TFS Financial Corporation
Q2 2013 Earnings Call Transcript

Published: 26 Apr 2013

[Operator:]

Welcome to the TFS Financial Corporation Second 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

[Marc A. Stefanski:]

Good morning, everyone, and welcome to our second quarter fiscal 2013 earnings conference call. I'm happy to say that here in Cleveland, Ohio, it's sunshine and blue sky. As a matter of fact, it's been that way since December 21, since the MOU was lifted. And we're also very, very happy to announce that this year, we're celebrating our 75th anniversary, where my parents founded Third Federal in 1938, and the first of week of May is that official anniversary time. So just to let you know that we have nothing but really good news for everyone. Earnings continue to grow. We earned 15% more than we did last quarter. The challenges with our regulators are always going to be there, but I think with their help and with their guidance, we've now become a much, much stronger company, operationally. And with profitability coming back and loan deal delinquencies and charge-offs going down, we continue to see a very, very good future for us, for our shareholders and that will allow us to sustain -- well, regardless of the economic conditions and or what's thrown at us continually from different angles, whether it be regulatory -- regulatorily, or again, economically. At this time, I've asked Paul Huml to jump in and go over a few statistical things. He will not be going over the entire deck that was sent down to everyone. And also, Meredith Weil is here to cover some of the market programs that we're involved in, that they're going to help grow the company and make us a much stronger force in the marketplaces that we serve. So let me turn it over to Paul. Mr. Huml?

[Paul J. Huml:]

Thank you, Marc. And welcome, everyone. Thanks for joining us. As Marc mentioned, I'm certainly not going to go through the entire slide. I thought I'd just hit a few highlights, so please slide to -- turn to Slide 6. It's really just the financial highlights. I think you'll see, obviously, the net income improved from last quarter and very significantly from last year's March quarter and big reason is, obviously were, net interest income has improved from last year, not the same from last year. Obviously, our provision has gone down considerably. Net interest margin is staying very, very strong, it's moved up the from last quarter. So those are some of the highlights from there. Obviously, on the next page, Page 7, just shows our capital levels continue to remain very strong. Page 8, really just gives you a brief snapshot of where our deposits have gone, how our costs of -- average cost on those deposits has continued to go down while we've maintained our deposit balance. So that's a good sign. Really, on Page 9, just a brief snapshot of our adjustable rate loan production and I think Meredith will talk about this in a little more detail. But just showing that we're continuing to keep that 50-50 mix of adjustable rate. I think one of the important things to note is the growth of our 10-year fixed loan, 10-year fixed rate loans, which is part of the fixed portion but represents 47% of that fixed portion in the current fiscal year. So that helps from our interest rate risk protection going forward. Obviously, some of the credit scores and average LTV for ARM production is very strong, as well as all of our mortgage loan production have remained strong. Page 10 just sort of shows that the adjustable rate growth is continuing. We're into other states, and that performance continues strong, as well. And Page 11, sort of goes through where we are from a delinquencies and really in between '11 and '12, gives you a pretty good indication of some of the improving metrics. As far as our loan performance, delinquencies are down. The Troubled Debt Restructurings are down. Nonperforming assets are down. Our charge-offs are leveling off at a much lower level from where they've been at. So as Marc mentioned, there's a lot of strong numbers that have continued to come through and obviously, the earnings improvement has helped. I think on Page 13 has a big focus for obviously, a number of investors. That's where we are with regulators. Obviously, the MOU from the OCC was removed in December, and that was a big part. We are able to satisfy them on removing that MOU for the Thrift, which represents 99% of our company. So now it's just our job to make sure the Fed is comfortable with the remaining piece as well and we can get that MOU removed. And certainly, the improved earnings will help down to move that further along. So that in a nutshell is really where we are for the quarter and where we're at. And I'll turn it back over to Marc.

[Marc A. Stefanski:]

Good, Paul. Thank you very much. Meredith, you had a couple things that you wanted to cover with our investors.

