WSFS Financial Corporation
Q3 2013 Earnings Call Transcript

Published: 25 Oct 2013

[Operator:]

Good day, ladies and gentlemen. And welcome to the WSFS Financial Corporation Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. (Operator Instructions) As a reminder, this conference is being recorded. I’d now like to turn the conference over to your host for today, Mr. Steve Fowle, Chief Financial Officer. Sir, you may begin.

[Steve Fowle:]

Thank you, Ben, and thanks to all of you for taking the time to participate on this call. Participating with me today in addition to myself are Mark Turner, President and CEO; Paul Geraghty, Chief Wealth Officer; Rodger Levenson, Chief Commercial Banking Officer; and Rick Wright, Chief Retail Banking Officer. Before Mark begins with opening remarks, I would like to read our Safe Harbor statement. Our discussions today will include information about our management’s view of our future expectations, plans and prospects that constitute forward-looking statements. Actual results may differ materially from historical results or those indicated by these forward-looking statements due to risks and uncertainties including but not limited to the risks factors included in our annual report on Form 10-K and our most recent quarterly reports on Form 10-Q, as well as other documents we periodically file with the Securities and Exchange Commission. With that read out, I’ll turn the call over to Mark Turner.

[Mark Turner:]

Thank you, Steve, and thank you everyone for your time and attention today. We are pleased to report third quarter earnings of a $54 per share, our best quarter of earnings since 2008 on both the reported and core basis. This quarter we will provide a little bit more color in our opening comments, as we will be on the road in November with analysts and investor in a few different venues and want to ensure as always we are disseminating important information as fairly as possible. Earnings in the quarter were positively impacted by a $3.8 million pre-tax gain or $0.28 a share, from consolidating our ownership interest in a 2002 reverse mortgage securitization. This is an interest we have owned since its origination, 11 years ago and the majority of the underlying loans we have owned or serviced from almost 20 years. That is to say we are very familiar with the underlying collateral and its cash flow dynamics. Our clean-up call became effective in the third quarter which triggered the consolidation accounting and the gain. This gain reflects real value earned and this asset also has longer term upside potential from among other things, a future cash flows from the underlying collateral, much of which is in California residential real estate in good mature neighborhoods. We don’t have any other similar residual investments in our portfolio. In the quarter, we also fully redeemed our preferred shares formerly TARP preferred. The interest in retirement of the issue cost us $0.04 per share this quarter, which cost will obviously be eliminated going forward. Setting these two positive (inaudible) aside, this is also our best quarter of core earnings in some time and reflects the continued momentum in growing our franchise and optimizing prior investments. Our core return on assets reached the cycle high of 1.04% and our quarter return on tangible common equity reached to healthy 13.6%. Loans were up 5% annualized in the quarter, led by a 9% annualized growth in commercial and industrial lending. Because C&I activities generally come with longer term relationships and with more products and services this is our most profitable lending segment. New funding of commercial loans was solid and within expectations. Net commercial loan growth was impacted by two commercial relationships, representing approximately $20 million, which were paid-off on the last day of the quarter. Otherwise, net commercial loan growth would have been our highest quarter in 2013. In addition to continuing to take market share, we did see an uptick in borrowings from selective existing customers and support of their organic business expansion, as one side of a continuing slow improvement in the local economy. Looking forward, our probability weighted 90-day expected to close commercial pipeline is a $140 million and is at its high point for the year. Therefore, we would expect to see a continuation of our mid single-digit annualized growth rate in loans. This obviously includes an expected portfolio churn, which is a result of the strong competitive environment. Credit cost continued to moderate, as most asset quality metrics modestly and steadily improved from already good levels. Total credit cost that is provision OREO cost, workout cost and related were $2.2 million in the quarter, consistent with the prior quarter and our prior expectations. Non-performing assets and classified loans also improved. Net charge-offs of $2 million were the lowest since mid-2008 before the financial crisis hit. And our provision max charge-offs, so there was no contribution to our results from reserve releases. One large substandard credit went delinquent in the quarter and large part of our provision this quarter was related to the risk of further deterioration in that credit. We continue to monitor this borrower closely through their heavy current fall selling