TFS Financial Corporation
Q3 2013 Earnings Call Transcript

Published: 31 Jul 2013

[Operator:]

Welcome to TFS Financial Corp.'s Third 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 [phone]. [Operator Instructions] Some of the information provided during this 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 www.thirdfederal.com. TFS Financial Corp. assumes no obligation to update any forward-looking statement -- 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:]

Good morning from Cleveland, Ohio, and welcome to Third Federal's third fiscal quarter for 2013. I'm very pleased to announce that we had a terrific quarter, our best quarter since 2007, making over $16 million. We continue to see sunshine and blue sky not only for Third Federal and -- from a profitability perspective, but also in all the markets that we serve. Just this morning, there was a Zillow report that was released having to do with home prices for the first half of 2013, showing that there's a gain in home prices of over 2.5%. For the month of June alone, it was 5.8%. And that's the largest gain since 2006. So the prospects are very, very good. Ohio continues to chug along in a very positive manner. I think we're continuing to see improvements in Florida, which are 2 primary markets that we're serving. And again, when you look back on the history and home prices plummeting in some cases 30% to 50%, the gains that are being made now in these markets, the employment that's beginning to change and improve are real positive signs not only for Third Federal but for the economy, generally speaking, across the country. The one thing that we've noticed, and I'm sure all of you have noticed, too, that you may see a spike one month in sales or a spike one month and -- good economic news and the next month isn't so good. And we foresee this kind of activity for the next 3 to 5 years. We're just going to continue to chug along. Although we think it's going to continue to be in a positive matter, we just don't see any dramatic changes in this kind of pattern for some time in the near future. With that, I would like to turn the floor over to Paul Huml, who is going to go over a few of the slides and not all of them, with us here this morning. So Paul, if you care to jump in?

[Paul J. Huml:]

Okay. Thanks, Marc, and thanks, everyone, for joining us. As usual, the first few pages in the slide deck are fairly basic information and background information that doesn't have a whole lot of change to it. Some I'm going to skip right to Page 6, which is titled Financial Highlights, we'll focus there. And as Marc mentioned, obviously, the net income number jumps off the page. It's quite an improvement, $16.2 million for the quarter and $40.2 million for the 9 months. A lot of that is driven by the provision, which is the -- it was $5 million for the quarter, $33 million for the 9 months. And certainly an improvement over where we were last year. Last year, we had some noise in there from regulatory reporting on bankruptcy loans and a few other issues. But definitely, the provision has helped. We have a improvement in gain on sale, alone, so there's some numbers in there that have helped the quarter. Obviously, our capital ratios remain very strong and, as Marc mentioned, we're seeing improvement in the asset quality ratios. And that'll be shown a little more detail on the slide a little further back. Going on to the next slide, Page 7, which is the capital position. Again, this reinforces the strength of the company. We've added, in addition to the TF -- Third Federal ratios, we've also included TFS Financial ratios as well this quarter, just to show what the strength is there as well. The deposits, on Page 8, we continue to see the average CD rates drop, which is a help to our margin. And going on to Page 9. To go through the fixed -- first mortgage loan production. And we've added this quarter end of the deck, the breakout of 10-year fixed-rate loans. And if you've been with us for a few quarters, we've certainly stressed the adjustable rate product that we've been doing. A lot of 10-year fixed-rate product is now coming into our production, and we feel that it's helpful to our interest rate risk outlook as well. So that's why we've added that onto this chart, just to sort of give you an indication of where we're turning the ship from being a long-term 30-year fixed rate lender to more of an adjustable-rate shorter fixed term. We're still originating longer terms but, definitely, that's a smaller piece and that helps our overall interest rate risk outlook, still having strong credit scores metrics that go with that. Page 10 is the Adjustable Rate Growth. Just to give you a little history of where we have been from an adjustable-rate, as far as our total portfolio, and where we are now and where are some of the new states that we continue to have a production in. And Page 11, again, we'll show some of the performance on delinquencies and charge-offs and the improvements we're seeing, over the fiscal year, from where we were last year and the current improvement on that. So you can see the numbers have definitely improved there. And in detail, on Page 12, is the loan portfolio trends. And we'll show you where -- from where our peaks were, we're definitely improving considerably on all of the categories that are out there. So that's what's driving our ability to get the provision down, which is helping us to drive some of the net income numbers. And the next page I'll explain now, a page that everyone loves to focus on because that's the key for us, is the Federal Reserve is continuing to keep the MOU in place on us. We're certainly doing what we need to do and responding to their questions and providing information to try to get out from under that. We're still under the dividend and buyback restriction, and -- but we continue to improve from an earnings standpoint, which can only help us going forward. And obviously, it's up to the Federal Reserve when that MOU gets lifted. But that really is a summary of where we're at for the quarter. And I'm going to turn it back over to Marc, or do you want to go right to Meredith?

