Provident Financial Holdings, Inc. (PROV) Q3 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter Earnings Release Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session with instructions being given at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the conference over to your host, Chairman and CEO Craig Blunden. Please go ahead.

Thank you. Good morning, everyone. This is Craig Blunden, Chairman and CEO of Provident Financial Holdings. And on the call with me is Donavon Ternes, our President, Chief Operating and Chief Financial Officer. Before we begin, I have a brief administrative item to address. Our presentation today discusses the company's business outlook, and will include forward-looking statements. Those statements include descriptions of management's plans, objectives or goals for future operations, products or services, forecast of financial or other performance measures and statements about the company's general outlook for economic and business conditions. We also may make forward-looking statements during the question-and-answer period following management's presentation. These forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially from those discussed today. Information on the risk factors that could cause actual results to differ from any forward-looking statement is available from the earnings release that was distributed yesterday. And the annual report on Form 10-K for the year ended June 30, 2011 and from the Form 10-Qs that are filed subsequent to Form 10-K. Forward-looking statements are effective only as of the date that they are made and the company assumes no obligation to update this information. To begin with, thank you for participating in our call. We hope that each of you has had an opportunity to review our earnings release, which describes our third quarter results. Major components influencing our current financial results are unchanged, credit quality and mortgage banking. Credit quality continues to improve, but at a slower pace. Total nonperforming assets on March 31, 2012 decreased to $38.2 million, a 62% decline from what appears to be the peak of $100.7 million on December 31, 2009. We recorded $1.6 million provision for loan losses during the quarter ended March 31, 2012 while net charge offs were $4.3 million, which was higher than the $2.9 million in the December 2011 quarter, but lower than the net charge offs of $5.1 million in the March 2011 quarter. We're pleased that loans in the 30 to 89 days delinquent category remained manageable and have declined substantially from prior year levels. As we have described in the past improving credit quality going forward will be inconsistent and irregular. Performance is closely tied to general economic conditions. While our outlook regarding credit quality continues to improve, we believe that high unemployment rates and slow economic growth may last through much of 2012 keeping our nonperforming elevated. It's important to note though that this quarter marks the ninth consecutive quarter, where asset quality has improved. Also noteworthy the delinquencies in our multifamily and commercial real estate portfolios have remained very low throughout the poor credit cycle of the last few years. We continue to believe that the mortgage banking environment remains favorable and provides us an excellent opportunity to enhance earnings. We have been investing in the business primarily by hiring additional personnel, we employ 316 FTE in mortgage banking on March 31, 2012 but will remain vigilant monitoring the operating environment so we can adjust our model, as we have done in the past commensurate with changes in loan origination volume. The highlight of the quarter was our acquisition of the 3 office retail mortgage banking group in Northern California in February 2012. Recruiting these highly successful mortgage bankers will accelerate our strategy to build a retail channel of loans originated for sale, where we have more control over the loan sale margin and loan quality and where are larger percentage of loan origination volume that's purchased money activity which is less interest rate sensitive in refinance activity. First few months of their employment has been spent on logistics familiarizing them with our systems and procedures and building their loan pipeline. We believe that they will hit their stride in the June 2012 quarter and become a meaningful component of our retail mortgage banking channel. The volume of loans originated for sale in the third quarter of fiscal 2012 increased significantly from the same quarter last year, but declined from the December 2011 sequential quarter levels. New applications though remained at elevated levels in the March 2012 quarter resulting in a robust locked pipeline from the start of our fourth quarter fiscal 2012, but suggests that the volume of loans originated for sale in the fourth quarter may be similar to current quarter level. Our loan sale margin for the quarter ended March 31 2012 improved significantly from the prior sequential quarter to the higher end of the range that we come to expect. Overall loan sale execution remains favorable at very liquid markets for agency conforming loans and we are working very hard to maintain our loan sale margins at these more profitable levels. In addition to our improving the guarded view of credit quality and our positive outlook on mortgage banking, there have been other developments regarding our operating results. For instance, during the quarter we originated and purchased a total of $11 million of multi-family commercial real estate loans, to augment loans held for investment, and allocated additional resources to the commercial real estate loan platform with a goal of increasing loan production for our portfolio. Additionally, our operating expenses have increased as a result of hiring additional mortgage banking personnel, but we expect the investments we are making in the retail mortgage banking channel to pay off in the near-term as we increase the percentage of retail originations to total originations. We continue to maintain higher liquidity balances in response to uncertain operating environment, but are less concerned with doing so today than this time last year, which is another reason we are expanding our multi-family commercial real estate capabilities. Additionally, we continue to invest in retail deposit franchise resulting in higher core deposit balances, as demonstrated by our announcement to open our 15th full service branch. Our net interest margin increased by 6 basis points this quarter in comparison to the same quarter last year, but declined by 11 basis points on a sequential quarter basis because liquidity was accumulated as a result of lower average balance of loans held for sale. Nonetheless the key takeaways with respect to our third quarter results are favorable credit quality trends and the investment we are making in mortgage banking, which has been near-term drag to profitability. Our short-term strategy for balance sheet management is unchanged from the last quarter. We do not believe deleveraging the balance sheet as required, but we recognize that loan demand has weakened, it may be difficult to generate a sufficient volume of loans held for investment to replace payoff. And, the last one, were investing in our multi-family commercial real estate loan platforms to take advantage of loan opportunities as they rise. For this foreseeable future, we believe that maintaining regulatory capital ratios above 9% for Tier 1 leverage, and 12% total risk base is critical and we're confident we will be able to do so. Additionally, in the March 2012 quarter, we repurchased approximately 181,000 shares of common stock, and continue to believe that executing our stock repurchase plans, as well as I see some capital in the current low-growth environment. We're encouraged everyone to review our March 31 Investor presentation posted to our website. You'll find that we've included slides regarding asset quality and mortgage banking, which we believe will give you additional information on the credit risk embedded in our portfolio, and favorable mortgage banking fundamentals. We will now entertain any questions you may have regarding our financial results. Thank you.

