TFS Financial's CEO Discusses F1Q2012 Results - Earnings Call Transcript

| About: TFS Financial (TFSL)

TFS Financial Corp (NASDAQ:TFSL)

F1Q2012 (Qtr End 12/31/2012) Earnings Call

February 2, 2012 04:00 pm ET

Executives

Marc Stefanski - President & CEO

Paul Huml - CAO, COO - TFS Financial Corporation

Dave Huffman - CFO

Meredith Weil - CRO

Analysts

Mike Shafir - Sterne Agee

Joe Stieven - Stieven Capital

Frank Rango - Purchase Capital Management

Mike Godby - FIG Partners

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; 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 6 PM EST. The dial-in number for the replay is 800-283-8217. 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 the interest of time and to get as many questions as possible, we ask that you limit yourself 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 on 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

Thanks very much and welcome everyone. I would like to at this time turn the phone over to Paul Huml who will just begin with the deck that was made available to all of you. And Paul, go ahead.

Paul Huml

Okay, thanks Marc. And thanks everyone for joining us. As Marc mentioned we filed our earnings release yesterday at 4 and along with the copy of the slides that we are going to go over today and at the end we will have time available for questions.

Really just jumping to page 3 of the slides. It is just a summary of where we are as a company at December 31st, very consistent with where we were at September 30, our last fiscal yearend. Total assets $11.1 billion and the shareholders’ equity at $1.8 billion. That is about a little over 16% capital ratio. So very consistent with where we are.

The next slide is just a summary of our strategic overview of what we are doing. And I think as you will see in through some of the slides later, we have traditionally been a fixed rate lender, but based on some of the issues that present itself, whether it be interest rates, some of the regulatory issues with our equity lines of credit, we have introduced an adjustable rate first mortgage product. That’s become more, a big part of what we are doing from a production standpoint. We have had the current quarter, the adjustable rate product with 58% of our first mortgage production which is up from 55% last quarter and 19% a year ago.

So that’s a big step from where we are trying to transition from a total fixed rate lender to more of a variable rate product. Now one of the areas that we have looked at is new state expansion and we’ve started that in mid-2011 and that is continue to expand. We are continuing to learn the best way to approach some of the out-of-state markets. But that will be a big part of what we are doing. We are going to continue to use our Third Federal associates to originate all loans, same credit standards. We’re not buying loans from brokers. They’re all being originated through Third Federal and you can see through the credit scores, 777 of an average FICO score and the loan-to-value average of 61%. So, we have tried to stay from a credit standpoint very high on the scale.

Going to the next page, it is very little change in our markets for operation. Our branches are in Ohio and Florida and that’s where we traditionally received all of our deposits and that has not changed.

Next page, page six, it really goes over the financial highlights and there is just a little different breakout between what we put in the earnings release. But some of the key items is really looking at the loan growth, if we look over where loans were a year ago, September 30, 2011, December 31. Even though we’ve not originated any equity loan products, the first mortgage has more than made up for that and we continue to have growth, a lot of that is from the strong refinance market that’s out there and we’ve also, as you can see maintained very strong capital.

Some of the highlights in the quarter-to-quarter earnings as you will see our provision is down a little bit, 19 million to 15 million as we’ve seen some of our delinquencies come down a little bit. So, that’s a positive trend. Net income is very consistent with where we are at and you will see at the bottom from the asset quality, some big improvements in our non-performing and delinquency numbers which is really driven by one particular factor, the charge-off of some specific valuation allowances that we can get into a little later.

But in spite of that, beyond the charge-offs, there were some improvements in the delinquency as well. The next page, capital, very consistent with what we are at, very high capital percentages. And again page 8, not a whole lot of change in our loan and deposit mix. I think you are seeing some people come down out of CDs as they mature because of the low rates and stay a little more short term and probably our equity lines are decreasing a little bit and the first mortgages are becoming more of a percentage of the total.

The next page 9 sort of starts to tell the story of where we are at the adjustable rate loan production and you can see over the last couple of years that production has really increased as we’ve responded to both the lower interest rates in the market and also the regulatory issues with our equity line of credits and it’s really from an approach of an interest rate risk management, since the HELOCs float at prime and we haven’t been able to originate any of those in the last year and half or so.

The first mortgage, the ARM product is helping from a long-term interest rate risk standpoint and as I said consistent with the total production, the ARM production is very high credit quality as well with the credit score in the average LTV is 778 for the credit score and 60% of the average LTV.

