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TFS Financial Corp (NASDAQ:TFSL)

Q1 2013 Earnings Call

January 31, 2013 10:00 am ET

Executives

Marc A. Stefanski - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Paul J. Huml - Chief Operating Officer and Chief Accounting Officer

Meredith S. Weil - Chief Operating Officer of Third Federal Savings and Loan

David S. Huffman - Chief Financial Officer, Secretary and Member of Investment Committee

Analysts

Matthew Breese - Sterne Agee & Leach Inc., Research Division

Frank Rango

Kevin O'Keefe

Operator

Welcome to TFS Financial Corporation's First Fiscal Quarter Earnings Conference Call and Webcast. Hosting the call today from TFS Financial is Mr. Marc Stefanski, Chief Executive Officer. He is joined by Mr. Dave Huffman, Chief Financial Officer; Ms. Meredith Weil, Chief Operating Officer of Third Federal Savings; and Mr. Paul Huml, Chief Accounting Officer.

Today's call is being recorded and will be available for replay beginning at 2 p.m. Eastern Time. The dial-in number for the replay is 1 (800) 677-6124. [Operator Instructions] Some of the information provided during the conference call may contain statements of future expectations and other forward-looking statements. These expectations are based on the management's current views and assumptions and involve known and unknown risks and uncertainties.

It is possible that the company's actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. For a discussion of some of the risks and important factors that could affect the firm's future results, see Risk Factors in the company's latest annual report on the website, www.thirdfederal.com. TFS Financial Corporation assumes no obligation to update any forward-looking information provided during the conference call.

It is now my pleasure to turn the floor over to Mr. Marc Stefanski. Sir, you may begin.

Marc A. Stefanski

Thank you very much. Welcome, everyone. In the past, we've had Paul Huml go through the deck that's been distributed out there page by page. And today, we're going to deviate from that process. We're going to -- first, I want to just make some general comments and then, Paul Huml will cover some statistical highlights of importance, and Meredith Weil is going to talk about our growth strategy and plans.

First of all, and foremost, it's no secret that the OCC has lifted the Memorandum of Understanding off of Third Federal, the Thrift. The MOU is -- being lifted is one big step toward regaining our ability to continue on with our three-pronged growth plan for a deployment of capital. And that three-pronged approach has been just growing the company, paying dividends and, of course, buying back stock.

The state of the economy has always been a concern of ours. But, you know, Ohio is looking really good right now. The unemployment rate is down to 6.6%, national average is at least 1 point higher than that. The housing market is pretty good, although Case-Shiller yesterday said that the -- in The Wall Street Journal, that Cleveland was down 1.8 -- 1.8%. But I don't know if that really encompasses the general Northeastern Ohio area, which is very stable, that prices are improving. The housing market that that we see in Northeastern Ohio, and in fact, all of Ohio, is very, very good. And of course, with the unemployment rate coming down, all those things are really good for our business.

As far as Florida is concerned, we look at and feel that in the markets that we're in, that the housing prices have stabilized. And in many cases, the improvement in the value of real estate is beginning to show.

We look forward to working with the regulators in terms of shedding ourselves from the additional MOU at the holding company level. And this has been a real, real good past 30 days for all of us from a management perspective. I think from an investor perspective, too, I think you're probably very pleased as we are all, too, as not only as a management team, but investors also.

Paul, you have some statistical highlights that you would like to cover with everyone, right?

Paul J. Huml

Yes, thanks, Marc, and welcome, everyone. Thanks for joining us on the call.

As Marc said, I'm not going to go through the entire slide deck, but -- and if we sort of jump to Page 6, it's got the financial highlights. And really, I just want to point out a couple of things. Obviously, the big thing is net income for the quarter is up to $11.2 million and certainly, an improvement over where we've been the last few quarters and even in last year. Our net interest income continues to increase, as we've been able to manage our cost of funds. The provision for loan losses is down from where it's been in the past, and we've also sold a few loans during the quarter, which has helped our noninterest income.

And a number of the other numbers are -- have remained strong and improving the asset quality numbers.

If you flip to Page 8, really, just contemplating how we've gone through the deposit book as we've had a number of higher cost CDs that roll off and renew. And we've obviously been able to reduce our funding cost significantly over time on our deposits. And that's something we want to keep a close eye on as we continue moving forward. And we've also been able to use Federal Home Loan Bank advances to help reduce some of the cost of funding and extend some of our maturities out. So that's been a good movement in helping our net interest income number.

Page 9 really just talks about the continued growth of our adjustable rate product and the high quality there. We have over 50% of our current production, is in the adjustable rate product, so that helps our future interest rate risk going forward.

And then going to Page 11, just sort of briefly, to look at charge-offs, another improving loan performance number, as our charge-offs for the quarter were $13 million, which is down from previous quarters and, obviously, the prior year.