season. While there is the possibility this may give non-accrual in the fourth quarter, based on our preliminary review of collateral, we do not believe a negative change in status, if any, will materially affect credit cost at that time. And we continue to expect total credit costs for the fourth quarter will be in the $2 million to $3 million range, but as always caution that credit cost can be uneven. Deposits were up 13% annualized, helped by expected a normal seasonal growth in public funds. Aside from that core deposits showed strong growth and with our continued intentional run-off of higher cost usually single service CDs, core deposits now represent a robust 82% of funds from our customers. With 43% of our total deposits being in usually stickier, multi-service, more profitable, no and low interest checking accounts. Further, with the rollout this quarter and next of our new deposit solution set, MyWSFSSM, we believe we’ll help improve our deposit efficiency and our deposit fee income. With this rollout, we are moving for a free checking model to a more traditional fee for service model. And over time, we would expect to be reducing single service accounts and rewarding customers for keeping more accounts and higher balances with us. These market share gains and improving mix of loan and deposits along with the disciplined pricing and an improving yield of our securities portfolio, all boosted our margin by core six basis points this quarter to 3.56% and boosted our reported margin by 11 basis point to 3.6%. When you add about $0.5 million in prepayment and related fees, went through yield from large loans I mentioned that paid off late in the quarter. With current trends, we expected that the core margin percentage will be in the mid to high 350s in the near term. Core fee income that is excluding the securitization consolidation gain and gains on security sales was flat from last quarter despite some expected seasonality in our wealth business and the headwinds that higher rates are having on mortgage banking gains across the industry. Mortgage selling, core fee income was up to solid 8% from this quarter last year as our ATM, wealth and traditional banking businesses continue to grow nicely. In the mortgage fee area, we’re pleased with the first couple of months of our combination with Array and Arrow which contributed solidly to fee income where neutral to bottom line operating results despite being with us for only two months. With those months being too slower selling months and months for a management team is rightly focused on integration activities. We have partnered with great talent, platform and brand and expect these businesses to be accretive in earnings in their first full year with us. We clearly demonstrated significant operating leverage this quarter, not only from growth in revenue but also prudent cost control accomplished over an extended period of time. Despite nearly all of our businesses growing, the addition of new businesses and our increased performance which led to appropriate increases in incentive compensation, expenses excluding accounting change were slightly better than both last quarter and this quarter last year. And this includes about $190,000 or little over a penny-ish year in transaction cost we occurred from the Array and Arrow integration. Our effective tax rate was 34% this quarter, benefiting a little bit from building a modest, high quality, bank qualified municipal bond portfolio and also a small benefit from the positive outcome of a recent tax authority exempt. We expect our normal effective tax rate going forward to be approximately 35%. Finally, strategically we are delivering on our brand promise of engaged associates delivering stellar service, growing customer advocates and value for our owners. And tactically, we are also delivering on our earlier commitment to optimize the significant investments made in our franchise during a period of deep opportunity from 2009 through 2011. Our steadily improving financial results and our outside recognitions of being a top work place and the top bank in Delaware for several years running now, all demonstrates our successes. Our goals are however loftier, to enhance our best-in-class service model and to become a consistent high performer. For our business model, we define that as achieving a sustainable return assets of 1.2% to 1.3% by the end of 2015. With continued good execution and little help from the economy, we believe that will still be difficult but achievable. Again, thank you for your time and attention and at this point, we will take questions.

[Operator:]

(Operator Instructions) Our first question today comes from the line of Jason O’Donnell of Merion Capital Group. Your line is open, please go ahead.

[Jason O’Donnell:]

Good afternoon and congratulations on a good quarter.

[Mark Turner:]

Thank you, Jason. Good afternoon.

[Jason O’Donnell:]

My first question, Mark, relates to your commentary around the outlook for mid-single digit loan growth going forward. Just to clarify is that the annualized growth rate that you are looking for over the next couple of quarters or is that what you are looking for just into the fourth quarter. Fourth quarter tends to be seasonably stronger and you get a weaker outcome typically into the first quarter?

