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TFS Financial Corporation (NASDAQ:TFSL)

F4Q2011 Earnings Call

November 17, 2011, 09:30 a.m. ET

Executives

Marc Stefanski - President and CEO

Paul Huml - CAO and COO

Dave Huffman - CFO

John Ringenbach - COO, Third Federal Savings and Loan

Meredith Weil - CRO, Third Federal Savings

Analysts

Mike Shafir - Sterne Agee

Michael Lee - Royal Capital

Frank Rango - Purchase Capital

Operator

Welcome to TFS Financial Corporation’s Fourth 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; Mr. John Ringenbach, Chief Operating Officer of Third Federal Savings; Ms. Meredith Weil, Chief Retail 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 12:00 Eastern. The dial-in number for the replay is 800-283-4216. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. (Operator Instructions) In interest of time and to get as many questions as possible, we ask that you limit yourselves to one question and one follow-up. Lastly, when posing a question, please pick up your handset to allow optimal sound quality.

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 conditions 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 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 Stefanski

Good morning, everyone, welcome. And at this time I’d like to turn the floor over to Paul Huml, who will go over the deck that was been made available to everyone and then we will follow on with questions. Paul?

Paul Huml

Okay. Thanks Marc. As you know we put out the earnings release yesterday and then also the slides that we will be briefly going over today. And really just jumping to Page 3 of the slides, just an overview of where TFS Financial Corporation is as of September 30 which was our fiscal year-end; very consistent with where we have been as it's little under 11 billion; shareholders’ equity of 1.8 billion which is a little over 16% capital, which we say is very consistent.

Going on to Page 4, just sort of a strategic overview and we are very consistent, simple organization focusing on individual mortgages and deposits and we have traditionally been a fixed rate lender. And recently as of July 2010, issues with the equity lines of credit where we stopped originating equity lines of credit, we looked at trying to respond to our interest rate risk exposure and we went more to way in adjustable rate product, what we call our smart rate product.

And so, if you look at where we are at going from a traditionally fixed-rate, now we have got 55% of our current fiscal year production was the Smart Rate adjustable product. So, we think that’s a pretty key going forward. Generally, most of our mortgage loans and deposits have been generated in our footprint, which is Ohio and Florida, but starting in May of 2011 and expand a little bit further on; we have introduced a Smart Rate product into other states and using our same underwriting, same credit standards going out to other states that generate some loans. So, that will be a key component of growth going forward. And again, everything is originated by Third Federal Associates team, tough credit standards and you can see on the first mortgage originations that we have done this year with the average credit score of 775 and an average LTV of 64 we are keeping that strong credit component.

From markets of operation on Page 5, really not a whole lot of change, Ohio and Florida is where our physical presence is and we stay very strong in those markets from a deposit standpoint.

On Page 6, I think you can see some of the things that stick out in a tough environment, our loan growth, even considering that we stopped originating HELOCs and we reduced those consciously down 350 million property in the last year. Our loan growth has increased, which is really the originations of some of the Smart Rate products.

We have been able to increase our net interest income from last year. I think probably the big difference is in the non-interest income where we lost some, is that we are not selling any more loans to Fannie Mae. So, you see a lot of the gains that have fallen out of there. Our provision for loan losses, we are starting to see that trending down, if you look at over the last few years and even from a quarter’s standpoint. And again, the strong capital position has always been, there are over 16% intangible capital percentage and the asset quality at the bottom, we have seen some improvements there.

In the capital on Page 7 is a little more definition of where each of the ratios are at both from a consolidated TFS Financial and the FD Thrift, Third Federal Savings.

And again on Page 8, just sort of reinforcement of the simple story that we are, that we are mainly in loans and deposits from individuals. We don’t do broker deposits. Most of are at this point, first mortgages are in Ohio, we still service over 5.4 billion of loans for mainly Fannie Mae. And you can see the deposits, we remain very strong on an average deposits per branch size 223 million.

I think on Page 9 it's really the key story that we have going forward. It's been the adjustable rate growth as we shifted from a traditional fixed rate lender into more of an adjustable rate price. So, we have generated 55% of our loan production in 2011 which was 2.14 billion during fiscal 2011. You can see on the chart, in 2010 we introduced the Smart Rate program in July of 2010. So, only 19% of our production last year was variable for this current fiscal year at 55%, so that’s kind of key, total ARMs on the books representing now 25% of our all first mortgages.

