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Pulaski Financial Corp. (NASDAQ:PULB)

F4Q08 (Qtr End 09/30/08) Earnings Call Transcript

October 22, 2008 11:00 am ET

Executives

Ramsey Hamadi- CFO

Gary Douglass - President & CEO

Analysts

Joe Stieven - Stieven Capital

David Schick - Stifel Nicolaus

Daniel Cardenas - Howe Barnes

Operator

Greetings, and welcome to the Pulaski Financial Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Ramsey Hamadi, Chief Financial Officer of Pulaski Financial, who will read the Safe Harbor statement. Thank you, Mr. Hamadi. You may begin.

Ramsey Hamadi

Thank you and good morning. Following the Safe Harbor I will turn the call over to Chief Executive Officer, Gary Douglass. This conference call may contain forward-looking statements about Pulaski Financial Corp, which the Company intends to be covered under the Safe Harbor provisions contained in the Private Securities Litigation Reform Act of 1995. Statements that are not historical or current facts include statements about beliefs and expectations are forward-looking statements.

For discussions of risks that may cause actual results to differ from expectations expressed in forward-looking statements refer to our Annual Report on Form 10-K for the year ended September 30, 2007, on file with the SEC including the sections entitled risk factors.

Forward-looking statements speak only as of the date they are made and the Company undertakes no obligations to update them in light of new information or future events.

With that, I will turn the call over to Mr. Douglass.

Gary Douglass

Well, thanks, Ramsey. Good morning and thanks to everyone for taking time from your schedules to join us today. As is customary, I have a brief set of prepared remarks after which we will open the lines for questions and comments.

Considering the unprecedented environment that we operated in for the year, including the substantial worsening of that environment in our September 30 quarter, I am actually quite proud of our entire Pulaski team and pleased with our core operating performance for the full year.

Despite dramatic challenges in our industry and our economy, Pulaski remains a true community bank serving St. Louis. We continue to make quality loans to our business and mortgage customers while providing a safe home for our customers' deposits.

Despite two large charges to earnings, one, the fourth-quarter loss in the sale of our Fannie Mae preferred securities, and two, the third quarter separation payments related to the resignation of our former CEO, which in total negatively impacted net earnings by $0.60 per share. And the doubling of our provision for loan losses, which is indicative of the difficult operating environment.

We still reported net earnings of $0.28 per share for fiscal 2008. This performance resulted from a strong growth in revenues driven by expansion in our net interest income, mortgage revenues, and retail banking fees. In addition, we maintained our well-capitalized regulatory status. The difficult operating environment notwithstanding, we saw a strong performance in all three of our major business lines.

During the year our core deposits grew 35%, our commercial loan portfolio grew 43%, and we originated $1.5 billion of mortgage loans. Our loan growth was achieved under continually tighter credit standards and our core deposit growth was achieved without paying the inflated deposit rates being offered by many banks in our market area in an effort to bolster their liquidity. Instead, we were able to grow our core deposits by offering convenient products at reasonable rates and by capitalizing on our strong reputation and high level of customer service.

As I stated on last quarter's call, I truly believe we have benefited from a flight to quality by many existing and new customers in this challenging operating environment. However, our September quarter, even after excluding the realized losses on the sale of our Fannie Mae securities, did not meet our expectations. The miss was principally caused by increased credit related cost, which is consistent with that being experienced by numerous other banks in our market and across the country, and resulting from the ongoing impact on our borrowers of a worsening economic climate during the quarter.

I would like to point out that the overall results for the quarter are somewhat masked so that the overall results for the quarter somewhat mask positive loan and deposit growth trends as we posted linked quarter loan growth of approximately 3% and linked quarter core deposit growth of approximately 10%.

With that as a brief overview of our performance for the year and the quarter. Let me take a few moments to discuss in a bit more detail our net interest income, net interest margin, non-interest income, and asset quality before concluding with our outlook for fiscal 2009.

