diluted by approximately 1.92%. The effect on pro forma net income per share is not material. |
(footnotes continued on following page)
49
Table of Contents
(continued from previous page)
The following table shows pro forma shareholders’ equity per share, assuming all the shares to fund the stock awards are obtained from authorized but unissued shares.
| At or For the Fiscal Year Ended September 30, 2006 |
64,400,510 Shares at Minimum of Offering Range |
75,765,306 Shares at Midpoint of Offering Range |
87,130,102 Shares at Maximum of Offering Range |
100,199,618 Shares at Adjusted Maximum of Offering Range | ||||||||
| Pro forma shareholders’ equity per share |
$ | 7.24 | $ | 6.54 | $ | 6.04 | $ | 5.60 | ||||
| (4) | The Office of Thrift Supervision has proposed amendments to its existing regulations regarding stock-based benefit plans that would clarify that we may grant options and award shares of common stock under one or more stock-based benefit plans in excess of 4.90% and 1.96%, respectively, of our total outstanding shares if the stock-based benefit plans are adopted more than one year following the stock offering, and shares used to fund the plans in excess of the foregoing amounts are obtained through stock repurchases. In the event the Office of Thrift Supervision adopts these regulations as proposed, or otherwise changes its regulations or policies to permit larger stock-based benefit plans, greater amounts of stock awards as compared to stock options or faster acceleration of vesting of benefits, we may increase the awards beyond current regulatory restrictions and beyond the amounts reflected in this table. |
| (5) | Gives effect to the granting of options pursuant to one or more stock-based benefit plans, which are expected to be adopted by TFS Financial Corporation following the stock offering and presented to shareholders for approval not earlier than six months after the completion of the stock offering. We have assumed that options will be granted to acquire shares of common stock equal to 4.90% of outstanding shares (including shares issued to Third Federal Savings and Loan Association of Cleveland, MHC and to Third Federal Foundation). In calculating the pro forma effect of the stock options, it is assumed that the exercise price of the stock options and the trading price of the stock at the date of grant were $10.00 per share, the estimated grant-date fair value pursuant to the application of the Black-Scholes option pricing model was $3.37 for each option, the aggregate grant-date fair value of the stock options was amortized to expense on a straight-line basis over a five-year vesting period of the options, and that 25.0% of the amortization expense (or the assumed portion relating to options granted to directors) resulted in a tax benefit using an assumed tax rate of 35.0%. Under the above assumptions, the adoption of the stock-based benefit plans will result in no additional shares under the treasury stock method for purposes of calculating earnings per share. There can be no assurance that the actual exercise price of the stock options will be equal to the $10.00 price per share. If a portion of the shares of common stock used to satisfy the exercise of options under the stock-based benefit plans are obtained from the issuance of authorized but unissued shares, our shareholders’ ownership interest would be diluted by up to 4.7%. |
| (6) | Does not give effect to the non-recurring expense that will be recognized in fiscal 2007 as a result of the contribution to the charitable foundation. The following table shows the estimated after-tax expense associated with the contribution to the charitable foundation, as well as pro forma net income and pro forma net income per share assuming the contribution to the charitable foundation had been expensed during the fiscal year ended September 30, 2006. |
| For the Fiscal Year Ended September 30, 2006 |
64,400,510 Shares at Minimum of Offering Range |
75,765,306 Shares at Midpoint of Offering Range |
87,130,102 Shares at Maximum of Offering Range |
100,199,618 Shares at Adjusted Maximum of Offering Range |
||||||||||||
| (In thousands, except per share amounts) | ||||||||||||||||
| After-tax expense of contribution to charitable foundation |
$ | (31,157 | ) | $ | (35,750 | ) | $ | (35,750 | ) | $ | (35,750 | ) | ||||
| Pro forma net income |
14,761 | 10,850 | 11,587 | 12,434 | ||||||||||||
| Pro forma net income per share |
0.07 | 0.04 | 0.04 | 0.04 | ||||||||||||
The pro forma data assume that we will realize 100.0% of the income tax benefit as a result of the contribution to the charitable foundation based on a 35.0% tax rate. The realization of the tax benefit is limited annually to 10.0% of our annual taxable income. However, for federal and state tax purposes, we can carry forward any unused portion of the deduction for five years following the year in which the contribution is made.
(footnotes continued on following page)
50
Table of Contents
(continued from previous page)
| (7) | Shares considered outstanding in calculating historical and pro forma net income per share is calculated by taking total shares outstanding at each level of the offering range excluding shares held by the employee stock ownership plan and, in accordance with SOP 93-6, adding back employee stock ownership plan shares that are committed to be released, as follows: |
| For the Fiscal Year Ended September 30, 2006 |
64,400,510 Shares at Minimum of Offering Range |
75,765,306 Shares at Midpoint of Offering Range |
87,130,102 Shares at Maximum of Offering Range |
100,199,618 Shares at Adjusted Maximum of Offering Range |
||||||||
| Total shares outstanding |
214,668,367 | 252,500,000 | 289,625,000 | 332,318,750 | ||||||||
| Total shares held by employee stock ownership plan |
(8,414,999 | ) | (9,898,000 | ) | (11,353,300 | ) | (13,026,895 | ) | ||||
| Employee stock ownership plan shares committed to be released |
910,000 | 910,000 | 910,000 | 910,000 | ||||||||
| Shares considered outstanding in calculating historical and pro forma net income per share |
207,163,368 | 243,512,000 | 279,181,700 | 320,201,855 | ||||||||
| (8) | The retained earnings of Third Federal Savings and Loan will continue to be substantially restricted after the stock offering. See “Supervision and Regulation—Federal Banking Regulation.” |
51
Table of Contents
COMPARISON OF VALUATION AND PRO FORMA INFORMATION WITH AND WITHOUT THE CHARITABLE FOUNDATION
As reflected in the table below, if the charitable foundation is not established and funded as part of the stock offering, FinPro, Inc. estimates that our pro forma valuation would be greater and, as a result, a greater number of shares of common stock would be issued in the stock offering. At the minimum, midpoint, maximum and adjusted maximum of the valuation range, our pro forma valuation is $2.1 billion, $2.5 billion, $2.9 billion and $3.3 billion with the charitable foundation, as compared to $2.2 billion, $2.6 billion, $3.0 billion and $3.5 billion, respectively, without the charitable foundation. There is no assurance that in the event the charitable foundation were not formed, the appraisal prepared at that time would conclude that our pro forma market value would be the same as that estimated in the table below. Any appraisal prepared at that time would be based on the facts and circumstances existing at that time, including, among other things, market and economic conditions.