[Meredith S. Weil:]

Thanks, Marc. Good morning, everybody. We really wanted to just share a few of the positive things that we're seeing in the industry. We have purchase volumes have been depressed for several years, and what we're seeing in the most recent quarter are increases in just our general volumes in the purchase market. This tends to be the time of year when people go out and buy a home. We've seen about 27% increase since last year in our purchase volumes. So we're looking at that as a positive sign in really what's happening in the industry. We're also seeing increases in our pre-approvals. We've seen about a 13% increase from last year in our pre-approvals. So these are all positive trends that we think are signs that things are getting better in the marketplace. With the refinance market, there's definitely been a lot of news about the refinance market slowing down. And what we've been able to do in order to keep our refinance volumes up is, create new products that trigger customers that weren't considering refinancing to refinance. Paul had mentioned our 10-year product, our 10-year fixed-rate product. We've actually added that to the products that we're offering in our new state. We have expanded into 11 new states, which we've mentioned in prior calls. And so we've expanded the product offering, in addition to offering our ARM products, we've been offering the 10-year product. And we've really seen a lot of additional interest in it and growth because of it. While we've had a lot of production, we haven't grown our overall loan portfolio, but that is because of the loan sales that we've also been doing to complement really, our overall strategy. So our AFM [ph] volume this quarter is up. We've had about a 58% increase in really our overall AFM [ph] Volume. Our ARM production continues to be 50% of our volume. The 10-year production has been very strong. The new markets have grown to almost $500 million. And we are working toward having a conforming Fannie Mae product. Right now, we are offering the Fannie Mae HARP product to current customers whose loans have been sold to Fannie Mae. That production continues. We've seen a slight increase because we've been mailing to those customers, soliciting their refinance. We want to expand our Fannie Mae program. We expect that to happen sometime this summer, and are looking forward to having the 30-year fixed-rate product go through Fannie Mae so that those loans can be sold, immediately. And then 70% of our refinanced volume is coming from new customers. So really, we are adding new customers instead of just refinancing our current customer base. So while the refinance market, I think, we keep saying, "When is this going to end?" We continue to try and come up with creative ways of attracting new population. And then our HELOC portfolio, we did recently introduce our new HELOC product to all customers in our end market states, so that's Ohio, Florida, and 3 counties in Kentucky. This product was developed and we started selling it to our current customer base. It's a principal and interest product. It's now the only HELOC product that we're offering. But it has some features that should be very attractive to customers. And really, I think some of the concerns that you hear in the industry are around payment shock when customers go into repayment. Because the customer is paying principal all long through their draw period, the theory is that, that when they go into repayment, they won't experience that debt payment shock. So we've just launched that product to consumers and are looking forward to seeing our HELOC portfolio shift from the losses that we've been experienced over the last couple of years to try and turn that around. So that's all I have about positive news. Marc, I'll turn it back to you.

[Marc A. Stefanski:]

Thank you, Meredith. At this time, we'd like to open up the floor for questions or comments. We're wide open, so where we go from here?

[Operator:]

[Operator Instructions] Our first question is coming from Chris Jenkin with Sterne Agee.

[Matthew Breese:]

It's actually Matt Breese. Maybe starting with the MOU, it's the topic of focus recently. Is there any change in -- from your perspective as to where we stand? I know last quarter it was more of a wait-and-see approach. You guys have done everything that you've needed to. Do you still feel that way that you've satisfied all the requirements and there's nothing left to do but for the Fed to come in and take another look and clear the way?

[Marc A. Stefanski:]

Yes, I think that -- don't forget that the enterprise risk management process is ongoing. So there's always something else that needs to be done, adjusted, changed. And so that's an ongoing process. But we feel that we've made some great progress in satisfying just some of the basics to move the MOU off a dead center. The critical piece is going to continue to be, with both of our regulators, for that matter, would be a consistency in earnings. The sustainability of that is critical. And I think we're proving that out and in fact, improving from quarter-to-quarter is something that, what our objective is, it's something that's very, very doable, given the delinquency patterns we've seen and the charge-offs. So that's what it's going to come down to. It's less operational in our opinion than anything else. It's more centered around earnings.

[Matthew Breese:]

It sounds like you're maybe backing off timing a little bit and saying it could take couple more quarters, am I hearing that right?

[Marc A. Stefanski:]

That's unclear. I just can't tell you. No one has said to us, 2 quarters of earnings indicates that it's consistent or 5 quarters. But I think some rational thought process is involved. If our delinquencies were going in the wrong direction or just holding, there may be some concern. But everything is moving in the right direction, and so I don't have a number for you, how many quarters of solid or sustained or improved earnings will cure that. But we are doing the right things, and that's all good news.

[Matthew Breese:]

Right. How does the OCC lift impact the Fed lift?

[Marc A. Stefanski:]

Well, those are mutually exclusive events because the OCC have their list of things that they were concerned with. But one of them was not necessarily enterprise risk management. And so those are kind of separate items. Of course, a lot of what the Fed looks at will be what the OCC has reported, but I think that the findings and what their -- what the concerns are, are really 2 different things.