[Mark Turner:]

I would -- I'll have Rodger comment on this but it certainly is the case for the fourth quarter and given the momentum probably into the early part of next year as well. However, we are going through as everybody else is, the annual budget process and would update our guidance on that -- on this call next quarter.

[Rodger Levenson:]

The other thing I would add Jason would be I think, if you look back over the past 12 months, we’ve been pretty consistent in that growth on an annual basis and quarterly. So it’s really a continuation of that same trend.

[Jason O’Donnell:]

Okay. Okay. Great. And then with respect to the loan yield, I apologize if I missed this but how much of a lift did you get in the third quarter from commercial loan pre-payment penalties related to these. Is that significant and if so, should we expect a loan yield to become a drago again on the margin over the near term?

[Steve Fowle:]

Yes. This is Steve, Jason. Netting out other items that the loan yields were probably three to four basis points higher than they would have been without those charges.

[Jason O’Donnell:]

Okay. So is it fair to assume, there was moderate over the time, the extra penalties and that -- those came out of the earning stream?

[Steve Fowle:]

That’s right. You may remember we got a little bit of benefit last quarter as well but wouldn’t expect that to continue ongoing. It is baked into our projection of the total margin being in the mid to high 350s in the near term.

[Jason O’Donnell:]

Okay. Great. And then one more and I’m going to hop out. With regard to the uptrend in the MBS yield with this in the third quarter, where do you see that settling out assuming a static yield curve? I’m just trying to understand the dynamic underlying the guidance. Should we expect that to level out given the duration strategy you’re currently pursuing?

[Mark Turner:]

Yeah. You may remember, we’ve talked in prior quarters about having actively managed the portfolio. So that we really brought our yields down quicker than a lot of other banks did.

[Jason O’Donnell:]

Right.

[Mark Turner:]

So we had reached kind of equilibrium state a couple quarters ago, what you saw this quarter had to do with slowdown of prepayment rates giving a little bit of lift to that yield. So, I’d expect go forward yields to kind of to normalize, near where they are but that will depend on again what happens in the rate environment in prepayments fees.

[Jason O’Donnell:]

Perfect. Thanks a lot guys.

[Mark Turner:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line Frank Schiraldi of Sandler O’Neill. Your line is open. Please go, ahead.

[Robert Haderer:]

Hey. Good afternoon, guys. It’s actually Rob Haderer, filling in for Frank today. I just had a few quick ones here.

[Mark Turner:]

Thanks, Rob.

[Robert Haderer:]

Sure. Can you guys give maybe anymore color on the mortgage bank and just given the acquisition in the quarter? And just kind of on a run rate going forward it seems like you guys expect this line that should pick up in the coming quarters just as you go into ramp up, but can you give any more color there on sort of a go forward run rate from here?

[Rick Wright:]

Yeah, this is Rick. As Mark mentioned for the past couple of months, Array and Arrow have been in the midst of trying to focus on integration issues. But even with that, they were responsible for about a third of our gain on sale for the quarter and we expect them to represent about two thirds that are going forward and for the fourth quarter at this point, we see gain on sale something in access of a $1 million.

[Robert Haderer:]

Got it. That’s very helpful. And just last one for me. Just wondering you guys give some more color on what’s really driving the market share gains. I mean, you’ve highlighted some sort of the fallout from the Wilmington Trust, M&T merger. Is that sort of still the case or just any color on what’s driving the sale of gains that would be helpful?

[Mark Turner:]

Yeah. I will comment and then Rodger, I think can jump in. We are in an unusual and fortunate position in our market and that’s 90% of the markets --- traditional banking market shares occupy by us and other institutions that’s our large regional, national or international player. So M&T, PNC, Wells Fargo, TD, Citizens Bank, that are all good banks but all running very similar, large regional playbook of product and price and ubiquity. We are the only player of size in our market that runs a local service model, communities typical super community bank service model with stressing local knowledge, responsiveness, access to decision markers, more flexibility. And so being the only one we are getting as we’re getting a lot of business for most people that appreciate that model. And there is a lot of potential flow to us because, Wilmington Trust have a similar business model, obviously non-executed well in the last cycle and since they’ve gone under. And we’re assumed by M&T, we’re the beneficiary of lot of their market share over time that want to get back to that type of business model. Roger?