Our next page is sort of the percentage of adjustable rate growth, where it stands as far our total portfolio you can see over the years that in 2010 total first mortgages, 14% of them were adjustable rate at the end of fiscal 2010, that's more than doubled as a percentage through December 31, 2011. We are now up to 29%. When you actually factor in the equity lines of credit that are out there that are adjusted to 43% of all of our real estate loans have an adjustable rate feature in the loan.

And from our new production and the new states that we are looking at again moving just starting in mid 2011 we have about $66 million of loans closed in those new states as of December 31, 2011. So we continue to work performance in those states.

Next page goes through the loan delinquencies and charge offs and you will see a little bit of the impact that I talked about earlier was the specific valuation allowance from a regulatory standpoint. For those of you who don't know we were always under an office of thrift supervision regulator up until July of 2011, under the Dodd-Frank Act that was converted. We are now under the control of the OCC, the Office of Controller and Currency. One of the things that's different between a thrift shop and an OCC shop was the treatment of specific valuation allowances.

The OCC has indicated to all of the thrifts that they have now taken over the supervision that each of those valuation allowances were to be charged off as of March 31, 2012. We have done that in this quarter December 31, 2011, so that balance that was $55 million at the end of September, its now 0 at the end of December 31. So that increased our charge offs for the quarter but you can see its also had a very positive impact on the delinquencies between September 30 and December 31. So that’s a pretty significant impact from the delinquencies standpoint and I think as we’ve seen all along Florida properties and particularly the [Keyllog] products and to the first mortgage to extend our bigger issues which mainly revolves around the values, property values down in Florida.

From a regulatory standpoint just an update on where we are because we had a few changes in regulatory standpoint. We had a memorandum of understanding that was in place from February of 2011. We believe that we met all those objectives, we responded to all the issues that they raised. However, at this point we are waiting for the OCC and the Fed to review and validate all of the progress that we have made. So we did go from the OTS as a regulator and essential split into two regulators the OCC regulates our thrift and Federal Reserve Bank regulates our holding company. So we have two to replace there. Also the fact that we have over 10 billion in assets, we also deal with the Consumer Financial Protection Bureau, which will be coming in and reviewing various parts of our business and also the FDIC has expressed an interest in begin over 10 billion that they also want to take a look at various things.

So it is a changing environment from a regulatory world and we’re working through those and as part of that this is the dividends and stock buyback problem which certainly have a high interest to all the investor and certainly a high interest to us. That is still subject to the 45 day non-objection period from the regulators and our intention is to work through the concerns of the regulator and hope we get the back to those two programs as soon as possible.

And again the some of the changes was the charge offs of the SVA, which I talked about earlier, is really no income statement impact but it did impact the allowance and the level of delinquencies accordingly.

Another issue from a regulatory standpoint that is still uncertain is the Federal Reserve since they are now the regulator of our holding company and that’s where dividends are paid from as the whole issue as a mutual holding company dividend waiver. In the past under OTS rules our mutual holding company which owns over 73% of the shares was able to waive the receipt of dividends, which allow dividend to only go to our stockholders, public stockholders who had paid for their shares.

However under the Federal Reserve, they have said in a preliminary comments that’s the only way that these dividend waivers can continue is that we get a positive vote at least once a year from our depositors. not our shareholders but our depositors of the bank. This certainly goes beyond whatever the Dodd-Frank provisions contemplated and there has been numerous comments to the proposed rules from the Federal Reserve of which we have sent in a letter. There were number of other letters sent to the Federal Reserve of this very issue.

At this point we are waiting for some type of final rule from the Fed to dictate where we go with the whole dividend waiver issue. So again that’s another item that spills over.

The next stage, just sort of summarizes where we are with the cash dividends, stock repurchases. We certainly love to restart those programs up. Right now, it’s under the control of the regulators to make sure that they are happy with the progress that we had under the MoU and hopefully we can move that forward.

So, really in summary on the last page, we’re going to continue to focus on high credit quality, one to four, family residential mortgages, mainly in our footprint, but also expanding into some of these new space, particularly as the refinance market stay strong. Obviously, we have a strong capital position. We have flexibility as the holding company. And we’re viewing some of these regulatory issues. We’re a long-term focus company and these regulatory issues, while frustrating from a shareholder standpoint, frustrating from a management standpoint, we view this as really good short-term, temporary setbacks and we hope to work through this and get back to our core focus of dividends and buybacks for our shareholders.