[Marc A. Stefanski:]

I just thought that I wanted to add one comment on the Page 9, where we're talking about the huge change in the mix for the 10-year fixed-rate being very, very popular. This is an indication that the markets that we serve and nationally, in general, the consumer out there wants to shed debt, not improve or increase debt. And so you're going to see, especially in housing, this gimping along because people want to get out from the mortgage debt. And it's just not going to be that massive pent-up demand, all of a sudden start to buy houses again. And this is why I said 3 to 5 years for a full recovery because we're going to be looking at the baby boomers shying away from this debt and the folks that are of younger generations beginning to get into housing, which will help fuel the economic recovery. But the baby boomers, the way the baby boomers go is usually the way the world goes, and this is the trend that we see for the near term. At this point, I'd like to turn it over to the Meredith Weil. And Meredith has some other interesting fun facts for everyone.

[Meredith S. Weil:]

Good morning. Thanks for joining the call. As I -- to continue on Marc's point, I think really, what we've been doing is trying to evolve our product set to really meet the needs of a new consumer out there. One of the positive trends that we've seen that was indicated in our release is the 34% increase in our purchase volume over last quarter. If we compare ourselves to third quarter last year, it's a 63% increase. And this change really is an indicator that there are more people out there buying homes just that the market is improving, while it's slow we're seeing a nice improvement over last year. We're not at the levels that we used to be at, but I think we're hopeful that this will change, the trend will change. Our pre-approvals continue to be strong. We've had a 17% improvement over last year. So the purchase market, really as the purchase market grows, we think that it will continue to create volume for us as the refinance market flows. So to move on to the refinance market. Our experience, while there's been a lot of media and press about the change in the refinance market, as we indicated earlier, we've really evolved our product set so we can continue to attract refinanced volumes. Our applications, compared to last year, are flat, but they aren't going down, and that's primarily because we are attracting ARM production. The ARM consumer, in general, continues to refinance because if they're in a 3-year ARM, every 3 years they look for a new product or a 5-year ARM. Our ARM production continues to be about 50% of our volume. As Paul mentioned, we continue to try and shift away from being a predominantly fixed rate lender. And I think, over the past few years, we've really been very successful at that. We've grown our ARM volumes to -- actually our balances, to over $3 billion. Our 10-year production is relatively new and has grown to be around 30% of our volume that -- those balance is around $200 million. And a lot of these we're actually attracting in new markets. We have earned 11 new states, and that's where we're able to attract new customers, as opposed to refinancing our current customer base. And that's allowed for just the continued growth. Now our assets haven't grown, and that's primarily because we've also experienced some sales, which is a good thing because it's helped our earnings. We are continuing to originate the Fannie Mae HARP loans. We've been marketing more and have actually been successful in attracting HARP volume. I think the ongoing challenge will be as -- if rates go up, there won't be as -- an attractive market. We also have started originating Fannie Mae conforming products in our Florida market. So all of our 30-year and 15-year fixed rates are going through what we consider to be a conforming channel. We continue to work with Fannie Mae. They need to come in and actually do a review of our process, but we are positive in our outlook for that to be successful and expect that to happen in the next quarter. And also on the next quarter, we will expand that to beyond Florida and include our Ohio market. And to sum up, really, we continue to have this aggressive focus on our 10-year and our ARM in our new markets. And then we'll focus on the purchases in Florida and Ohio and the conforming product to keep our volumes up. Equities are increasing in volumes. We have started to market again for our equities. We -- it's slow going. We continue to experience runoff, and that's just part of Marc's comments about the market retracting a little bit and consumers not willing to take on as much debt. I think what we expect, given that really in 2003 and '04, there was a big production of equities. We expect people to go into repayment and want to refinance into a new line of credit and so we expect to have some potential going forward. On the deposits side, we've been able to manage our cost of funds nicely. We've had continued repricing on our CDs. The -- we've seen a change in our margin because of this and our spread. We expect -- we still have a little bit of room for our CDs to continue to reprice. We are taking advantage of wholesale borrowings where it makes it sense, and we're really looking for a more efficient way of funding our loan production. And also, obviously, with the loan sales, that's contributed also to our funding sources. So that's my summary.

[Marc A. Stefanski:]

Okay. I think we're done with our overview. And we're wide open for questions at this point.

[Operator:]

[Operator Instructions] And we will take our first question from Matthew Breese, Sterne Agee.

[Matthew Breese:]

I guess my first question is really around the margin. I was hoping for a little bit more detail on the outlook, considering the steepening of the yield curve. Your balance sheet is primarily residential loans, so I imagine you're seeing some better rates. And on the flip side, you are putting on some more borrowings. So I just wanted to know how that dynamic plays out and where do you think the margin is going over the next year?