[Rodger Levenson:]

I don’t really have anything to add to that.

[Robert Haderer:]

Okay. Great. Thanks a lot, guys.

[Mark Turner:]

Thank you.

[Operator:]

Thank you. (Operator Instruction) Our next question comes from the line of Matt Schultheis of Boenning & Scattergood. Your line is open. Please go ahead.

[Matt Schultheis:]

Good afternoon.

[Mark Turner:]

Matt, good afternoon.

[Steve Fowle:]

Good afternoon, Matt.

[Matt Schultheis:]

Quick question regarding the clean up on this residual of the reverse mortgage securitization, what’s the par value on that?

[Mark Turner:]

There is about $44 million in bonds outstanding.

[Matt Schultheis:]

Okay. And what are they on your books for today?

[Mark Turner:]

They’re on the books that at that amounts. There is also assets that we picked up mostly the reversed mortgage loans that are on our balance sheet as well.

[Matt Schultheis:]

Okay. So there is no significant discount to taking earnings over time with those then.

[Mark Turner:]

So it’s a great question, the underlying liabilities that I mentioned here about $44 million. Our best estimate of the underlying collateral value that exists in the loans and this is based on recent BPOs of the underlying loans. There is about $76 million of underlying collateral values, so there is about $32 million difference there. And that’s what is that significantly discounted back based on the time it will take for that income to come into our earning stream.

[Matt Schultheis:]

Because collecting those is starting to take a live event.

[Mark Turner:]

Yeah, so their reverse mortgages and they are older. The non-insured and so this is the product to came out in the early infancy of reverse mortgages where the lender promises to provide a monthly payment for life and then when the person dies or leaves the home, then the whole value of the home reverts to the lender. So, yes, it does takes a maturity event, somebody dieing, somebody leaving a home to get back collateral and then obviously it take some time to sell that once you get possession of the collateral. So the assumptions that we have to account for in terms of valuing this are, when our people going to pay us a way, which is fairly predictable based on actuarial tables that are updated and then what the house will be worth when they pass away. But again is given the small number of loans that are left to something that we can go out and do BPO’s on an annual basis and get pretty good valuations. So we has -- let's say we have a very good understanding of the collateral and the dynamics that our cash flow having owned their service, most of the underlying loans for the better part of 20 years now and modeling it for the better part of 20 years. And I think our appropriate and assigning significant discounts to those future cash flows. And that said, as a result of that -- we expect to earn significant yield off of what’s now an $8 million investment on our balance sheet.

[Matt Schultheis:]

So you’ve got $72 million worth of collateral, $44 million of liability…

[Mark Turner:]

$76 million.

[Matt Schultheis:]

$76 million, from your estimates knowing these loans as well as what we do. When does that start happening. When did this live event start and when do they end from your actuary tables?

[Mark Turner:]

And so they -- obviously I think there is about 110 loans there. And so the equity -- the maturely of that as we call them happen every day. And the average age of the borrower on most of those loans, the once that we know very well is 94. So obviously the people the people that are in that pool now are probably the healthier people with better genes. And in terms of long lividness but we would expect most of our cash flow to come in over the next five years or six years just based on the age of the -- the underlying homeowners.

[Matt Schultheis:]

That’s a significant increase to your capital base. What would you anticipate doing with that sort of deploying it. I mean, their loan growth isn’t quite and I observe that from where I can tell. So looking forward, when those come in, does this mean that you might actually start buying back -- buying back stock again or special dividends or anything on those lines?