So that sums up the presentation that we’ve had. I am going to open it up for questions from the investors and thank you.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Mike Shafir with Sterne Agee. Go ahead please. Your line is open.

Mike Shafir - Sterne Agee

I was just wondering if maybe you could speak about some of the offsets, your margins remain relatively stable but, cost of CD is still at 2.5% and I was wondering why is that kind of so far above the market and how much more do you guys have re-pricing this year, kind what rates are you putting in new CDs on so we can continue to potentially fight the pressures of reinvestment yields on the security side.

Dave Huffman

Hi Mike this is Dave Huffman and thanks for listening in on the call. And that is s a great question. It is one that we certainly pay a lot of attention to our CD portfolio is probably a little bit longer than lot of other instruments because we have a longer duration asset with our fixed rate model. So we do try to target to longer CD so anytime you have a [positive assured] in your current you are going to have a higher rate factor. So we do have re-pricing coming and so that should continue for us.

Mike Shafir - Sterne Agee

And just real quickly on the non interest income that really fell off a lot sequentially this quarter. I was wondering is there anything unique or one-time in the numbers there?

Dave Huffman

I see that when we look at it – are talking about the non-interest expense Mike?

Mike Shafir - Sterne Agee

No the non-interest income

Dave Huffman

On the income we have a little bit more in a way of our servicing the amortization on our sold loan portfolio because the repayments kicked up. So that was probably the biggest variance there and plus the portfolio is shrinking in and off itself because we haven’t been selling our backend of anyway. So, I’d say that’s where when we look at it I think we were down about a million dollars in the fees and service charges and the amortization that’s what caused that.

Operator

And our next question comes from Joe Stieven with Stieven Capital. Go ahead please. Your line is open

Joe Stieven - Stieven Capital

Can you tell me how much cash do you have sitting at the holding company; the cash and real short term investments? That's question one.

Paul Huml

I would say there is probably capital wise there is about $275 million probably liquid funds, maybe a $160 million to $165 million or so.

Joe Stieven - Stieven Capital

Sorry Paul, say those numbers again. You said $275 million?

Paul Huml

Total capital at the holding company, separate from the Thrift is probably about $275 million. Liquid is probably a $165 million.

Joe Stieven - Stieven Capital

And so obviously your ability to use that for share repurchases and dividend has no impact at all on the Bank capital ratios which you are still tremendously in excess of all the requirements. And I guess, what is taking, I mean we as stockholders, we’ve been very supportive, but at some point it just starts to get annoying that this process is taking so long and I mean why do you guys think it’s taking so long? Well, probably a good reason not to answer.

Marc Stefanski

It’s Marc Stefanski; you know we’re dealing with the federal government, we’re dealing with a regulator and that’s brand new to some of the Thrifts and the mutual holding companies, so they are digesting what we have. It just takes time; there has been a lot of training by the OCC and some by the fed for the group that comes in and actually monitors what we’re doing and examines the books of Third Federal and all the other companies.

So this has just taken unfortunately longer than we had hoped for and obviously we feel your pain and understand and commensurate with you from that perspective and no one wants to move them all further and faster down the field than all of us here in this room and the entire company as well as all the other shareholders. So Joe, I hear you….

Joe Stieven - Stieven Capital

Its just for us trading Marc, when you hear that kind of quote you know statutory guidance on TV right now saying the biggest banks have the toughest capital ratios and we’re looking at you guys with 20% total cap being told you can’t pay dividends when people with far less capital ratios and they were paying dividend, its just annoying. So I am sorry, it was mandatorial comment for the day. Thanks.

Operator

Thank you. (Operator Instructions) Now we’ll move on to Frank Rango from Purchase Capital Management. Go ahead please.

Frank Rango - Purchase Capital Management

With regards to your production of ARMs, do you guys have a target in mind as to where your portfolio mix; your objective will be between ARMs and fixed rate mortgage?

Meredith Weil

Really been focusing on trying to balance some our fixed rate in our portfolio, I am sorry this is Meredith Weil, to more of our 50-50 balance and we’ve actually gotten at a point where we’re approaching a 50-50 balance with the adjustable rates in general and so we’ll continue to – and really that’s why we’re expanding in the new markets so that we can continue to grow the ARMs specifically. In the new markets we are only offering ARMs. So that’s really been helpful in balancing out the fixed rate versus ARMs.

Frank Rango - Purchase Capital Management

And can you explain what the difference is between the product you are offering now and conforming product and exactly why you haven’t been taking advantage perhaps of the fact that you could possibly sell some of these to the agencies?