[David S. Huffman:]

It's Dave. Thanks for your questions. Thanks for listening in. The margin, if you looked at it on a linked-quarter basis, we did see kind of the first dip in that margin in both the spread and the margin. Did you see that, Matt?

[Matthew Breese:]

Yes.

[David S. Huffman:]

Okay. There were a couple of things that happened in there that kind of diluted that or exacerbated that dip. One was the loan sales. We've had $128 million of smart sales in the March quarter that actually occurred right at the end of March. The impact of that sale hurt our margin in the June quarter. And then we've sold about $90 million worth of 30-year fixed rate in the middle of June that had a smaller impact but also hurt the margin for the June quarter. So if our margin went down by about $1.8 million on a linked-quarter basis, that was about $1 million worth of that. Then the number of days actually impacts our margin and our net interest income because the savings accounts and our borrowings we pay on a daily basis. The preponderance of our mortgage portfolio is on a 30 through 60. So there was a portion of the margin that was negatively impacted because the June quarter has 91 days and the March quarter has only 30 days. So that, maybe, was another couple hundred thousand. So if you pull those pieces out, we might have seen the margin compress by about 1% on a -- or maybe $600,000, on a linked-quarter basis. As we go forward, the steepening of the yield curve should help our incremental business. But that steepening didn't occur until -- or begin until probably the middle or latter part of May. So the process of loan apps that are taken, from that point forward, converting into margin, probably takes us 60 to 90 days. So we won't see that benefit yet. But longer term, we should see the margin hang in there for us. I don't know if that answers your question or addresses what you're thinking would happen.

[Matthew Breese:]

Got it, that's about what I was expecting. And then, Meredith, I was hoping for a little more detail on the mortgage gain on sale [ph] business. First, you guys are originating products, conventional product, in Florida. Was any of that sold this quarter, a? And then, b, looking ahead, I guess what was the production in Florida that occurred this quarter that would -- that you would sell?

[Meredith S. Weil:]

The production that had been sold to this point is all HARP production. We have not had any of the conforming production yet sell. The numbers are still very small. We really just started originating earlier in this quarter. And so we wouldn't expect to see that. I think that the numbers next quarter really will be -- will continue to be small. It will -- I think we'll really see an effect more in next year, next fiscal year. We still have to work through. We have our -- we are able to sell the HARP loans. We have to regain our active status with Fannie Mae, and that's really what we expect to get this quarter. But the loans -- mortgage lending is no longer something that's really simple to do, and it just takes lots of time to get the loans from application through closing and then through sale. And really, our philosophy about selling loans will continue to be a combination of managing interest rate risks and then looking at whether or not there's a gain. And so we really -- we'll lead with managing our interest rate risk.

[Matthew Breese:]

Okay. And then my last question is really around the MOU. So I guess, first, I was just curious, what updates do you have since we last spoke in terms of maybe conversations you've had with the regulators? And then, two, as far as improvements, the infrastructure goes, what's been done to enhance your likelihood of getting the resolution since we last spoke?

[Marc A. Stefanski:]

Thanks, Matt. As far as where the regulator is, obviously, they continue to stress that we're not to communicate what our communication with them is. Strictly, the MOU that's out there deals with the enterprise risk assessment. As we've said before, the OCC also have that as it relates to interest rate risk, which is the bulk of the risk that we take as an enterprise. The OCC was comfortable in December of last year in removing their MOU. We continue to respond to issues that the Fed raises. A lot of them are just history and going through validation of numbers. So what is going to happen that's going to trigger the Fed to release the MOU is uncertain at this point. We certainly are working and providing whatever further questions they come up with, but we're hoping that continuing to do what we're doing, which made the OCC comfortable back in December, will at some point convince the Fed to remove the constraints placed by the MOU in the future. It's difficult to say when that's going to be because they have a different process than the OCC. But we continue to respond to whatever questions they have, and we hope that will happen soon.

[Matthew Breese:]

When was your last safety and soundness again by the FRB?

[Marc A. Stefanski:]

Again, that's something that they've told us we're not to comment on the timing of any of exams or the communications.

[Operator:]

[Operator Instructions] Our next question comes from Frank Rango [ph], Purchase Capital.

[Unknown Analyst:]

I couldn't help but notice the trend in the non-interest expense was up again. And I recognize that you guys put a premium on customer service and whatnot and probably have increased expenses because of the regulatory stuff going on. But given you're laser focus, it seems, on the interest rate risk, I'm just wondering if your -- the size of your non-interest expense is growing bigger than the bank can really profitably support? I mean, it seems to me either you may have to take more interest rate risk to increase your net interest margin so as to accommodate the increased non-interest expense or maybe something else has to happen? I'd just being curious as to your comments -- as to your observations on that, please.