So we continue to see good numbers there. Delinquencies have stayed low and decreased from September 30, and went down about $11 million or so from where we were.

On Page 12, you can see some of those numbers appear on the charts. Our delinquencies are continuing down, our troubled debt restructurings have leveled off, and our nonperforming assets have -- are continuing to trend down. So those are strong numbers from a performance standpoint. Obviously, it -- that surface is in the provision that we've had record, so that's a good sign.

And then going onto Page 13, which Marc alluded to previously, is obviously, the MOU from the OCC was eliminated, and we're still certainly working with the Federal Reserve on the MOU that they have in place, to get that removed and to get back to our capital deployment strategy.

So that sort of summarized quickly where we're at, from a financial standpoint. And I think we can just open the -- or Meredith, you're going to...

Marc A. Stefanski

Yes, Meredith, if you would cover some of our future growth plans and thoughts on where we think we'll be?

Meredith S. Weil

This is Meredith. We really have been continuing our efforts to focus on our Smart Rate growth. That's our adjustable rate product that we introduced in 2010. We have expanded out to 11 states, and we continue to have a very aggressive marketing plan. We are mailing approximately 2 million pieces in those markets to try and really continue to capture refinance volumes. We've been successful at capturing customers moving from a fixed rate into an ARM. But our hope is that as the refinance market shifts, we'll continue to capture ARM volumes.

The other hope is that as the economy gets better and prices -- home prices rise there will be another refinance volume coming in from customers who weren't able to refinance in the past. That will probably take a little bit more time, just based on really whether or not, or how quickly the home prices increase.

We've also expanded our 10-year product. We do have a 10-year fixed-rate product that has been very successful for us. We've added a no-cost -- or a low-cost feature to that product and are marketing that also in our new states. So that's a new approach for us. The 10-year is, from the interest-rate perspective, a good interest rate risk product for us. It doesn't present the same kind of interest rate risk that a 30-year product does. So we're excited about that. That was just recently introduced, so we don't have specific numbers there.

We also are working hard to sell more to Fannie Mae. We are actively involved in the HARP program. And we are evaluating, creating an approach, to also generating some conforming loans to sell to Fannie Mae. And then we have had some private investors that have been willing to, or interested in purchasing out of our portfolio.

The sales will affect our growth, obviously. And so, it's really a management effort to make a decision on whether or not we actively sell versus growing. I think the Fannie Mae loans, and what we'll be able to do, is offer more competitive fixed-rate products, once we're actively selling to Fannie Mae. And so the goal will be to both sell, offer customers the ARM and the fixed-rate, and hopefully, able to grow our ARM volume and capture some fixed-rate volume, too. Okay.

Marc A. Stefanski

Yes, just the last thing I'd like to mention, with the MOU being lifted, the shackles are pretty much off on our lending, which means that we will be diving back into home equity lines of credit. The outlook from the CFPB, the Consumer Protection Bureau, the rules are out now under the qualified mortgages, so we have a better handle on that. So we will be steering this ship toward growth and continuing our strategy of being #1 or 2 in the marketplace, in all the markets that we serve, and widening the gap.

That's it for the presentation. We can open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Matthew Breese of Sterne Agee.

Matthew Breese - Sterne Agee & Leach Inc., Research Division

My first question is really around the MOU. It sounds like there's still some tweaking to be done on the enterprise risk management processes. So I wanted to gauge your overall comfort with the process you put in place. If I remember correctly, that was something you addressed very early on, if not prior to the MOU being put in place. So I'm just curious, where you stand there, and your comfort level with what you have?

Marc A. Stefanski

Yes, your memory is real good, that's exactly right. And we have a real good comfort level, that we have been in compliance with the completion of most items on that part of the MOU. Enterprise risk management is not something that's -- that just stops one day. It's an ongoing process. It just continues. So, yes, we're continuing to evolve with the changes that need to take place. But certainly, with all the things that have been required of us, we feel that we're just right there and ready to work with the Fed to try to get this part of the MOU lifted from the holding company.

Matthew Breese - Sterne Agee & Leach Inc., Research Division

Okay. And then maybe looking beyond the MOU and returning to your three-pronged approach to capital deployment. Specifically, with buybacks, given where the stock is and your prior history of repurchasing stock, quite aggressively at higher levels than where the stock is now. Could you give us an idea of what kind -- what can we expect on the buyback front? And considering where the stock is, would you employ other means of purchasing stock, perhaps? I know you'd mentioned the Dutch auction.