Net interest income rose 14% for the quarter and 22% for the year compared to the comparable periods of fiscal 2007. This performance was driven by strong growth in both average balances of loans, principally commercial loans, and in core deposits which helped us reduce our overall cost of funds on a year-over-year basis from 4.72% to 2.99%.

Our net interest margin of 3.04% for the September 2008 quarter was comparable to that of the September 2007 quarter, but did decline 19 basis points from the June 2008 quarter. This decline was due to a reduction in the yield on average interest earning assets caused primarily by a rise in non-accruing loans during the September 2008 quarter and a loss of dividend income resulting from the sale of our Fannie Mae preferred stock.

As to non-interest income, continued growth in mortgage revenues in an extremely challenging market bolstered our non-interest income. Mortgage revenues, which are our largest element of non-interest income, increased to 105% quarter-over-quarter and 24% year-over-year.

The fourth-quarter performance is especially significant given that we experienced a 14% reduction in loan sales activity in the quarter as a result of weaken loan demand caused by an overall shrinkage in the number of qualified creditworthy borrowers in the market.

However, we were able to overcome the lower overall demand by getting more than our fair share of the remaining qualified borrowers due to our strong reputation in the marketplace.

In addition, we realized significantly higher margins due to a change in product mix to more profitable FHA loans and by our diligent focus on cost and efficiency. Retail banking fees, the second largest component of our non-interest income, increased 3% for the quarter and 16% for the year driven principally by continued growth in retail checking accounts.

Moving on to asset quality, maintaining manageable asset quality in the midst of the current environment continues to be one of our top priorities. Last quarter on our call in an attempt to provide you with a perspective on the asset quality of our loan portfolio, I reviewed with you the general nature and characteristics of the loans that we originate. I believe these are worth repeating. First is our commercial loans, we are a direct origination, in-market lender to borrowers we know.

We are also a collateral-based lender and we strive to obtain personal guarantees from substantive principles. On the residential side, we are again a direct origination, end market lender with a strong predisposition toward owner occupiers. We know and live in the markets to which we lend. We consciously avoided sub-prime and option arm lending and we underwrote customers on credit and affordability, not anticipation of collateral appreciation.

Even though these standards and principles have served us well and we continue to tighten our underwriting to adjust to deteriorating market conditions, we are not immune to credit challenges. Especially given the length and depth of the current economic and mortgage crisis.

In the September 2008 quarter, we like a number of our brethren locally and across the country, saw an increase in credit related cost. In our particular case, the increased credit cost impacted three areas. First, net interest income, which was negatively impacted by an increase in non-occurring residential first mortgage loans. Second, provision for loan losses which increased to $2.8 million for the quarter, due principally to increase net charge offs, increased levels of non-performing loans, primarily residential first mortgage, and growth in performing commercial loans.

Net charge offs for the quarter totaled $2 million and included $539,000 of losses related to two loans involving fraudulent borrowing activity. Excluding those losses net charge offs approximated the charge offs experienced in the June 2008 quarter.

We continued to aggressively charge off problem loans, mostly mortgage related, while prudently building reserves in this environment. A substantial portion of the growth in non-performing loans related to residential first mortgage loans, which represent 65% of all non-performing loans.

At September 30, 2008, our residential first mortgage loan portfolio totaled approximately $240 million and had a 70% average loan to value at origination. Residential first mortgage loans carry a lower level of inherent risk of loss than other types of loans in our portfolio, especially compared to second mortgage loans and home equity lines of credit where we often do not own or service the first mortgage.

The third element is foreclosure cost. We have experienced increased levels of foreclosure activity, again, primarily in residential first mortgage properties. As a result of the continuing decline in property values coupled with the deepening economic recession, we are realizing additional write-downs on properties subsequent to foreclosure as well as realized losses on ultimate sales of foreclosed property.

We are doing everything possible to keep cooperative borrowers that are willing to work with us in their homes to preserve the value they have invested and to avoid costly and time-consuming foreclosure activity. Our take away from all of this is that we continue to believe we have a manageable level of asset quality in a very challenging environment. The fact is that our commercial portfolio continues to perform extremely well, while as discussed, 65% of our non-performing loans are residential first mortgage loans where we historically realize lower levels of loan losses than on our entire portfolio.