[David S. Huffman:]

Thanks, Frank, this is Dave. When we looked at the -- as we look at the expenses, on a linked-quarter basis, they're probably not up too much from last quarter. They're up, when you look at us compared to last year, but I'd say a number of things have changed since last year. The -- your question as to what is the appropriate level of earnings targets for us is a good one, it's something that we always wrestle with. I think we, as a group, always think more is better. But the balancing of the level of interest rate risk with the contribution to the margin and the ability to absorb the operating expenses is -- it's a conundrum for us. We sometimes are -- not sometimes, we look at our expenses versus our peers and our, if you will, structural peers and feel relatively comfortable that our expense structure is good. We have the ability to grow the balance sheet. I think we believe that we could end the balance sheet by 30% to 50% without a substantial increase in the expense. So going forward, Frank, that's something that we have, I think, verbalized and that we have targeted internally to grow the balance sheet. Just last year, we sold probably a couple hundred -- $220 million worth of loans that we didn't contemplate selling in the beginning of the year, and that's impacted our ability to grow the balance sheet. We've also seen the level of originations on a fiscal year basis, the closings haven't been as strong as they were last year. That also has impacted our ability to grow the balance sheet. And we continue to see the attrition in our equity portfolio that has actually shrunk that portion of the balance sheet. So, respectively, we do look to see the balance sheet grow, the margin should grow with that and provide better coverage for the expense structure. At this point, to reduce the structure, there may be a couple expense items that are related to our servicing portfolio. As some of the Fannie Mae review process concludes itself it will result in lower expenses. We'd like to see our deposit insurance expense be reduced at some point here in the near future. But beyond that, we look at our average grant size, it's still near industry leads for the type of business that we participate in. So I don't know if that's helpful for you, Frank, but the...

[Unknown Analyst:]

No, it's very helpful. I just -- I'm just wondering how you get the bank to be -- as you said, you get your loan balances up 40% or 50%, because then the, obviously, the leverage would be wonderful for shareholders. But that's what's in my mind what's unclear.

[David S. Huffman:]

I'd say there's a relative reluctance to extend our interest rate risk dramatically at any point in time. As we attempt to grow the balance sheet, we are trying to temper that with the appropriate risk matching in the assets and liabilities. And when we pursue that risk matching, the incremental margin may not be as significant as the, let's say, the current margin.

[Unknown Analyst:]

Just one other question, any reason why you're not originating conforming product in Ohio as well?

[Meredith S. Weil:]

The plan is to actually start originating the conforming products in Ohio this quarter. It's really just rolling out the process and there has been significant operational change that we've absorbed. And so it's going through that process. We also want to get our active status back with Fannie Mae before we originate a lot of loans at lower interest rates, to ensure that we can sell the loans. I think what we've seen with our private loan sales is that there's definitely a market out there. And so even if we don't have our active status back with Fannie, we could find other buyers for those loans. It's more just really the implementation process that have to go through just the growth. But our expectation is by the end of this quarter, we will be originating in Ohio.

[Operator:]

[Operator Instructions] And it appears that we have no further questions at this time. I'd like to turn the floor back over to Mr. Marc Stefanski for any additional or closing remarks.

[Marc A. Stefanski:]

Just a couple things I'd like to mention is that if we all want to see an improvement in the housing market, if you talk to your Congressmen or Senators out there, you might want to suggest that Homebuyer's Tax Credit, which, in 2009 and 2010 had a significant impact on national sales, these are sales of existing homes and some new homes, too, so that's a very important thing. The other thing is I want -- like to make it perfectly clear to all of our investors, shareholders, all the analysts and everyone else who's listening that we're not taking a backseat with our regulators in terms of how we feel about the buyback and dividend programs that have been suspended for the last 3 years. We -- as a matter of fact, we are -- we continue to talk with the Federal Reserve and have a dialogue with them about the reinstatement of the buyback program. And we will be relentless in our pursuit of that until we finally get resolution. So again, I'd like to emphasize that we are not sitting on our hands with this. Although we can't discuss much of the detail, you can be rest assured that we're spending a lot of time and a lot of effort on trying to get the suspension released. And finally, we will continue to be a growing -- a driving force in the markets that we serve in the home mortgage business. And our goal is to be #1 or #2 in market share and widen the gap. And again, we are very competitive. We have always been very competitive. We've had some operational snafus. We have some things that we have to resolve with Fannie Mae before we can get those sales fully under way. But we will continue to be a driving force in that market and grow the balance sheet and continue our three-pronged approach of growing the balance sheet, paying dividends when we can and, of course, the buyback program. So with that, I'd like to say thank you very much for tuning in, and we'll continue to work diligently. In fact, as Buddha says, "Strive with diligence to be a lamp into ourselves." So we will continue to strive for excellence. Thank you very much.

[Operator:]

Thank you. 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.