And as I mentioned before we have expanded the Smart Rate refinance option to a number of new states. Four of them were done in May and then we have added six more in September. Now, there is not much of an impact in fiscal 2011. We probably have about 20 million of loans that are booked from those states, but we think that’s going to be an item to keep an eye on that as we move forward.

On Page 10, just going over some of the loan delinquencies and charge-offs, and pretty consistent with where we have been. Florida has been the issue that’s given us the most concern both mainly from the HELOC standpoint but also from the first mortgages, you see the delinquencies are a little higher there. And a lot of that is based on the values, these real estate values and the job issues down in Florida. So, we continue to keep an eye on that, but I think the key thing looking in there is that, our Ohio production has done very well. First mortgage is 5.7 million in Ohio with total delinquencies of 1.4%. So, we think we have done a good job, it comes back that’s 50% of our total loans is in that category. So, we have done a good job from a credit standpoint trying to keep control of that.

One of the key items, going on to Page 11, has been our regulatory issues. We have asked an MOU in place since February, that put us on a couple of things, we have responded to a number of the issues the regulators have. At this point, we feel we have responded to the issues in the MOU. However, we still have to wait for the regulators to come out and validate that the issues we have. We feel we have responded. It’s up to them to come in and take a look at it.

We had a change in regulators. The Office of Thrift Supervision was our primary regulator. That changed as a result of the Dodd-Frank Act. So, in July 21, 2011 that changed and now we have essentially two primary regulators, the OCC will regulate the thrift and the Federal Reserve will regulate the holding company. As part of that MOU, we have some restrictions on dividends and buybacks. That continues still under the 45-day non-objection period. One thing that comes out from the OCC coming to be our primary regulator for the thrift is their position on specific reserves in our valuation of our loan impairments.

Under the OTS, there was a category called specific reserves that were remained on the books. From an OCC standpoint, they have indicated in an October directive to all of the savings institutions that all of these specific reserves need to be charged off by the March 31st quarter. So, that will be at September 30, we had about 55 million of charge specific valuation reserves that’s sitting in our allowance. We intend at this point to convert to the OCC methodology in the December quarter. So, that will do one-time boost to the charge-offs in the next quarter, it won’t impact our P&L, it’s really just going to be a reduction of the allowance and a reduction of our non-performing loans and delinquencies. So, that will be a one-time occurrence that we will see in the next quarter.

Another issue from a regulatory standpoint is the Federal Reserve came out with some proposed guidance on the mutual holding companies and dividend waivers. There was a comment period that closed at the end of October and we responded to that. We think they have put in some constraints that set for a mutual holding company to waive its right to receive dividends which we have done in the past. It's that they would require a member vote of all of our depositors. We think that’s overreaching with the rules were from the OTS and obviously overreaches what the Dodd-Frank provision provided for and there has been a number of comment letters that have been sent to the Fed addressing that and I think they are still in process of evaluating that and we will wait to see where that comes out.

So, Page 12, we are still on the sort of a waiting game on cash dividends and stock repurchases. We understand that’s very critical to shareholders and it’s very critical to us. We were all part owners of the company as well it's very critical to what we are doing from a company, but I think that the key is we have to get the regulators happy with what we have done in response to some other concerns, so we will wait for that to happen.

In summary, our focus is continuing, that high credit quality, 1-4 family mortgages, residential markets that we are going after traditionally in our banking footprint, and as you saw we have expanded into some new states, we can see how that development goes, and hopefully that can be a growth area for us. We continue to have strong capital and we have a lot of flexibility as a holding company, and we are looking to work with our new regulators to get us over the hump that we are and be able to get back to hopefully dividends and share buybacks. So, that really in a nutshell is where we are at. I think it's very consistent. We are seeing some trends that hopefully will continue.

And now, I’m going to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And we will go first to the site of Mike Shafir with Sterne Agee. Your line is open.

Mike Shafir - Sterne Agee

Just a bit of a housekeeping question on your tax rate and then also the federal insurance premium. I was wondering kind of what occurred there on the insurance premium this quarter with it rising so significantly. And then also what kind of tax rate should we be thinking about moving forward?

Dave Huffman

This is Dave Huffman, Mike. On the deposit insurance, the Dodd-Frank changed the rules effective April 1, right, where now instead of being based just on deposits it’s based on our liabilities. And I believe that in that process the rate was adjusted so that the FDIC collected in total the same amount. So, companies with limited non-deposit borrowings saw a reduction in their rate while companies that had a wholesale borrowings in addition to deposits generally saw an increase to their rate. So, we did see an improvement from that standpoint. In the June quarter, however, and I think we might have tried to include a note about this, we had an interpretation with respect to long-term unsecured borrowings that we haven’t taken advantage of previously and in June, we filed a recovery for that. So, those two things impacted June and we didn’t have a recurrence of the recovery in the September quarter. So, I don’t know if that answers your question there, Mike?