Let's shift gears a moment and go to really our 2009 outlook. Absent the losses on the sale of Fannie Mae preferred stock and the separation payments made to our former CEO that we incurred in 2008, we expect 2009 results to be appreciably better than those reported in 2008. However, we believe 2009 will likely be another challenging year for the banking industry.

We are all diligently watching to see how the various government initiatives will curtail the length and depth of the current economic recession and the national mortgage crisis, including the current oversupply of housing and the resulting declines in property values. Nonetheless, we are confident that our experienced, talented, and dedicated employees and our growing base of loyal customers will enable us to effectively manage through these challenging times and emerge even stronger than we already are.

Our focus for 2009, therefore, will be on the following. One, managing asset quality to control the level of our credit-related cost. Two, improving our net interest margin by insisting on appropriate market rates on loan renewals and new loan originations while continuing to resist the irrational deposit pricing mentality that exists today in the market.

Three, implementing a cost management culture by measuring spending productivity and insisting upon line item budget accountability by our people. Four, continuing our disciplined approach to capital allocation. In addition, we are carefully evaluating the merits of participating in the Treasury Department's recently announced Capital Injection Program, which based on our due diligence to date looks like an attractive and affordable source of capital with minimal dilution and manageable conditions.

In closing, I would like to personally thank our loyal shareholders, customers, and employees for their continuing support during this unprecedented period of time for the banking industry. I remain extremely confident about the Pulaski's future.

That concludes my prepared remarks. Latonia, let's open the line for questions and comments.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from Joe Stieven from Stieven Capital. Please proceed with your question.

Joe Stieven - Stieven Capital

Hi, Gary, how are you?

Gary Douglass

Hi, Joe, how are you?

Joe Stieven - Stieven Capital

Very well. Gary do me a favor, looking at the -- you have got restructured residential loans and could you just give me a little thought on how those are being modified and what they are paying you guys and how quickly some of those can return back to performing? Thanks.

Gary Douglass

Sure, Joe. Those are typically being modified to reduce interest rates and in some cases capitalize past-due interest into principal. I would say that would be the majority of them. Frankly, we hope, although again depending upon the length and depth of this malaise that we are in, we hope that they can return because we are only doing that with what I called in my comments willing and cooperative borrowers. So that is the case, typically just reduced interest rates and capitalizing interest, capitalizing interest in adding to principal.

Ramsey Hamadi

Joe, I will also add to that. We are seeing a few more borrowers who were in the middle of bridge loans who couldn't sell their existing homes and found themselves at the end of a maturing loan period. We were having to go through and modify terms, put them in to different structures. Again the one common denominator with all of these customers is we are finding more and more equity in these first mortgage homes and consequently we are better able to work with them.

Gary Douglass

Joe, let me add one more thing. That represents the trouble that restructuring represent 39 residential mortgages. I think that is up considerably from last quarter. But it's evidence of our willingness and desire to work with borrowers as opposed to go to foreclosure, because foreclosure in this market certainly is not a winner for anybody.

Joe Stieven - Stieven Capital

Gary, then assuming these -- once you restructure these loans and assuming they start paying as agreed, how long is it till they return to a performing status?

Ramsey Hamadi

In general, it's going to be 60 days -- I'm sorry, in general it's going to be six months.

Joe Stieven - Stieven Capital

Six months, that is what I thought.

Ramsey Hamadi

There are a few infrequent items where you can look at on a loan by loan basis. They are commercial customers where if they were performing before and after then you kind of treat those on a case-by-case basis. In general, it's six months of performance.

Joe Stieven - Stieven Capital

Okay. Okay, thank you.

Gary Douglass

Thanks, Joe.

Operator

Our next question comes from David Schick from Stifel Nicolaus. Please proceed with your question.

David Schick - Stifel Nicolaus

Good morning.