For comparative purposes only, set forth below are certain pricing ratios and financial data and ratios at and for the fiscal year ended September 30, 2006 at the minimum, midpoint, maximum and adjusted maximum of the offering range, assuming the stock offering was completed at September 30, 2006, with and without the charitable foundation.
| Minimum of Offering Range | Midpoint of Offering Range | Maximum of Offering Range | Adjusted Maximum of Offering Range |
|||||||||||||||||||||||||||||
| With Foundation |
Without Foundation |
With Foundation |
Without Foundation |
With Foundation |
Without Foundation |
With Foundation |
Without Foundation |
|||||||||||||||||||||||||
| (Dollars in thousands, except per share amounts) | ||||||||||||||||||||||||||||||||
| Estimated stock offering amount |
$ | 644,005 | $ | 668,100 | $ | 757,653 | $ | 786,000 | $ | 871,301 | $ | 903,900 | $ | 1,001,996 | $ | 1,039,485 | ||||||||||||||||
| Pro forma market capitalization of stock offering and charitable foundation |
686,939 | 668,100 | 807,653 | 786,000 | 921,301 | 903,900 | 1,051,996 | 1,039,485 | ||||||||||||||||||||||||
| Estimated full value |
2,146,684 | 2,227,000 | 2,525,000 | 2,620,000 | 2,896,250 | 3,013,000 | 3,323,188 | 3,464,950 | ||||||||||||||||||||||||
| Total assets |
9,124,733 | 9,132,193 | 9,217,967 | 9,226,318 | 9,309,141 | 9,320,442 | 9,413,992 | 9,428,687 | ||||||||||||||||||||||||
| Total liabilities |
7,582,973 | 7,582,973 | 7,582,973 | 7,582,973 | 7,582,973 | 7,582,973 | 7,582,973 | 7,582,973 | ||||||||||||||||||||||||
| Pro forma shareholders’ equity |
1,541,760 | 1,549,220 | 1,634,994 | 1,643,345 | 1,726,168 | 1,737,469 | 1,831,019 | 1,845,714 | ||||||||||||||||||||||||
| Pro forma net income |
45,918 | 46,222 | 46,600 | 46,925 | 47,337 | 47,628 | 48,184 | 48,437 | ||||||||||||||||||||||||
| Pro forma shareholders’ equity per share |
7.18 | 6.96 | 6.48 | 6.27 | 5.96 | 5.77 | 5.51 | 5.33 | ||||||||||||||||||||||||
| Pro forma net income per share |
0.22 | 0.22 | 0.19 | 0.19 | 0.17 | 0.16 | 0.15 | 0.15 | ||||||||||||||||||||||||
| Pro forma pricing ratios: |
||||||||||||||||||||||||||||||||
| Offering price as a percentage of pro forma shareholders’ equity per share |
139.28 | % | 143.68 | % | 154.32 | % | 159.49 | % | 167.79 | % | 173.31 | % | 181.49 | % | 187.62 | % | ||||||||||||||||
| Offering price to pro forma net income per share |
45.45x | 45.45x | 52.63x | 52.63x | 58.82x | 62.50x | 66.67x | 66.67x | ||||||||||||||||||||||||
| Pro forma financial ratios: |
||||||||||||||||||||||||||||||||
| Return on assets |
0.50 | % | 0.51 | % | 0.51 | % | 0.51 | % | 0.51 | % | 0.51 | % | 0.51 | % | 0.51 | % | ||||||||||||||||
| Return on equity |
2.98 | 2.98 | 2.85 | 2.86 | 2.74 | 2.74 | 2.63 | 2.62 | ||||||||||||||||||||||||
| Equity to assets |
16.90 | 16.96 | 17.74 | 17.81 | 18.54 | 18.64 | 19.45 | 19.58 | ||||||||||||||||||||||||
52
Table of Contents
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section is intended to help potential investors understand our financial performance through a discussion of the factors affecting our financial condition at September 30, 2006 and 2005 and our consolidated results of operations for the fiscal years ended September 30, 2006, 2005 and 2004. This section should be read in conjunction with the consolidated financial statements and notes to the financial statements that appear elsewhere in this prospectus.
Overview
Our business has traditionally focused on originating one- to four-family residential real estate mortgage loans, home equity loans and home equity lines of credit, and attracting retail deposits, in our primary market areas consisting of the States of Ohio and Florida. During the last several years, the operating environment for financial institutions, and particularly those that focus on originating longer-term mortgage loans, has been challenging. Short-term interest rates, which guide our pricing of deposits, have been rising while longer-term interest rates, which guide our pricing of loans, have been relatively constant. This “flattening” of the U.S. Treasury yield curve has negatively affected our net interest income. Specifically, our interest rate spread decreased to 2.01% for the fiscal year ended September 30, 2006 from 2.09% for the fiscal year ended September 30, 2005, and our net interest margin decreased to 2.37% for the fiscal year ended September 30, 2006 from 2.38% for the fiscal year ended September 30, 2005.
Our total loans receivable (including loans held for sale) decreased to $7.9 billion at September 30, 2006 from $8.3 billion at September 30, 2005. Although we continue to originate a significant amount of loans ($2.7 billion of mortgage loans for the fiscal year ended September 30, 2006), we sold $2.2 billion of long-term, fixed-rate loans during the fiscal year ended September 30, 2006, including $943.0 million of such sales during the quarter ended September 30, 2006. We sold these loans on a servicing-retained basis. We effected these sales in order to improve our interest rate risk position in the event of continued increases in short-term market interest rates. In addition, we were able to use a portion of the proceeds of the loan sales to reduce our Federal Home Loan Bank advances to $25.1 million at September 30, 2006 from $717.4 million at September 30, 2005. However, we incurred pre-tax losses of $47.1 million in connection with the sale of loans during the fiscal year ended September 30, 2006.