[Operator Instructions] And our first question comes from the line of Tim Coffey with FIG Partners.

Craig, you were talking about the long-term margins being at the higher range during the quarter, coming after the 2 recent growth, was declining, do you see it starting to expand again?

I think we're pretty confident, Tim that we're going to hold these higher levels in this range that we talked about. It looks like we'll be able to do that. Seeing it further, it's hard to say.

Okay. What's that a function of it, which is about kind of normalized market now?

I think the market, Tim, has stabilized to some degree with respect to the exit of a couple of players in the fourth calendar quarter of 2011 and those that are committed to the business, the large aggregators and correspondents, I think have probably increased their staffing to be able to take advantage of the volume and to fill the vacuum left by the exit of the large players. And as a result, I think we have a bit more pricing power than we did last year, while that turmoil was going on.

Okay. And then the follow-up on mortgage banking, if I heard you right, the production that you saw from this quarter came from, I guess you talked about legacy platform?

Well, if you're referring to the new group that we hired in Northern California, they contributed very little to our volume in the March quarter because literally they came on in February. They were building pipelines and while they did fund some loans, they really didn't fund the volume that we would expect from them and the total amount that they funded was insignificant, really in comparison to the total.

And then in fact Tim, they were coming on over about a three-month period from February through this month, then to April. So, some of the loans we did get, were actually being processed by our owned legacy branches that were already in existence.

And then the [indiscernible] during the positive in the quarter, you touched on that a little bit, Craig, maybe, where that came from, what that was in total?

I think each March quarter of every year, you may see deposit growth looked pretty favorable across the industry or at least for those banks located in California, because income taxes are due, and real estate property taxes are due in April. So, we have seen historically that transaction account balances, increased during the latter half of the March quarter, and then perhaps they cycle out to some degree in the very first part of April, as people are paying income taxes and California real estate taxes.

We'll go to the line of Tim O'Brien with Sandler O'Neill. Tim O’Brien: Do you say that and pardon me, I got into the call a little bit late. So, I might have missed something, but you said that you expect all things considered where we are in the quarter and looking forward that volumes, if things hold up could be similar and production could be similar in the fourth quarter to the third quarter level, is that what I heard you say, correct?

Yes. Tim O’Brien: So did that include this production that's coming on from the new group or is that - because that would indicate that production in the rest of the team would be down this quarter relative to what they did in the third quarter. So, can you clarify a little bit there?

Yes. I think I can add, if we look back historically over the last 18 months or so, I think our best origination quarter was $649 million and I think that might had been September of 2010 or something like that, I can't recall the specific quarter, but it was $649 million. We just ended with what was it, 560 million or so this quarter and I think volumes overall are down a bit from when we did that really big quarter. So, if I were to suggest our range of volume for June, it would be at this level to may be as high as our best quarter ever, but it's always difficult to forecast that you are going to do better than your best quarter ever. Tim O’Brien: I got you.