[Matthew Breese:]

Okay. I do want to touch on the loan sales. It seems to be a growing line of business. The last couple of quarters, you guys have dabbled in a couple of different types of loan sales, HARP, private investors, and now you're looking to build out the Fannie Mae platform. Is the three-pronged approach going to continue? And in addition, what kind of -- how substantial can this business be to the overall revenue pie?

[Marc A. Stefanski:]

When you say the three-pronged approach, you mean all 3 ways to grow the company?

[Matthew Breese:]

To sell loans.

[Marc A. Stefanski:]

Okay. Yes, we're going to continue that. And what was the other part?

[David S. Huffman:]

Well, I think just to clarify, we're certainly looking at the Fannie Mae piece. I would say, some of the loan sales, we did an adjustable rate loan sales during the quarter, I would say, that's not going to be a big part of what we're doing. Certainly, the Fannie Mae piece, we think, we can be. And I think a lot of the individual loan sales come down to more of a proof of concept that I'm looking at from a regulation standpoint that yes, these loans are saleable. They are marketable. However, our focus is trying to grow the company. And so I don't think there's going to be massive loan sales. But I think that the Fannie Mae piece will be something we wanted to focus on going forward.

[Meredith S. Weil:]

The Fannie Mae piece allows us to be more competitive on our fixed rate products than we've been in the past. Really, how we've been managing the fixed rate portfolio, which hasn't grown, is by pricing our rate so high that we're out of the market. And so adding the Fannie Mae as a complementary piece of what we're doing, we can be more competitive on the fixed-rate product. We're expecting that we'll experience just overall volume growth. Our plan is to continue to drive the ARM volume and also have the fixed-rate volume.

[Operator:]

Your next question comes from Howard Henick with Scurlydog Capital.

[Howard Henick:]

I just want to ask, in light of the fact that, I think in the past, you said just the fancy -- the second -- the next generation of this is the Stefanski family would decide when the second step would come. And in light of the fact that an MHC really can't pay dividends, without getting a waiver from all the depositors, which is expensive and hard to do. What are -- how possibly do you reward the minority stockholders for their capital going forward? I don't really understand.

[David S. Huffman:]

Well, the original statement about the next generation looking at the second step, that's in a perfect world, of course. 5 years ago, that was a good thing to say, because economic times were different. The rules of the game were different, and certainly, we were in a different position company-wide. So we don't necessarily have the second step off the table completely, never going to do. We do bring that up as possibility. Right now, it's not a -- the probability that happening is not high. But our approach to creating wealth for our shareholders comes in the form of, actually, it's a three-pronged approach as we mentioned before. One is growth, growth of the company. Secondly is -- would be the buybacks, which we have every intention of starting that as soon as we can get out of the MOU. Yes, that's critical. And although it may be difficult for dividends, we haven't given up that, either. There's a few different avenues we're going to still maybe wrestle with the Fed on and see if we can come up creatively with something that might work, which does -- it doesn't necessarily mean we won't have to get the vote of the shareholders but might not be as onerous as what's out there now. Also, there's the mutual association out in -- out of DC. We have a small trade group that's working to get some legislation passed, which would make the dividend process, the paying process, a little less onerous.

[Howard Henick:]

Don't you think the regulators are basically trying to squeeze mutuals to make them go away? They kind of think it's a bastardized structure and that really doesn't have a reason to exist?

[David S. Huffman:]

It sounds like a fair assessment. I have not heard that from anyone, so I can't confirm that specifically. But it is more difficult to live in this environment than work in this environment and pay dividends, but with the kind of structure that's currently in place, even though Dodd-Frank did say that everything that was given to us or allotted to us under the OTS rules should be carried forward.

[Operator:]

Your next question comes from Fred Disanto with Ancora.

[Frederick D. DiSanto:]

I would maybe like to follow up on a previous question. From our perspective, we understand that it is onerous to try to institute a dividend. But we really believe that and I'd like, maybe, your opinion a little bit more on this that the best use of capital once the MOU gets lifted, which we are very confident that it will in the next 6, 9, 3 to 9 months, whenever, that the best use of capital is really to buy back stocks, especially given where your capital base is and where you'd be buying the stocks back. And maybe if you can expound a little bit on that, on how -- on your thoughts on that maybe going forward?

[Marc A. Stefanski:]

Yes, I mean that's a strong commitment on our part. I know that there's been some suggestions out there for a tender offer. That's something that we've looked at and talked about. It's not off the table. But this is also premature if we are not free to do what we would like to do in terms of the Fed having this MOUs still in place. So we can talk about it but until MOU is gone, there's not a whole lot we can do about it, even with our plan. So we're looking at all the different avenues in terms of that. But it's a little frustrating because we just can't act on it.