As part of our strategy of focusing on our traditional lines of business, we sold the loan origination platform of DeepGreen Bank in a two-step process in 2004. DeepGreen Bank was a subsidiary of TFS Financial Corporation that operated as an internet-only bank that originated home equity loans and lines of credit throughout the United States. Similarly, we spun-off Ohio Central Savings in March 2005. Ohio Central Savings was a subsidiary of TFS Financial Corporation that primarily originated automobile loans.
Deposits increased $346.8 million to $7.4 billion at September 30, 2006 from the previous fiscal year end. We have continued to emphasize high-yield checking accounts. These accounts reprice in a manner similar to our home equity loan products, and therefore assist us in managing our interest rate risk, and provide us with a stable source of funds. The increase in deposits is also attributable to our customers’ preference for shorter-term, higher interest paying deposit products such as NOW accounts and certificates of deposit in a rising interest rate environment.
Our net income decreased $21.0 million to $43.5 million for the fiscal year ended September 30, 2006, from $64.5 million for the fiscal year ended September 30, 2005. This decrease was caused by the losses incurred on the sale of loans, described above.
53
Table of Contents
Anticipated Increase in Non-Interest Expense
Following the completion of the stock offering, we anticipate that our non-interest expense will increase as a result of the increased costs associated with operating as a public company, increased compensation expenses associated with purchases of shares of common stock by our employee stock ownership plan, and the adoption of one or more stock-based benefit plans, if approved by our shareholders.
Assuming that 100,199,618 shares of common stock are sold in the stock offering (the adjusted maximum of the offering range):
| • | The employee stock ownership plan will acquire 13,026,895 shares of common stock with a $9.1 million contribution from Third Federal Savings and Loan that occurred during the quarter ended September 30, 2006 and with a $121.2 million loan that is expected to be repaid over 30 years, resulting in an average annual pre-tax expense of approximately $4.0 million (assuming that the common stock maintains a value of $10.00 per share). |
| • | The stock-based benefit plans would grant options to purchase shares equal to 4.90% of the total outstanding shares (including shares issued to Third Federal Savings and Loan Association of Cleveland, MHC and to Third Federal Foundation), or 16,283,618 shares, to eligible participants, which would result in compensation expense over the vesting period of the options. Assuming the market price of the common stock is $10.00 per share; the options are granted with an exercise price of $10.00 per share; the dividend yield on the stock is 0%; the expected option life is 7.5 years; the risk free interest rate is 4.56% (based on the seven-year Treasury rate) and the volatility rate on the shares of common stock is 16.34% (based on an index of publicly traded mutual holding companies), the estimated grant-date fair value of the options using a Black-Scholes option pricing analysis is $3.37 per option granted. Assuming this value is amortized over the five-year vesting period, the corresponding annual pre-tax expense associated with the stock options would be approximately $11.0 million. |
| • | The stock-based benefit plans would award a number of shares of common stock equal to 1.96% of the outstanding shares (including shares issued to Third Federal Savings and Loan Association of Cleveland, MHC and to Third Federal Foundation), or 6,513,447 shares, to eligible participants, which would be expensed as the awards vest. Assuming that all shares are awarded under the stock-based benefit plans at a price of $10.00 per share, and that the awards vest over a five-year period, the corresponding annual pre-tax expense associated with shares awarded under the stock-based benefit plans would be approximately $13.0 million. |
The actual expense that will be recorded for the employee stock ownership plan will be determined by the market value of our common stock as shares are released to employees over the term of the loan, and whether the loan is repaid faster than its contractual term. Accordingly, any increases in our stock price above $10.00 per share will increase the total employee stock ownership plan expense, and any accelerated repayment of the loan will increase the annual employee stock ownership plan expense. Further, the actual expense of the stock awards under the stock-based benefit plans will be determined by the fair market value of the common stock on the grant date, which may be greater than $10.00 per share, and the actual expense of stock options under the stock-based benefit plans will be based on the grant-date fair value of the options, which will be affected by a number of factors, including the market value of our common stock, the term and vesting period of the stock options, our dividend yield and other valuation assumptions contained in the option pricing model that we ultimately use.
The Office of Thrift Supervision has proposed amendments to its existing regulations regarding stock-based benefit plans that are intended to clarify and simplify such regulations. Specifically, the amendments would clarify that we may grant options and award shares of common stock under one or more stock-based benefit plans in excess of 4.90% and 1.96%, respectively, of our total outstanding shares if the stock-based benefit plans are adopted more than one year following the stock offering, provided shares of common stock used to fund the plans in excess of these amounts are obtained through stock repurchases. In the event the Office of Thrift Supervision adopts these regulations as proposed, or
54
Table of Contents
otherwise changes its existing regulations or policies regarding stock-based benefit plans, we may implement stock-based benefit plans that exceed the current limits applicable to the overall size of such plans, the relative amounts of stock options and stock awards and the individual awards thereunder, which would further increase our expenses associated with stock-based benefit plans.
Critical Accounting Policies
Critical accounting policies are defined as those that involve significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. We believe that the most critical accounting policies upon which our financial condition and results of operation depend, and which involve the most complex subjective decisions or assessments, are our policies with respect to our allowance for loan losses, intangible assets, mortgage servicing rights and income taxes.
Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. The amount of the allowance is based on significant estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. The methodology for determining the allowance for loan losses is considered a critical accounting policy by management due to the high degree of judgment involved, the subjectivity of the assumptions used and the potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses.
As a substantial percentage of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans are critical in determining the amount of the allowance required for specific loans. Assumptions are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly affect the valuation of a property securing a loan and the related allowance determined. Management carefully reviews the assumptions supporting such appraisals to determine that the resulting values reasonably reflect amounts realizable on the related loans.
Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. We consider a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates by management that may be susceptible to significant change based on changes in economic and real estate market conditions.
The evaluation has a specific and general component. The specific component relates to loans that are delinquent or otherwise identified as a problem loan through the application of our loan review process and our loan grading system. All such loans are evaluated individually, with principal consideration given to the value of the collateral securing the loan. Specific allowances are established as required by this analysis. The general component is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We also analyze historical loss experience, delinquency trends, general economic conditions and geographic concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general component of the allowance for loan losses.
Actual loan losses may be significantly more than the allowances we have established which could have a material negative effect on our financial results.