Tim, I think I know what you are getting to, but as I look as you fund out certain office pipelines and you have other new office producing more volume. It's really hard to say, I don't think that necessarily means that everybody else is down when we have 3 new originating branches to hit the thing. Tim O’Brien: Yes. I think you guys, I am trying to kind of I understand as I am really interested in trying to get at what, what the potential is that this new group added to its potentially here in this quarter that you said it's going to come online and be a meaningful contributor. I'm trying to kind of get at that number, so that I can be accurate in my modeling.

Yes. I understand what you are getting to.

I think one thing that you could expect with respect to the addition of the new group is that our composition or mix between retail and wholesale origination volume will swing more toward retail volume, which is part of the entire strategy of building up that channel, because profit margins are better, credit quality is more controllable. There's just advantages for that to occur. And if we think about what has occurred just through this fiscal year, in Q1, we did 208 million of retail, in Q2, we did 220 million, in Q3, we did 233 million. And in Q3, retail volume was 40% of total volume. In comparison to last year, when retail was only 30% of total volume. So our goals with respect to bringing on a retail group is that our retail volume as a percentage to total volume is going to increase closer to 50% over time and maybe even go over 50% at some particular point in the future, because it is beneficial for that to occur from a profitability perspective. Tim O’Brien: So that's gets to another question, as far as contribution or I guess strength of margin, how wide are the margins? What's the margin for retail production versus wholesale production?

Yes. We're not going to describe that for competitive... Tim O’Brien: Can you describe without giving a hard number. Just kind of give us a sense of how much more profitable is retail I guess? That's a different way to put it, typically your...

Well, it's a lot more profitable really, because when you consider wholesale, you're essentially going out with a rate sheet to mortgage brokers, who are looking at your rates in comparison to a hundred other lenders, and if you don't have those rates set at very competitive levels, you're simply not going to drive any origination volume in the wholesale channel, so it's very competitive. And the difference with retail is, you really have more control over the production volume because the relationships are embedded with the realtors who are driving the volume and the retail originators who are on board. And as a result, it is less about rate and less about refinance activity, and more about service, and can we get this deal closed by the time their escrow is scheduled to close. Tim O’Brien: That makes perfect sense. I thoroughly understand.

So that's why we're going in that direction and it's a meaningful difference with respect to profitability.

And the other thing, Tim, is that it's really harder for us to estimate where our margins will be on the wholesale than it is on retail because as Donavon went through. And we've seen them swing all over the place. So to give you a spread number between the 2, it's really been varying tremendously over the last year. Tim O’Brien: In order to kind of achieve that idea of 50% contribution from retail, does that -- I mean do you envision, does additional retail outlets and hiring kind of fit into the strategy or is that a necessity of that strategy to get to that number, will you be opening more offices in other parts of California?

I think the 14 retail production offices that we now have, will be sufficient to get to that 50% level during the course of the next couple of quarters. And we don't have to necessarily add new offices in order to accomplish that goal. There could be additional FTE hired in those existing offices, in that if we find an originator that has particular volume and relationships near an existing office, we would certainly look to add him to our payroll. But I don't know that in less the tremendous opportunity presents itself that we wouldn't necessarily be opening more brick and mortar offices.

And we'd like to really swallow that kind of pig that we took in the last few months, and get it profitable before we add a lot of more expense. Tim O’Brien: Due to out of curiosity, and you alluded to this and saying that really the first quarter -- the first calendar quarter was a -- calendar year was a kind of ramping process for that group, how much actual dollar amount contribution did that group provide to that $10 million income mortgage sale income number?

I'm not going to describe it that way Tim, but I... Tim O’Brien: All right, Donovan. I was hoping that [indiscernible] just busted out but....

Yes, but I have a number for you. There was a pre-tax drag to earnings of approximately $550,000 for the March quarter as a result of the net impact of the revenue they generated, and the expenses that we absorbed as a result of bringing them onboard. So, we would expect that that 550,000 would get close to zero, perhaps even profitable for the June quarter. So it would no longer be a drag for the quarter. But that's about what the number was, without describing the total volume that they did. Tim O’Brien: And then, are there, given all of the changes in the market dynamics that have occurred, and continue to occur, are there other levers that you feel like, obviously you had a great improvement in margins this quarter, are there other levers you can pull, or other opportunities the market is presenting to you guys now that you are looking at, for I guess channel routing and such to improve that margin additionally beyond where it stands now?