Meredith Weil

On our fixed rate, we have a different process. In the past, we were granted waivers from Fannie Mae and those waivers are no longer available for any lender. Our practice really are underwriting guidelines that are very strong obviously from the loans that we’ve have been originating. We have very high credit scores and very low LTVs, but our practice does differ a little bit from what Fannie Mae requires. They have certain rules along way when you are originating loans, when you are closing a loan, the requirements that you have to go through and what you have to put the customer through.

We look at our relationship with the customers, the long-term relationship and we want successful homeowners and so we really look at high credit standards. But we also want to treat our customers well and some of the requirements that Fannie Mae has instituted require you to possibly deny a customer close to closing and those are things that we don’t really want to do and treat high credit quality customers that way.

And so at this point in time, we’ve made a decision to follow our standards and hopefully in the future we will be able to sell loans, but at this point, we’ve made the decision not to.

Frank Rango - Purchase Capital Management

One other question, I never really focused on Bank owned life insurance contracts. It is a $172 million. Are those life settlements or exactly what are those?

Dave Huffman

Frank this is Dave Huffman. Those are standard contracts.

Frank Rango - Purchase Capital Management

So, this is a savings bank life insurance?

Dave Huffman

No. They’re individual life insurance policies.

Frank Rango - Purchase Capital Management

And they end up on your balance sheet because….?

Dave Huffman

The premiums were funded upfront.

Frank Rango - Purchase Capital Management

But the Bank is actually the beneficiary of the death benefits?

Dave Huffman

Yes.

Frank Rango - Purchase Capital Management

That’s a pretty big, that’s a pretty good big investment in life insurance policies, isn’t it?

Dave Huffman

I think we catered for about 10 years and I think that from a regulatory perspective there has always been a 25% of capital limit and we’ve saved a substantially below that. So it’s not, I think an uncommon investment.

Frank Rango - Purchase Capital Management

Just, if we could just follow-up for a second. I am just wondering how you value those policies?

Paul Huml

It’s really the cash surrender value.

Frank Rango - Purchase Capital Management

Cash surrender value.

Operator

Thank you. We will now move on to Mike Godby from FIG Partners. Go ahead please. Your line is open.

Mike Godby - FIG Partners

I’ve got a simple question. Given your regulatory environment, I know how harsh it’s been on you folks as far as repurchases and the concerns about potential dividends. If by chance, the regulatory environment doesn’t shift and we don’t get relief on dividends or the repurchase possibilities, how many years would you have to go through that in order to come to terms with the second step conversion?

Marc Stefanski

That’s a good question. We really haven’t given that much thought. We’re optimistic that this thing is going to be moved along in the very next future, but we haven’t given that much thought in terms of the second step and how that applies to what’s going on now.

Operator

(Operator Instructions) It appears we have a follow-up question from Frank Rango. Go ahead please.

Frank Rango - Purchase Capital Management

Sorry to keep asking on this, but with regard to the regulatory scrutiny you are under right now, is there any – do you guys get the sense at all the fact that you are not originating conforming mortgages that you have a sort of a non-standard product; not that I am saying there is anything wrong with it, but you think that might be having some impact on the amount of time it’s taking to get your application to be able to repurchase stock and do dividends with regulatory agencies?

Marc Stefanski

We don’t have a sense that that’s the case at all. The focus is certainly going to be on what we have done with the items listed in the MOU and Dave did you have any other?

Dave Huffman

Actually also Frank occasionally, we did sell loans in the last year just as kind of a proof-of-concept; we did some more loans because we’ve been sitting -- we had so much cash that was really no advantage to us to sell the loans. So the fact that we don’t sell the Fannie Mae currently, we don’t view that as suggesting that our portfolio is either untradeable or in a back foot.

Operator

And I am showing no further audio questions at this time, so I would like to hand it back to Marc Stefanski for any additional or closing comments.

Marc Stefanski

Just wanted to thank all of you for chiming in and again Paul Huml will be available for other questions if you had some along the way as he has done in the past. So thank you Paul for your presentation, that's well done and thank you again for your time and effort and the coordinating all this Paul and everyone else here at Third Federal and to our shareholders, we are working in your benefit and we will continue to strive to make things better with the regulatory environment and work on your behalf to allow our newer investment to be enhanced. So thank you again.

Operator

Thank you. This does conclude today's teleconference. As a reminder, the dial-in number for the replay is 800-283-8217. Please disconnect your lines at this time and have a wonderful day.

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