Intangible Assets. Acquisitions accounted for under purchase accounting must follow SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 requires us to record as assets on our financial statements both goodwill, an intangible asset which is equal to the excess of the purchase price which we pay for another company over the estimated fair value of the net assets acquired, and identifiable intangible assets such as core deposit intangibles and non-compete agreements. Under SFAS No. 142, we regularly evaluate goodwill for impairment, and we will reduce its carrying value through a charge
55
Table of Contents
to earnings if impairment exists. Core deposit and other identifiable intangible assets are amortized to expense over their estimated useful lives and are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The valuation techniques used by us to determine the carrying value of tangible and intangible assets acquired in acquisitions and the estimated lives of identifiable intangible assets involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based on changes in economic conditions and other factors. Future events or changes in the estimates that we used to determine the carrying value of our goodwill and identifiable intangible assets or which otherwise adversely affect their value or estimated lives could have a material adverse impact on our results of operations. As of September 30, 2006, our intangible assets consisted of goodwill of $9.7 million.
Mortgage Servicing Rights. Mortgage servicing rights represent the present value of the future servicing fees from the right to service loans in our loan servicing portfolio. Mortgage servicing rights are recognized as assets for both purchased rights and for the allocation value of retained servicing rights on loans sold. The most critical accounting policy associated with mortgage servicing is the methodology used to determine the fair value of capitalized mortgage servicing rights, which requires a number of estimates, the most critical of which is the mortgage loan prepayment speed assumption. The mortgage loan prepayment speed assumption is significantly affected by interest rates. In general, during periods of falling interest rates, mortgage loans prepay faster and the value of our mortgage servicing assets decreases. Conversely, during periods of rising rates, the value of mortgage servicing rights generally increases due to slower rates of prepayments. The amount and timing of mortgage servicing rights amortization is adjusted monthly based on actual results. In addition, on a quarterly basis, we perform a valuation review of mortgage servicing rights for potential decreases in value. This quarterly valuation review entails applying current assumptions to the portfolio classified by interest rates and, secondarily, by prepayment characteristics.
Key economic assumptions and the sensitivity of the current fair value of mortgage loan servicing assets to immediate 10% and 20% adverse changes in those assumptions are as follows:
| At September 30, 2006 |
||||
| (Dollars in thousands) | ||||
| Fair value of mortgage loan servicing assets |
$ | 61,177 | ||
| Prepayment speed assumptions (weighted average annual rate) |
16.3 | % | ||
| Impact on fair value of 10% adverse change |
$ | (1,768 | ) | |
| Impact on fair value of 20% adverse change |
$ | (3,527 | ) | |
| Discount rate |
12.0 | % | ||
| Impact on fair value of 10% adverse change |
$ | (1,721 | ) | |
| Impact on fair value of 20% adverse change |
$ | (3,444 | ) | |
These sensitivities are hypothetical and should be used with caution. As indicated in the table above, changes in fair value based on a 10% variation in assumptions generally cannot be extrapolated because the relationship in the change in assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which could magnify or counteract the sensitivities.
Income Taxes. We consider accounting for income taxes a critical accounting policy due to the subjective nature of certain estimates that are involved in the calculation. We use the asset/liability method of accounting for income taxes in which deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. We must assess the realization of the deferred tax asset and, to the extent that we believe that recovery is not likely, a valuation allowance is established. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to
56
Table of Contents
income tax expense. No valuation allowances were required at September 30, 2006. Although we have determined a valuation allowance is not required for any deferred tax assets, there is no guarantee that these assets will be recognizable in the future.
Pension and Other Postretirement Benefits. The determination of our obligations and expense for pension and other postretirement benefits is dependent upon certain assumptions used in calculating such amounts. Key assumptions used in the actuarial valuations include the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation. Actual results could differ from the assumptions and market driven rates may fluctuate. Significant differences in actual experience or significant changes in the assumptions could materially affect future pension and other postretirement obligations and expense.
Business Strategy
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.
Highlights of our business strategy are as follows:
| • | Following our mission of creating value for our customers, our communities and our company. Since being organized in 1938, we have grown to become 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, as well as our Home Today program, as described below. Our values are further reflected in the Broadway Redevelopment Initiative (a long-term revitalization program encompassing the three-mile corridor of the Broadway-Slavic Village neighborhood in Cleveland, Ohio where our main office is located) and the education programs we have established and/or supported. We intend to continue to support our customers and our communities following the completion of the stock offering. |
| • | Encouraging home ownership by offering competitive interest rates and attractive product features on mortgage loans and home equity loans and lines of credit in our primary market areas. More than 85% of our assets consist of one- to four-family residential real estate loans and home equity loans and lines of credit, the overwhelming majority of which were originated to borrowers in the States of Ohio and Florida. We have increased these assets by offering competitive interest rates and product features to customers in our marketplace. Part of this strategy involves programs such as our Lowest Rate Guarantee program (in which we will offer a better interest rate than a competitor’s interest rate for certain types of loans or give the loan applicant cash after they close a loan at a lower interest rate) and our Home Today program (where we provide our standard interest rates and flexible credit terms to borrowers who would not normally qualify for such loans). We also offer loan products and features such as high loan-to-value loans (up to 97%) that do not require private mortgage insurance, and adjustable-rate mortgage loans that can convert to fixed-rate loans at no cost to the borrower. See “Business of Third Federal Savings and Loan Association of Cleveland—Lending Activities—One- to Four-Family Residential Real Estate Mortgage Lending” and “—Home Equity Loans and Home Equity Lines of Credit” for a more extensive description of these loan products. |
| • | Promoting savings by our customers by offering competitive rates on certificates of deposit and other deposit products. Historically, we have tried to provide our customers with attractive rates of return on our deposit products. Our deposit products typically offer rates that are competitive with the rates on similar products offered by other financial institutions. We intend to continue this practice following the stock offering. Our high-yield checking accounts, which represented 20.4% of our total deposits as of September 30, 2006, have provided us with funds that reprice in a manner similar to our home equity lines of credit, which has assisted us in managing interest rate risk. |
57
Table of Contents
| • | Controlling and managing operating expenses. Our ratio of non-interest expense to average assets was 1.41% for the fiscal year ended September 30, 2006, which is significantly lower than the average for our peer group. For the fiscal year ended September 30, 2006, our average assets per full-time employee and our average deposits per full-time employee were $9.7 million and $8.0 million, respectively, each of which is significantly higher than the averages for our peer group. Our average deposits held at our branch offices (an average of $185.0 million per branch office as of September 30, 2006) contribute to our expense management efforts by limiting the overhead costs of serving our deposit customers. We will continue our efforts to control operating expenses as we use the capital we raise in the stock offering to grow our business. |
| • | Growing through de novo branching. We anticipate using part of the net proceeds of the stock offering to finance the expansion of our branch network. Our future efforts to expand will focus primarily on eliminating gaps in our current market areas, most likely in the State of Florida. However, we have not established a timetable for expanding our branch network, nor have we determined the specific locations where we will focus our expansion efforts. |
Comparison of Financial Condition at September 30, 2006 and 2005
Total assets decreased $318.3 million, or 3.6%, to $8.6 billion at September 30, 2006 from $8.9 billion at September 30, 2005. The decrease was primarily the result of a decrease in loans, partially offset by an increase in cash and cash equivalents. We sold $2.2 billion of loans during the fiscal year ended September 30, 2006 in an effort to improve our interest rate risk position.