Mike Shafir - Sterne Agee

So, I mean is that 5 million, kind of the run rate moving forward depending on your [table scores] and so forth?

Dave Huffman

Yes. The number that’s in the September quarter would reflect our run rate.

Mike Shafir - Sterne Agee

Okay. And then on the tax rate, which is lower this quarter?

Dave Huffman

On the tax rate, I think we might have talked about this last time. We have the BOLI, which is our most significant tax permanent item and it’s a fixed amount and it fluctuates depending on what the pre-tax earnings is going to be or its impact fluctuates depending on what pre-tax earnings are. And as we move through the June period, we didn't want to get ahead of ourselves with respect to what our taxable income was going to be. So, we base the estimate at that time on what we knew. And as we progressed through the September quarter, we came to the realization as to what our pre-tax earnings would be and then as we are required to do, we then adjusted the effective rate to reflect the impact of that (inaudible). Mike, does that help you on that one?

Mike Shafir - Sterne Agee

Sure. And then moving forward, should we think about tax rate somewhere in that 30% range then? I mean if I look at the average for the following year it’s around 27?

Dave Huffman

Mike, I’d say it’s a function of what the pre-tax earnings are. If we think about having a permanent difference of somewhere around 5 or $6 million, then it becomes a function of pre-tax earnings. So, in an absurd example, our pre-tax earnings were $5 million we would expect to have a tax rate of zero. If it’s $10 million then our tax rate might be 17%. As the pre-tax number increases that effective rate will gradually increase.

Mike Shafir - Sterne Agee

Okay. And then just one final one on the specific valuation charge-off. So just to confirm this, if we just kind of thought about this in isolation during this quarter, your loan loss reserve to loan ratio would drop from that 1.58 to somewhere in that 1.03, 1.04 range.

Dave Huffman

Yes.

Operator

We will take our next question from the site of Michael Lee from Royal Capital. Your line is open.

Michael Lee - Royal Capital

Could you guys just give us an update on how your latest exam has gone or if that’s in process, when it's scheduled for, and your expectations on when you will be able to get a ruling on the MOU?

Dave Huffman

What I can say is we have not had the exam and we are anticipating that in the near future, but the exact date we are not sure of and we can’t comment on.

Michael Lee - Royal Capital

And then just any visibility on when you might be able to take up the MOU issue with the OCC?

Dave Huffman

Sure. The day after they are done. We will be right there talking to them. We feel that we have complied with all the things in the MOU and probably more. And we are very, very confident that we can have a positive outcome with the review coming up, but again we are dealing with a new regulator. We were not exactly sure how they will look at certain things. So, this is kind of a burn-in period now and we are going to know, I’m sure within the next few weeks or months, and certainly, but everyone knows as soon as we find out something has changed.

Operator

(Operator Instructions) With that we move next to the site of Frank Rango with Purchase Capital. Your line is open.

Frank Rango - Purchase Capital

Just wanted to know if there were any changes in the mix between adjustable rate and fixed rate assets on the asset side of your balance sheet for the quarter?

Dave Huffman

Yes. I mean originations have been about 55% adjustable and 45% fixed for the year. So, that sort of continues to increase since we introduced the Smart Rate program in July 2010.

Frank Rango - Purchase Capital

Got it. So, what’s the current ratio between adjustable rate and fixed rate assets?

Dave Huffman

Well, as far as the first mortgages, it’s probably close to 25% adjustable now, 75% fixed.

Meredith Weil

That’s just under 20% overall.

Frank Rango - Purchase Capital

Just under 20 overall. Okay, great. Thanks.

Operator

And at this time, I’m showing no further questions in queue. I’ll turn the call back to Mr. Marc Stefanski for any additional or closing remarks.

Marc Stefanski

The only thing I want to say is, happy Thanksgiving. Thank you for joining in. And Paul Huml, of course, is available for all the shareholders to call right after the meeting. Good luck, Paul. Thank you very much.

Operator

Thank you. This does conclude today’s teleconference. As a reminder, the dial-in number for the replay is 800-283-4216. Please disconnect your lines at this time and have a wonderful day.

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