Marc A. Stefanski

Well, yes, if the stock stays below 10, I think we'll buy it all back, according to Dave Huffman. In all seriousness, that's -- the Dutch auction or the -- to buy a single big block of stock, that's a little bit premature to really be discussing. Until we know that we're out from under the MOU from the Fed, until that the Fed has a comfort level with our current buyback program, which I don't know if they have even reviewed. But it's been just in a limbo mode right now. We just -- it's too premature to even comment to try to make sense of that. Certainly, that the more money we're making from quarter-to-quarter, adds to the war chest. We will continue to focus in on buybacks, the growth and payment of dividends, when possible.

Matthew Breese - Sterne Agee & Leach Inc., Research Division

And then as it relates to the dividend, there are some precedents being set in the MHC space, as far as gaining deposit or approvals and going after the waiver. Is that something you guys would go after as well? And to what extent would you pay a dividend if granted the approvals?

Marc A. Stefanski

Yes, I think I don't want to put the cart before the horse but certainly, we will definitely be looking at that as we move down the road a little bit with the anticipated lifting of the MOU by the Fed, at some time in the near future. We just don't know when. So yes, we will be looking at that. It may be a little onerous and complicated. I don't think it's going to get much more complicated than what it is right now. Although like you said, there has been some precedents set that it can be done this way, where the members have to vote. But don't forget, those are much, much smaller companies. And for us to get that vote, it requires a whole heck of a lot more money and effort and a lot of people voting.

Matthew Breese - Sterne Agee & Leach Inc., Research Division

And then my last question was really around the gain on sale income this quarter of around $3 million, which was a nice surprise. Can you give us some better idea of how that business line is operating right now? Was this quarter more of a onetime kind of gain on sale? Or can we expect some consistency?

David S. Huffman

Good morning, Matt. This is Dave. I think that in the December quarter, we had a couple of private transactions that settled. The private transactions generally take more lead time than our HARP and continuing, to say the worst, through the HARP program to Fannie Mae. We had about $20 million worth of Fannie Mae-type sales and probably closer to $60 million of private. So that, I think, increased our gains that we had for the quarter. The timing of future privates is something that's difficult to estimate accurately. It's something that we continue to pursue, that we're looking at different types of products, with different buyers. And those could come to pass if we go through an extensive due diligence process with a buyer, looking at the collateral. And until the deal is done, it's something that's hard to say, that is going to be recurring. I think that Meredith mentioned earlier that our negotiations with Fannie Mae are turning up, and we're looking for maybe a little bit more in the way of recurring Fannie Mae-type transactions. So I would say that the month of -- or in the September quarter, we probably had between $10 million and $15 million worth of Fannie sales. This quarter, we were probably closer to $20 million. And here, I would view that as being kind of a, at least the baseline, and then we would go up from there.

Matthew Breese - Sterne Agee & Leach Inc., Research Division

Okay. So -- I'm sorry, did I hear that correctly, that we could start with the baseline of what you had in September. What was that number again?

David S. Huffman

We were probably between $10 million and $15 million of sales into Fannie Mae in the September quarter. And the gain, of course, on those sales, is pretty healthy. So -- and there's -- actually, there's different gain level on our agency sales than there is on our private transactions.

Matthew Breese - Sterne Agee & Leach Inc., Research Division

So it sounds like hold off just yet, on kind of working through gain on -- this level of gain on sale through the model. It sounds like this quarter was one of a more -- was a onetime event and, well, news pending, so to speak.

David S. Huffman

Yes, it would -- it might have been a little bit higher than what we could absolutely predict going forward. But that doesn't mean we're not going to try to do that.

Marc A. Stefanski

Yes, and also, what may happen when you have these private investors, they might come in and do their due diligence and say, yes. And then at the end, when you think you're going to close, they say no. And they get cold feet for whatever reason, and you can fill in the blanks. It could be a regulatory issue with the QM or it could be a board issue on their part. It's not necessarily a sure thing like it is selling to -- through Fannie Mae.

Meredith S. Weil

And on the Fannie Mae sales, the HARP deals are going to continue. I think we had a slow start to HARP, and it is a process that requires quite a bit of due diligence, getting the deals actually sold. But the loans that are close to actually getting them sold takes some time. And we haven't actively marketed to that population. But there is an intention to do so. So as we get through the process to actively market to the HARP, potential customers who can refinance through HARP, I would expect that volume will continue or possibly grow.

Matthew Breese - Sterne Agee & Leach Inc., Research Division

How much of the loan's held-for-sale balance of $324 million is HARP?

David S. Huffman

It's about 10%.

Matthew Breese - Sterne Agee & Leach Inc., Research Division

Okay. And the gain on sales last quarter from the HARP sales?

David S. Huffman

About 30%.

Matthew Breese - Sterne Agee & Leach Inc., Research Division

30% gain on sale margins?

David S. Huffman

Oh, I'm sorry. I thought you meant how much of the gain on sales, the $3 million gain that we had, was HARP-related.