[Frederick D. DiSanto:]

Right. But you continue to perform the way you're performing this MOUs going to get lifted and I'm sure that you're talking strategy forward, especially the stocks base at this level?

[Marc A. Stefanski:]

Absolutely. Absolutely. And Dave Huffman who is here in the room, I think, would buy back every share of stock where it's at, right?

[Frederick D. DiSanto:]

Well, maybe not where it's at, maybe a little higher.

[Operator:]

And our next question comes from Joe Stieven with Stieven Capital.

[Joseph Albert Stieven:]

I'm not trying to be a pain on the side but I will be, anyway. You talked about the earnings [indiscernible] but I got 3 simple questions for you. Number one, did you take TARP? I know you didn't. Number two, you've always made money every single year going back, okay? And number three, your tangible common equity is over 16% the holding company level. To me, it appears you're being held to a totally different standard than other financial institutions out there. And this is our capital that appears to be held hostage, and it's very frustrating. And can you comment on that one?

[Marc A. Stefanski:]

Yes, and I got to tell you that for all of us here in the room and a lot more than aren't in the room, it's equally as frustrating. We are remaining optimistic and very, very positive at this point. But if you look back on the OTS and what was done back then, and we're just -- I think that the current regulators, they understand where we're at. They get it. They're working hand in glove with us to try resolve -- we're working with them to try to resolve all these issues that were brought up by the former regulator, which is currently out of existence. But the only way I can explain it is there's a book out called Too Soon Old, Too Late Smart, by Gordon Livingston, he's a Psychiatrist. And there's a chapter in that book that's basically -- the name of the chapter is, "It's Difficult to Remove by Logic an Idea Not Placed by Logic in the First Place." So we're trying to logically wade in the water with you on this and it's no -- certainly, no fault of the current regulators but we are stuck with what we're stuck with. And we see light at the end of the tunnel. We see sunshine and blue sky for our investors and for Third Federal. And sustainability, not only in earnings, but we're a strong company. We're going to be a long -- around a long time and we're not sure that the economic scenario that we're in is necessarily going to last. Now it could get worse or it could get better. But we're prepared for -- to do battle in either case.

[Joseph Albert Stieven:]

Marc, from our perspective, we've had 2.5 years of repurchases put on hold and I would certainly hope that on a go-forward basis, somebody doesn't talk about your level of net income as the only amount of repurchases available. I would hope that they take into account the excessive amount of capital you have.

[Marc A. Stefanski:]

Yes, and with the earnings report from this past quarter, along with some of the previous quarters, we feel that there is consistency there. It's sustainable. And, in fact, we think it's going to get better. Again, all those tools will be in our toolkit when we have our direct discussions with the Fed and support of the OCC is critical. If we don't make sure that the Thrift and the OCC pieces of that puzzle are in order, certainly the regulators collectively will look at us not favorably. But we feel that we're working very, very closely with both regulators and I think we are again, we're satisfying everything that needs to be done, including now, the consistency and sustainability in earnings.

[Operator:]

[Operator Instructions] Our next question comes from Kevin O'Keefe with Brown Advisory.

[Kevin O'Keefe:]

I just wanted to comment at a different -- very actually, very similar way to the prior caller. Marc, in your prepared comments you mentioned that getting out of the MOU, I think you said, would require rational thought. And I'd like to add a rational thought to the discussion. You guys have $11 billion in assets, and a capital surplus of $1 billion in excess of well-capitalized status. So I'm kind of curious and hopefully the regulators are listening, I'm kind of curious what could possibly be needed, in any circumstance, for a bank that never lost money and has a home-equity and a combined home-equity and first mortgage book of what, 63% LTV, that could possibly be needed and found a risk here that would impede us, as shareholders being, getting the capital return that the prior caller just mentioned has been on hold for 2.5 years. And you keep bringing up earnings and it's alarming, from my perspective, I understand that this is what the regulators are asking from you, but you keep bringing up earnings and from my standpoint, the risk of this institution is practically 0. So I don't really understand what earnings have to do with anything given that you guys never lost money, never needed TARP, have a $1 billion of surplus, et cetera. So if you could just expound on your prior comments about the earnings because from my perspective, I would think that once this MOU is lifted from the Fed that you would be armed and ready to start returning significant amounts of capital to us and I'd reiterate what, I think, was -- the guy's name was Fred, saying that, that I would vote for the best alternative right now for your shareholders is the buy back stock like you used to do, which was -- which you had a great track record and were very aggressive. So do you just, maybe help us understand again kind of some of the push and pull there, it would will help me out a lot.