[Mark Turner:]

Yes. So there is still risk involved. Residuals have risks and so that’s why we put a significant discount rate on it. Even though it’s not a residual security anymore, it’s still is residual risk in that. We get the remaining equity in those homes. So we have applied significant discounts to those estimated future cash flows come up with what we think is -- may fair but conservative value on the assets that put on our books. I think Matt, it was beginning ahead of our sales to start thinking about what we are going to do with that capital and still -- until it starts coming in. But more broadly to your question, we just completed a $53 million repurchase of equity, either preferred formally toward equity that will create significant benefits at the bottom line. And right now at about 7.75% change of a common equity at Asia, we believe we are operating with the appropriate capital levels to support our business and for the opportunities we see to grow our business in the near term. Longer term, we are very likely to continue our philosophy of having much more heavily weighed on buybacks of our dividends as a way to return capital because of the flexibility we see that it provides to both the company in managing our affairs and are owners in taking their cash and burden (inaudible).

[Matt Schultheis:]

Okay. That’s it for me. Thank you.

[Mark Turner:]

Yeah. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Damon DelMonte from KBW. Your line is open. Please go ahead.

[Damon DelMonte:]

Hi. Good afternoon, guys. How are you?

[Mark Turner:]

Good. Damon, how are you?

[Damon DelMonte:]

Great. Thanks. I apologies if I -- if this has been address, I was bouncing between conference calls? But could you talk a little bit about the pricing dynamics that you are seeing in your markets and maybe structure in pockets and maybe structure in and kind of how that plays in with competition in some of those players across your markets?

[Rodger Levenson:]

Yeah. Hi, Damon. It’s Rodger. First, as it relates to two large pales, I would just broadly say that that getting into all these specifics, obviously the risk reward equation didn't work for us. And that sort of the combination of pricing and structural reasons, we let those relationships go. I would broadly say that we are still seeing fairly intense price competition just to put some definition around that, five-year fixed rates can be as low as in the mid-threes and we’re still seeing some playing at the 10-year fixed rates sort of right around 4%-ish. I say that has moderated a little bit since earlier in the year, particularly we ended the first early part of the second quarter when that was fairly intense. But there are still heavy price competition and you see to some degree that’s in our yield. Structure, I wouldn’t say there’s any kind of broad statement I would make in terms of anybody being super aggressive in structure. We don't plays as you know very much in this sort of the board syndication market, well, I know there’s been a lot of conversation around that kind of going back to pre-crisis dynamics. In our core business, structure is really what's driving things except for those limited situations which I talked about previously.

[Damon DelMonte:]

Okay. That's helpful. Thank you. And then, I guess, as you guys look to manage your expense phase, have you given thought to your branch network any structure, maybe where you could become more efficient by either consolidating a couple or maybe redesigning and shrinking the size or something?

[Rick Wright:]

This is Rick again. We are comfortable where we are for the short-term, particularly in Delaware we’ve closed a branch this year, we close one last year. We continue to try to look at the options and design to get to the smaller footprint to take advantage of the electronic mobile opportunities that are out there. But there’s not going to be a wholesale kind of pruning at this point and we are clearly still looking for opportunities in the Southeastern Pennsylvania market.

[Damon DelMonte:]

Okay. And then I guess my last question just regarding the dividend. Any thought, I know, Mark, historically, you guys have not to focus on the dividend as much but with the single -- pretty much single-digit payout ratio and earnings continuing to increase, have you given any thoughts maybe increasing that payout?

[Mark Turner:]

We approach that subject once annually in April and intent to do so this April and I think we are just -- we will take a full look at it this time. But, again, I think our, if we increase it, if we increase it, it wouldn't be by much, I would expect that the management and board still take a similar posture that if we have excess capital we can use or proceed it we’re going to use in the business in the near-term that we much preferred buybacks.

[Damon DelMonte:]

Okay. That’s all that I had. Thank you very much guys.

[Mark Turner:]

Thank you.

[Operator:]

Thank you. And with no further questions in queue, I would like to turn the conference back over to Mr. Mark Turner for any closing remarks.

[Mark Turner:]

Okay. Thank you. Finally, as I mentioned, Steve, Rodger and I will be on the road in November for investor relations activities and hope to see many of you out there. Thanks again for your time and attention, and have a great weekend.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program and you may all disconnect. Have a great rest of your day.