Cash and cash equivalents (cash and due from banks, federal funds sold and interest-bearing deposits) increased $132.6 million, or 110.2%, to $252.9 million at September 30, 2006 from $120.3 million at September 30, 2005. As described below, we sold $943.0 million of loans in the quarter ended September 30, 2006, and the increase in cash and cash equivalents represents the proceeds of these loan sales that were not used to repay Federal Home Loan Bank advances.
Total securities (investment securities and mortgage-backed securities) decreased $56.8 million, or 30.3%, to $131.0 million at September 30, 2006 from $187.8 million at September 30, 2005. We used the proceeds from maturing securities and principal repayments and prepayments on securities to repay Federal Home Loan Bank advances and to fund loan originations.
Total loans receivable (including loans held for sale) decreased $411.5 million, or 4.9%, to $7.9 billion at September 30, 2006 from $8.3 billion at September 30, 2005. Loans held for sale decreased $227.5 million, or 41.9%, to $315.0 million at September 30, 2006 from $542.5 million at September 30, 2005. Loans held for investment decreased $183.9 million, or 2.4%, to $7.6 billion at September 30, 2006 from $7.8 billion at September 30, 2005. Although we originated $2.7 billion of loans during the fiscal year ended September 30, 2006, we sold $2.2 billion of loans during the fiscal year, including $943.0 million of such sales during the quarter ended September 30, 2006. All of the loans sold during the quarter ended September 30, 2006, were long-term, fixed-rate loans. We effected these sales to improve our interest rate risk position in the event of continued increases in market interest rates.
Home equity loans and home equity lines of credit decreased $161.7 million, or 8.2%, to $1.8 billion at September 30, 2006 from $2.0 billion at September 30, 2005. The decrease was primarily the result of our sale of DeepGreen Bank’s loan origination platform in February 2004, and increases in market interest rates that both reduced Third Federal Savings and Loan’s originations of home equity loans and home equity lines of credit and increased repayments of this lending product. DeepGreen Bank focused on originating home equity loans and home equity lines of credit throughout the United States.
Construction loans decreased $62.5 million, or 23.1%, to $207.6 million at September 30, 2006 from $270.1 million at September 30, 2005. We believe the decrease resulted from a reduction in construction activity in our market areas, which reduced the demand for construction loans.
58
Table of Contents
Deposits increased $346.8 million, or 4.9%, to $7.4 billion at September 30, 2006 from $7.1 billion at September 30, 2005. NOW accounts (including high-yield checking accounts) increased $307.9 million, or 23.8%, to $1.6 billion at September 30, 2006 from $1.3 billion at September 30, 2005. Certificates of deposit increased $129.2 million, or 2.4%, to $5.5 billion at September 30, 2006 from $5.3 billion at September 30, 2005. Passbook savings accounts decreased $91.4 million, or 21.4%, to $335.9 million at September 30, 2006 from $427.3 million at September 30, 2005. The shift from savings accounts to certificates of deposit and NOW accounts reflected our customers seeking higher interest-paying deposit products during a period of rising market interest rates. The increase in NOW accounts demonstrated our continued focus on opening high-yield checking accounts, as well as higher interest rates paid on this product in connection with increases in market interest rates. High-yield checking accounts increased $350.1 million, or 30.2%, to $1.5 billion at September 30, 2006 from $1.2 billion at September 30, 2005. We have focused on promoting this type of deposit product since we believe it provides a stable source of funds. In addition, our high-yield checking accounts reprice in a manner similar to our equity loan products, and therefore assist us in managing interest rate risk.
Federal Home Loan Bank advances decreased $692.3 million, or 96.5%, to $25.1 million at September 30, 2006 from $717.4 million at September 30, 2005. We used a portion of the proceeds from loan sales during the fiscal year ended September 30, 2006 to repay nearly all of our outstanding Federal Home Loan Bank advances, without any prepayment penalties.
Shareholder’s equity increased $38.7 million, or 4.0%, to $1.0 billion at September 30, 2006 from $973.9 million at September 30, 2005. The increase resulted from net income of $43.5 million, which was partially offset by a $4.8 million increase in other comprehensive loss.
Comparison of Operating Results for the Fiscal Years Ended September 30, 2006 and 2005
General. Net income decreased $21.0 million, or 32.5%, to $43.5 million for the fiscal year ended September 30, 2006 from $64.5 million for the fiscal year ended September 30, 2005. The decrease was caused by losses incurred on the sale of loans.
Interest Income. Interest income increased $67.0 million, or 16.0%, to $485.8 million for the fiscal year ended September 30, 2006 from $418.8 million for the fiscal year ended September 30, 2005. The increase in interest income resulted from an increase in interest income on loans.