[Marc A. Stefanski:]

Well, was your question or comment, was that directed directly to the regulators who might be listening or do you want us to try to address that?

[Kevin O'Keefe:]

I would love for you to address it, but the regulators can find my number on the Brown Advisory website and I would be happy to discuss my viewpoint with them, as well.

[Marc A. Stefanski:]

Well, thanks. Again, I think it's one of these things where, again, we're logically trying to sift through this. And my quote by Gordon Livingston, in my mind, hits the nail on the head. We're trying to logically come up with a rationale here and I don't think, in my opinion, our opinion as a management team and even the board, we were struggling as to logically why we were putting in this bucket to begin with. Now every organization has risks, but I think to your point about the amount of capital we have, we built this company, my father built this company to sustain and to survive a depression. We've had a depression in the housing market. The recession word is used but I'm telling you, when the interest rates are where they are and yet you can't qualify some of your own borrowers because the values have dropped 30% or 50% in some markets, I mean, that's a depressed environment. Now we are seeing sunshine and blue sky. I mean, in every market that we have a branch office, we have a footprint there, we're seeing improvement in the housing values, which is -- it's music to our ears. The economy in Ohio is probably one of the best and fastest-growing economies in the country with the leadership that we have. And so we're very, very optimistic that we can continue to sustain, not only our earnings, but to satisfy anything and everything that else that might be on the table in terms of the regulators. I can't answer it better than that, and I know it defies logic at this point. But these are the cards we dealt. We're working with them, and we're going to play them out and return ourselves to an environment where we're paying dividends and we're growing the company and we are buying back stock.

[Kevin O'Keefe:]

Great. I agree with everything you're saying. I think you guys have done an excellent job and I think you just mentioned there's a depression and this institution didn't need any money and it didn't really lose any money. So I mean, I would hope that this is no longer an issue very soon. Can I ask 2 more questions? Number one, once the OCC or excuse me, once the Fed lifts the regulatory order, is your intention to return more than 100% of capital, more than 100% of earnings to shareholders given your capital position? And number two, are you doing anything preemptively? Last call we discussed all the work it would require to get a waiver. Are you guys doing anything to position yourselves so that once the Fed does call you and tell you that the MOU is lifted and you're free to return capital, that you can come right of the gate and not have to worry about getting all the requisite approvals from your depositors, your board, et cetera?

[Marc A. Stefanski:]

Okay, I'll take a stab at the second question. And that is, to do that would definitely be putting the cart before the horse and we would not have favorable discussions, I don't think, with any of the regulators, in terms of trying to get that done. So that there's something on the shelves. So the day that they take off the MOU, that we immediately start buying back stock. I just don't see that as happening. But Paul, did you want to address the formula that he's talking about?

[Paul J. Huml:]

Yes, I would say it's premature to try to say what exactly we're coming up. What we're going to do is whenever the MOU gets released. We certainly have an existing board approved plan that's still has a little over 2 million shares authorized to buyback. Obviously, we're dealing with the regulators who have to sign up. We have to give notice of everything that we're doing. So the fact -- where we're coming from a regulation standpoint, it's kind of unlikely that they're going to unrelease everything and say you can go back and buy whatever you want. So I think we're going to have to see how that travels down the road. I mean, we certainly understand the importance of buybacks and what it does to the value of the shareholders and price of the stock, and we have intention of certainly going down that path, trying to put a dollar amount on it. At this point, as Marc said, it's premature.

[Joseph Albert Stieven:]

Fair enough. I understand. I don't mean to sound harsh. It's a very good quarter and we understand that the progress is, it's definitely heading in the right direction.

[Operator:]

We have no further questions at this time. I'd like to turn the floor back over to Mr. Stefanski for closing remarks.

[Marc A. Stefanski:]

Okay, well, again. Thank you for your participation, your patience. And we're going to have too continue to fight for our shareholders' interest. And again, this company was built by my mom and dad, 75 years ago, in the heart of the depression. And one thing that Dad said, he said, if you have high capital ratios and you make loans to people that are going to pay you back, people with good credit quality, you're going to have a sustainable model in any economic scenario. That's where we're at, and we will continue to work on your shareholders' -- on the shareholders' behalf to try to make things happen with the -- with our regulators and be able to grow the company like we've been, pay a dividend and buy back stock in the near future. So thank you very much, and that's all we have.

[Operator:]

This does conclude today's teleconference. As a reminder, the dial-in number for the replay is [phone]. Please disconnect your lines at this time, and have a wonderful day.