I think the key driver is going to be the composition mix between retail and wholesale. Wholesale is a thinner loan sale margin than retail, and to the extent that we can increase the percentage of retail origination volume, that margin in the environment or in the secondary marketplace should improve in comparison to what it would have been without that volume.

Tim there is also some technology I think improvements that are going to happen too, because we're working pretty hard on our mortgage banking software right now to improve efficiencies with these higher volumes, which will really help us on the expense side in the future. Tim O’Brien: That's great. And speaking of expenses, last question and this should be a quickie. I did not see any increase in occupancy cost, in fact if anything it came down this quarter relative sequentially. And yet you did all the hiring, is there going to be a hit on that line item, as a result of the offices that you guys are taking on in Northern California? Or are those people being absorbed into existing space up here?

No. We did pick up 3 new offices in Northern California, we subleased them for the organization that we picked up the employees from on market terms. But it's a very small number in its own right, relative to total operating expenses. So occupancy will go up a bit, but it's not a huge number. I mean think about renting or leasing a 4,000 square foot space. It's really not that much comparatively speaking. Tim O’Brien: Given how tightfisted you guys are on leasing office space that is?

I don't know about that but...

Next, we go to the line of Jason Stewart with Compass Point.

I have 2 questions. One relates to loan size, and if there is any expectation for it to differ in Northern California versus Southern California?

Yes. I don't know if it will. Jas, I guess it will depend up on where we originate the bulk of our loans in the Northern California group, but generally speaking some parts of Northern California are more expensive than Southern California. But then if you go inland or east, it seems some of the areas are less expensive. Right now, I think our average loan size on originated for-sale loans through the 9 months of fiscal 2012, it's approximately 273,000. So if it were to go up to 300,000, I don't that that would be meaningfully different from 273,000.

I guess the simple answer is yes, but not significantly, but definitely they do originate a bit larger loans, but still within confirming loan sizes.

Right and then in terms of margin on a larger loan size, I'm hearing not material, but if you went from 273 to 400, I am guessing the margin would be on a percentage terms maybe a touch higher?

I have to be honest, I don't know that I've looked at it in that way to be able to give you a good answer, I really don't look, I look at it within the context of conforming versus nonconforming, but I don't look at within the context of the conforming versus nonconforming but I don't look at in the context of the conforming size itself and the strata that might be in conforming size in and of itself.

Okay, fair enough. And then the second question was related to builder activity and then footprint, I don't recall any relationships with, and this is a good thing I guess recently, that you have with builders in terms of financing new homes purchased, but is that something that you do have or you looking at it or is that of a significant portion of the volume on the purchase side?

You're right, at this point you won't see anything on the new side, although we have developed all the relationships in our mortgage banking area, because the number of builders in the last year or 2, have been picking up homes, rehabbing them and selling them. And, we have built relationships with a number of builders to take that type of business, but you are right, as far as new construction not at this point, no.

And, we'll go to the line of Don Worthington with Raymond James.

In terms of, I may have missed this because I got on a little late as well, if you commented on this, I apologize, but in terms of the organic loan growth and the opportunity you might see for -- what you are determining to be preferred loans. Do you see that picking up at some point this year?

We hope it's going to pick up. We are investing in that platform by hiring loan originators, but it is very competitive in multi-family and commercial real estate. And, it is so competitive that we are uncomfortable sometimes with some of the deals we are looking at, either as a result of the conditions that our competitors are willing to live with, such as no personal guarantees or the rates that are being quoted by some of our competitors, kind of make us take a step back. So it's something we want to do, it's something we have to do, we don't want to see our loans held for investment portfolio continually decline, but is has been very difficult to put origination capacity onboard such that it's enough to stem the tide of payoffs.

Okay. And then any update in terms of, have you had your OCC exam, or what's the status of that?

No, we haven't, but it's scheduled for the end of, just start at the end of May.

Okay.

We are in the midst of preparing for that exam at this point, but that's when it starts.

[Operator Instructions] And I have no more questions in queue, please continue.

All right, well, if there are no more questions, I'd like to thank everyone for joining our quarterly conference call, and look forward to meeting with you again next quarter, thank you.

And ladies and gentlemen, this call will be available for replay after 11 o'clock PM, or 11 o'clock AM, Pacific Time today, through Friday, May 11, at midnight. You may access the AT&T playback service at any time by dialing 1-800-475-6701, and entering the access code 245-701. That number again is 1-800-475-6701 with the access code 245-701. And that does conclude your conference for the day. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.