Interest and fee income on loans increased $70.4 million, or 17.4%, to $474.1 million for the fiscal year ended September 30, 2006 from $403.7 million for the fiscal year ended September 30, 2005. The increase resulted from increases in both the average balance of our loan portfolio as well as an increase in the average yield we earned on loans. The average balance of loans increased $445.4 million, or 5.9%, to $8.1 billion for the fiscal year ended September 30, 2006 from $7.6 billion for the fiscal year ended September 30, 2005, reflecting our continued efforts to grow our loan portfolio. The average yield on our loan portfolio increased 58 basis points to 5.88% for the fiscal year ended September 30, 2006 from 5.30% for the fiscal year ended September 30, 2005, primarily as a result of increases in the interest rates on adjustable-rate loans and as we increased rates on newly-originated loans in response to increases in market interest rates.
Interest Expense. Interest expense increased $61.5 million, or 27.0%, to $289.1 million for the fiscal year ended September 30, 2006 from $227.6 million for the fiscal year ended September 30, 2005. The increase in interest expense resulted from increases in interest expense on certificates of deposit, NOW accounts and Federal Home Loan Bank advances.
Interest expense on certificates of deposit increased $27.6 million, or 14.4%, to $219.6 million for the fiscal year ended September 30, 2006 from $192.0 million for the fiscal year ended September 30, 2005. The increase was caused primarily by a 51 basis point increase in the rate we paid on certificates of deposit to 4.10% for the fiscal year ended September 30, 2006 from 3.59% for the fiscal year ended September 30, 2005. We increased
59
Table of Contents
rates on deposits in response to increases in market interest rates. The average balance of certificates of deposit increased slightly, by $11.9 million, or less than 1%, to $5.36 billion for the fiscal year ended September 30, 2006 from $5.35 billion for the fiscal year ended September 30, 2005.
Interest expense on NOW accounts increased $26.0 million, or 100.0%, to $52.1 million for the fiscal year ended September 30, 2006 from $26.0 million for the fiscal year ended September 30, 2005. The increase was caused by a 152 basis point increase in the rate we paid on NOW accounts to 3.55% for the fiscal year ended September 30, 2006 from 2.03% for the fiscal year ended September 30, 2005. We increased rates on deposits in response to increases in market interest rates. In addition, the average balance of NOW accounts increased $182.4 million, or 14.2%, to $1.5 billion for the fiscal year ended September 30, 2006 from $1.3 billion for the fiscal year ended September 30, 2005. The increase in NOW accounts reflects our customers seeking higher interest-paying deposit products during a period of rising market interest rates. The increase also reflects our continued focus on high-yield checking accounts, since we believe this type of deposit reprices in a manner similar to our equity loan products, and therefore assist us in managing interest rate risk.
Interest expense on Federal Home Loan Bank advances increased $8.7 million, or 163.7%, to $13.9 million for the fiscal year ended September 30, 2006 from $5.3 million for the fiscal year ended September 30, 2005. The increase was caused by an increase in our average balance of Federal Home Loan Bank advances. The average balance increased $157.4 million to $341.8 million for the fiscal year ended September 30, 2006 from $184.4 million for the fiscal year ended September 30, 2005. At various points during the fiscal year ended September 30, 2006, we increased our Federal Home Loan Bank advances to fund loan originations. However, throughout the fiscal year ended September 30, 2006, we repaid nearly all of our Federal Home Loan Bank advances, without incurring prepayment penalties, with a portion of the proceeds of the sale of $2.2 billion of loans during the fiscal year.
Net Interest Income. Net interest income increased by $5.5 million, or 2.9%, to $196.7 million for the fiscal year ended September 30, 2006 from $191.1 million for the fiscal year ended September 30, 2005. The increase resulted solely from an increase in average net interest-earning assets ($18.7 million, or 2.5%), as our interest rate spread decreased eight basis points to 2.01% for the fiscal year ended September 30, 2006 from 2.09% for the fiscal year ended September 30, 2005, and our net interest margin decreased one basis point to 2.37% for the fiscal year ended September 30, 2006 from 2.38% for the fiscal year ended September 30, 2005. The decrease in our interest rate spread and net interest margin are consistent with the continued flattening of the U.S. Treasury yield curve. From June 30, 2004 to September 30, 2006, the Federal Reserve Board has increased its target for the federal funds rate from 1.0% to 5.25%. While these short-term market interest rates (which we use as a guide to price our deposits) have increased, longer-term market interest rates (which we use as a guide to price our longer-term loans) have not increased to the same degree. If rates on our deposits and borrowings continue to reprice upwards faster than the rates on our long-term loans and investments, we would experience further compression of our interest rate spread and net interest margin, which would have a negative effect on our profitability.
Provision for Loan Losses. We establish provisions for loan losses, which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan and the levels of nonperforming and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses on a quarterly basis and make provisions for loan losses in order to maintain the allowance.
Based on our evaluation of the above factors, we recorded a provision for loan losses of $6.1 million for the fiscal year ended September 30, 2006 and a provision for loan losses of $6.0 million for the fiscal year ended
60
Table of Contents
September 30, 2005. The provisions recorded reflected net chargeoffs of $3.9 million and $2.3 million for the fiscal years ended September 30, 2006 and 2005, respectively, as well as a reduction in the allowance of $193,000 for the fiscal year ended September 30, 2005, resulting from the spin-off of our subsidiary, Ohio Central Savings, in March 2005. The allowance for loans losses was $20.7 million, or 0.27% of total loans receivable at September 30, 2006, compared to $18.6 million, or 0.24% of total loans receivable at September 30, 2005. We increased the allowance for loan losses to reflect an increase in non-performing loans from September 30, 2005 to September 30, 2006. Nonperforming loans increased by $18.6 million to $79.7 million, or 1.05% of total loans, at September 30, 2006 from $61.1 million, or 0.78% of total loans, at September 30, 2005. The increase in nonperforming loans occurred primarily in our one- to four-family residential real estate mortgage loan portfolio, and specifically a $14.4 million increase in non-performing loans originated through our Home Today program, which was established in 2000. See “Business of Third Federal Savings and Loan Association of Cleveland—Non-Performing Assets” and “—Delinquent Loans” for a discussion of the asset quality of this portion of our loan portfolio. We had one impaired loan with a principal balance of $2.3 million and $2.4 million at September 30, 2006 and 2005, respectively. We used the same general methodology in assessing the allowance for both fiscal years. To the best of our knowledge, we have recorded all losses that are both probable and reasonable to estimate for the fiscal years ended September 30, 2006 and 2005.