Matthew Breese - Sterne Agee & Leach Inc., Research Division

What was the margin -- what was the gain on sale margin for the HARP loans that you sold in the quarter?

David S. Huffman

86%.

Matthew Breese - Sterne Agee & Leach Inc., Research Division

86%?

David S. Huffman

No, sorry. 6%. I wish it was 86%.

Operator

[Operator Instructions] We'll move next to the side of Frank Rango, of Purchase Capital.

Frank Rango

On noninterest expense x real estate-owned expense, it looks like it was about a 2% increase year-over-year. Will that be a pretty good way of thinking about future -- the future trend of increase in noninterest expense, x the other -- x in managing -- the management expenses for the real estate?

David S. Huffman

Good morning, Frank. This is Dave. When we look back a year ago, there are a lot of different variables that fall into that process. If you think in terms of a 2% annualized increase in expenses, that's probably not bad. One other way to look at it, though, is if you were to look at the September quarter versus the December quarter, you'll actually see that there's a decline in our noninterest expense. And I'd say that the major portion of that was related to the costs related to our sold loan portfolio, where we were not only providing loss reimbursement, but we were also establishing an accrual on the books for potential future claims. And in the December quarter, our experience was pretty good, and that was a lot of the reason that we picked up there.

Frank Rango

And Paul was saying that now that the MOU is lifted, you guys are going to go out there and make more loans. I mean, do you have sufficient capacity to, from an infrastructure and personnel point of view, to do that? Or is that going to put upward pressure on the noninterest expense?

Meredith S. Weil

Our hope is that it won't put pressure. I think that as the market gets better, what we've done in the past is we've moved people throughout the organization, and then the economy gets better, we have grown our default management area quite a bit. And so the hope is that the economy gets better, we can move some of those folks into our production area. I will say, we have -- we do have some capacity right now in our production area. Last quarter was not as -- there wasn't as much production. And so I think right now, we're busy and excited to take on more volumes.

Operator

[Operator Instructions] We'll move next to the side of Kevin O'Keefe of Brown Advisory.

Kevin O'Keefe

I thought Matt Breese actually raised an interesting point on the dividend waiver, and I wanted to just kind of follow up with a couple of additional thoughts. You mentioned cost and kind of the hassle on how it might be a bit prohibitive in getting that. But I guess, as a shareholder, I look at it, and I think in the institution even if I say, a normalized earnings year would be $50 million. If you could get this across the goal line and even just pay out 50% to the minority holders, $25 million, you're looking at a 3.5% yield on the shares. And that's pretty compelling even if you're going to tell me that it's going to cost $2 million, I don't know how much it would be. And as a shareholder, I'd like to say I'm happy to volunteer a Saturday to work the call tree, if that's what it takes because the math looks pretty compelling to me. So I was kind of hoping you could just expound a little bit on that, and about the hassle and the costs that would be involved, and a little bit more thoughts on how you're thinking about that?

Marc A. Stefanski

Yes, thank you, and we will look forward to employing you when we start that process.

Kevin O'Keefe

I'm pretty cheap, honestly.

Marc A. Stefanski

Our estimates are somewhere around $1 million. But we're a little spoiled because not too long ago, it didn't cost us anything. So we have to get over that hump a little bit. And the earnings haven't been the greatest. So when you talk about spending $1 million for something, we're all a little, kind of gun-shy, in spending money we really don't have. That being said, though, with the anticipation of some kind of more better normalcy in earnings, and that's indicated by the real estate market getting better, more loan production, delinquencies being down, among other things, again, we anticipate that we will pursue every avenue to try to get that dividend waiver. But it won't be happening until, first of all, the MOU is lifted at the holding company, and the Federal Reserve and Third Federal have discussions as to our capital planning process.

Kevin O'Keefe

Sure, and I completely get that. We have a few steps to get towards, but as I think about the next couple of years, it's certainly a compelling proposition. And this quarter, obviously, was a good step, and toward generating that kind of earnings power that you need to support it. And again, as a shareholder, I would be more than pleased to see you drop $1 million to get the dividend waiver achieved.

Operator

And there are no further questions at this time.

Marc A. Stefanski

Good.

Operator

I'd like to turn the program back over to Mr. Stefanski for any additional or closing remarks.

Marc A. Stefanski

Yes, thank you very much. It has been a good few weeks for us. We look forward to more in the future. Paul, of course, is accessible 24/7. If you need to follow up with some questions, he's got big shoulders and more than happy to take your calls. Thank you, again, and we'll see you again next quarter.

Operator

Thank you. This does conclude today's teleconference. As a reminder, the dial-in number for the replay is 1 (800) 677-6124. Please disconnect your lines at this time, and have a wonderful day.

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