Gary Douglass

Hi, David.

David Schick - Stifel Nicolaus

Hi, Gary. My question relates to not the loan side, which you I think have covered quite adequately, but relates to how the decision was made and what seemed to me to be an excessive investment in the Fannie Mae preferred, Fannie and Freddie preferreds, which I think was $8 million, $9 million, $10 million which seems like a lot for a company of your size.

Gary Douglass

I think the decision was made by an internal management committee to invest in Fannie. And I think that we have looked at that carefully and somewhat agreed with your conclusion that investment of that proportion should be treated more like a loan which goes through a loan committee for approval of capital allocation, so we have adjusted our investment policy to reflect a policy more consistent with what we do on the loan side.

I will point out, as you well know, that at time we made that investment in December 2007 that was a fairly new preferred issue. It was investment grade rated by both Standard & Poor's and Moody's, but you are correct in terms of an allocation of capital. We do believe that a policy more akin to our loan policy is what we should have and that is what we have subsequently adopted.

David Schick - Stifel Nicolaus

Thank you. I have made the same mistake.

Gary Douglass

Thanks, David.

Operator

(Operator Instruction). Our next question comes from Daniel Cardenas with Howe Barnes. Please proceed with your question.

Daniel Cardenas - Howe Barnes

Good morning, guys.

Gary Douglass

Hi, Dan.

Daniel Cardenas - Howe Barnes

If you could just refresh my memory, in your investment portfolio do you had any investments in trust preferred securities either in pools or stand-alone basis?

Gary Douglass

That would be a no.

Ramsey Hamadi

No, no, we do not. In fact, we have had very little activity in investments. We have focused very much on investing in loans for our customers. Fannie Mae is a little bit unique in that it directly supports the industry that we are very active in, in the mortgage industry.

But that said, after the sale of the Fannie Mae preferred securities we have remaining around $1 million of the 100% risk-weighted investments. Everything else is at 20% or 0%, so everything else is either a direct issue, senior by Fannie Mae, or is a Ginnie Mae security.

Daniel Cardenas - Howe Barnes

Then on the loan side, how do your pipelines look coming into your first quarter?

Gary Douglass

In terms of commercial loans and mortgage loans, Dan?

Daniel Cardenas - Howe Barnes

Correct.

Gary Douglass

Well, obviously mortgage -- just to go backwards here, mortgage loans are certainly being impacted in today's interest-rate environment which obviously can change very rapidly. But at least as of yesterday, 30-year mortgage rates were pretty high and if those would continue they would certainly put a dampening on the number of originations that we see. So that pipeline really is really interest-rate dependent.

As you saw during the quarter and during the year, we did a remarkable job of -- we have $1.5 billion in originations in this market is pretty unbelievable. But long-term mortgage interest rates certainly have to come down to make that pipeline continue at that pace. On the commercial side, the pipeline continues to be there. We are very selective in terms of what we put on the books, but we still see a reasonable amount, although it has slowed somewhat, but still a reasonable amount of quality loan demand out there. So we are certainly encouraged on the commercial side.

Our challenge there is to make sure we get very fair and adequate market returns for those loans, because we still in this marketplace there are a number of our competitors that have retreated and really are not offering products. We need to make sure we get paid for our allocation of capital.

Daniel Cardenas - Howe Barnes

Great, thank you. What was your risk weighted assets at the end of the quarter?

Gary Douglass

$1.04 billion.

Daniel Cardenas - Howe Barnes

That will do me for right now. Thank you.

Gary Douglass

Thanks, Dan.

Operator

(Operator Instructions). Mr. Hamadi, there are no further questions in queue at this time. Do you have any closing comments?

Gary Douglass

This is Gary Douglass. Thank you very much, Latonia, and thank you again to all of our participants and again to our shareholders, customers, and employees for the strong support that you have given us during this challenging time. We look forward to talking with you again next quarter and working through this situation that we are in along with you. So, thank you very much for your time and we will talk to you soon.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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