Non-interest Income (Loss). Non-interest income (loss) decreased $41.5 million to a loss of $6.4 million for the fiscal year ended September 30, 2006 from income of $35.1 million for the fiscal year ended September 30, 2005. The loss was caused entirely by losses of $47.1 million on loan sales for the fiscal year ended September 30, 2006, compared to $1.5 million of such losses for the fiscal year ended September 30, 2005. We sold $2.2 billion of loans during the fiscal year ended September 30, 2006, including $943.0 million of such sales during the quarter ended September 30, 2006. We sold $1.3 billion of loans during the fiscal year ended September 30, 2005. Fees and service charges increased $4.2 million, or 22.7%, to $22.6 million for the fiscal year ended September 30, 2006 from $18.4 million for the fiscal year ended September 30, 2005, reflecting increases in loan originations and in customer deposit accounts.
Non-Interest Expense. Non-interest expense decreased $693,000, or 0.6%, to $122.5 million for the fiscal year ended September 30, 2006 from $123.2 million for the fiscal year ended September 30, 2005. Salaries and employee benefits decreased $2.8 million, or 3.9%, to $68.4 million for the fiscal year ended September 30, 2006 from $71.1 million for the fiscal year ended September 30, 2005. Our continued efforts to provide operating efficiencies through our employee base decreased this expense item despite our recognizing benefits expense of $6.8 million (pre-tax) for the fiscal year ended September 30, 2006 as a result of funding our employee stock ownership plan with a $9.1 million contribution. Marketing services increased $4.4 million, or 66.8%, to $10.9 million for the fiscal year ended September 30, 2006 from $6.6 million for the fiscal year ended September 30, 2005. We increased our marketing efforts during the fiscal year ended September 30, 2006 in an effort to continue to grow our customer base.
Income Tax Expense. The provision for income taxes was $18.2 million for the fiscal year ended September 30, 2006, compared to $32.5 million for the fiscal year ended September 30, 2005, reflecting a decrease in pre-tax income between the fiscal years. Our effective tax rate was 29.4% for the fiscal year ended September 30, 2006 compared to 33.5% for the fiscal year ended September 30, 2005. Our effective tax rate is below the combined state and federal statutory rate because of our ownership of bank-owned life insurance.
Comparison of Operating Results for the Fiscal Years Ended September 30, 2005 and 2004
General. Net income increased $9.0 million, or 16.3%, to $64.5 million for the fiscal year ended September 30, 2005 from $55.5 million for the fiscal year ended September 30, 2004. An increase in interest income and a decrease in non-interest expense were partially offset by a decrease in non-interest income.
Interest Income. Interest income increased $22.9 million, or 5.8%, to $418.8 million for the fiscal year ended September 30, 2005 from $395.9 million for the fiscal year ended September 30, 2004. The increase in interest income resulted from an increase in interest income on loans.
61
Table of Contents
Interest and fee income on loans increased $27.8 million, or 7.4%, to $403.7 million for the fiscal year ended September 30, 2005 from $375.9 million for the fiscal year ended September 30, 2004. The increase resulted from increases in both the average balance of our loan portfolio as well as an increase in the average yield we earned on loans. The average balance of loans increased $186.6 million, or 2.5%, to $7.6 billion for the fiscal year ended September 30, 2005 from $7.4 billion for the fiscal year ended September 30, 2004. The average yield on our loan portfolio increased 24 basis points to 5.30% for the fiscal year ended September 30, 2005 from 5.06% for the fiscal year ended September 30, 2004, as we increased rates on newly-originated loans in response to increases in market interest rates.
Interest income on securities (investment securities and mortgage-backed securities) decreased $5.9 million, or 35.9%, to $10.5 million for the fiscal year ended September 30, 2005 from $16.4 million for the fiscal year ended September 30, 2004. The decrease in interest income on securities was caused by a significant decrease in the average balance of our securities portfolio. The average balance of investment securities decreased $124.8 million, or 57.7%, to $91.3 million for the fiscal year ended September 30, 2005 from $216.1 million for the fiscal year ended September 30, 2004, and the average balance of mortgage-backed securities decreased $85.1 million, or 31.8%, to $182.8 million for the fiscal year ended September 30, 2005 from $267.9 million for the fiscal year ended September 30, 2004. We generally used the proceeds from the repayments and prepayments of investment and mortgage-backed securities during the fiscal year ended September 30, 2005 to fund loan originations and deposit withdrawals, as we purchased no securities during the fiscal year ended September 30, 2005.
Interest Expense. Interest expense increased $1.4 million, or 0.6%, to $227.6 million for the fiscal year ended September 30, 2005 from $226.2 million for the fiscal year ended September 30, 2004. The increase in interest expense resulted from an increase in interest expense on NOW accounts, partially offset by a decrease in interest expense on certificates of deposit.
Interest expense on NOW accounts increased $5.0 million, or 23.9%, to $26.0 million for the fiscal year ended September 30, 2005 from $21.0 million for the fiscal year ended September 30, 2004. The increase was caused by a 46 basis point increase in the interest rates we paid on NOW accounts to 2.03% for the fiscal year ended September 30, 2005 from 1.57% for the fiscal year ended September 30, 2004, which offset a $55.4 million decrease in average balance of NOW accounts to $1.28 billion for the fiscal year ended September 30, 2005 from $1.34 billion for the fiscal year ended September 30, 2004. We increased rates on our NOW accounts in response to increases in market interest rates.
Interest expense on certificates of deposit decreased $3.8 million, or 1.9%, to $192.0 million for the fiscal year ended September 30, 2005 from $195.8 million for the fiscal year ended September 30, 2004. The decrease resulted from a six basis points decrease in the average rate we paid on certificates of deposit to 3.59% for the fiscal year ended September 30, 2005 compared to 3.65% for the fiscal year ended September 30, 2004, and a decrease in the average balance of certificates of deposit to $5.35 billion for the fiscal year ended September 30, 2005 from $5.37 billion for the fiscal year ended September 30, 2004. Despite increases in market interest rates, the rate we paid on certificates of deposit decreased because some long-term, high yielding certificates of deposit (with interest rates as high as 12.0%) matured during the fiscal year ended September 30, 2004 and, if renewed, were renewed at significantly lower interest rates.
Net Interest Income. Net interest income increased by $21.5 million, or 12.6%, to $191.1 million for the fiscal year ended September 30, 2005 from $169.7 million for the fiscal year ended September 30, 2004. The increase resulted from an increase in our net interest-earning assets and from an improvement in our interest rate spread and our net interest margin. Our interest rate spread increased 27 basis points to 2.09% for the fiscal year ended September 30, 2005 from 1.82% for the fiscal year ended September 30, 2004, and our net interest margin increased 28 basis points to 2.38% for the fiscal year ended September 30, 2005 from 2.10% for the fiscal year ended September 30, 2004. In addition, our net interest-earning assets increased $27.4 million, or 3.8%, to $744.9 million for the fiscal year ended September 30, 2005 from $717.5 million for the fiscal year ended September 30, 2004.
62
Table of Contents
Provision for Loan Losses. We recorded a provision for loan losses of $6.0 million for the fiscal year ended September 30, 2005 and a provision for loan losses of $5.5 million for the fiscal year ended September 30, 2004. The provisions recorded reflected net chargeoffs of $2.3 million and $2.1 million for the fiscal years ended September 30, 2005 and 2004, respectively, as well as a reduction to the allowance of $193,000 for the fiscal year ended September 30, 2005, resulting from the spin-off of our subsidiary, Ohio Central Savings, in March 2005. The allowance for loans losses was $18.6 million, or 0.24% of total loans receivable at September 30, 2005, compared to $15.1 million, or 0.20% of total loans receivable at September 30, 2004. We increased the allowance for loan losses to reflect an increase in non-performing loans from September 30, 2004 to September 30, 2005. Nonperforming loans increased by $22.8 million to $61.1 million, or 0.78% of total loans, at September 30, 2005 from $38.3 million, or 0.52% of total loans, at September 30, 2004. The increase in nonperforming loans occurred primarily in our one- to four-family residential real estate mortgage loan portfolio, and specifically a $16.4 million increase in non-performing loans originated through our Home Today program, which was established in 2000. See “Business of Third Federal Savings and Loan Association of Cleveland—Non-Performing Assets” and “—Delinquent Loans” for a discussion of the asset quality of this portion of our loan portfolio. We had one impaired loan with a principal balance of $2.4 million at September 30, 2005 and 2004, respectively. We used the same general methodology in assessing the allowance for both fiscal years. To the best of our knowledge, we have recorded all losses that are both probable and reasonable to estimate for the fiscal years ended September 30, 2005 and 2004.
Non-interest Income. Non-interest income decreased $16.1 million, or 31.4%, to $35.1 million for the fiscal year ended September 30, 2005 from $51.1 million for the fiscal year ended September 30, 2004. We recognized a $12.2 million gain when we sold DeepGreen Bank’s loan origination platform in 2004. There was no similar gain during the fiscal year ended September 30, 2005. In addition, we recognized losses of $1.5 million on loan sales for the fiscal year ended September 30, 2005, compared to $7.1 million of gains for the fiscal year ended September 30, 2004. We sold $1.3 billion of loans during the fiscal year ended September 30, 2005, compared to $1.4 billion of such sales during the fiscal year ended September 30, 2004.
Non-Interest Expense. Non-interest expense decreased $10.3 million, or 7.7%, to $123.2 million for the fiscal year ended September 30, 2005 from $133.5 million for the fiscal year ended September 30, 2004. The decrease resulted from the sale of DeepGreen Bank’s loan origination platform in February 2004, as we incurred $9.2 million of non-interest expense in operating DeepGreen Bank during the fiscal year ended September 30, 2004, compared to no such expense for the fiscal year ended September 30, 2005.
Income Tax Expense. The provision for income taxes was $32.5 million for the fiscal year ended September 30, 2005, compared to $26.3 million for the fiscal year ended September 30, 2004, reflecting an increase in pre-tax income between the fiscal years. Our effective tax rate was 33.5% for the fiscal year ended September 30, 2005 compared to 32.2% for the fiscal year ended September 30, 2004. Our effective tax rate is below the combined state and federal statutory rate because of our ownership of bank-owned life insurance.
Average balances and yields. The following table sets forth average balance sheets, average yields and costs, and certain other information at and for the fiscal years indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are monthly average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or interest expense.
63
Table of Contents
| At September 30, 2006 |
For the Fiscal Years Ended September 30, | |||||||||||||||||||||||||||||||||||
| 2006 | 2005 | 2004 | ||||||||||||||||||||||||||||||||||
| Average Balance |
Interest Expense |
Yield/ Cost |
Average Balance |
Interest Expense |
Yield/ Cost |
Average Balance |
Interest Expense |
Yield/ Cost |
||||||||||||||||||||||||||||
| Yield/ Cost |
||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||||||||||||||
| Interest-earning assets: |
||||||||||||||||||||||||||||||||||||
| Cash and due from banks |
1.93 | % | $ | 21,149 | $ | 245 | 1.16 | % | $ | 17,569 | $ | 103 | 0.59 | % | $ | 21,989 | $ | 135 | 0.61 | % | ||||||||||||||||
| Federal funds sold |
5.34 | % | 11,064 | 579 | 5.23 | % | 57,807 | 1,289 | 2.23 | % | 77,946 | 787 | 1.01 | % | ||||||||||||||||||||||
| Investment securities |
3.55 | % | 40,370 | 1,516 | 3.76 | % | 91,335 | 2,554 | 2.80 | % | 216,117 | 5,560 | 2.57 | % | ||||||||||||||||||||||
| Mortgage-backed securities |
5.00 | % | 112,543 | 5,306 | 4.71 | % | 182,803 | 7,975 | 4.36 | % | 267,927 | 10,854 | 4.05 | % | ||||||||||||||||||||||
| Loans |
6.05 | % | 8,056,105 | 474,100 | 5.88 | % | 7,610,658 | 403,717 | 5.30 | % | 7,424,084 | 375,916 | 5.06 | % | ||||||||||||||||||||||
| Federal Home Loan Bank stock |
5.75 | % | 70,739 | 4,058 | 5.74 | % | 67,516 | 3,119 | 4.62 | % | ||||||||||||||||||||||||||