Provident Financial Holdings, Inc. (PROV) Q4 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, good morning. Thank you for standing by, and welcome to the Fourth Quarter Earnings Release. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn the conference over to our host, Chairman and CEO, Mr. 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, from 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 the Form 10-K. Forward-looking statements are effective only as of the date they are made, and the company assumes no obligation to update this information. To begin with, thank you for participating in our call. I hope that each of you has had an opportunity to review our earnings release, which describes our fourth quarter results. Credit quality is stable and we continue to believe improvement is likely but at a slower pace. Total nonperforming assets on June 30, 2012, were $40 million, a 60% decline from what appears to be the peak of $100.7 million on December 31, 2009. We recorded a $2.1 million provision for loan losses during the quarter ended June 30, 2012, while net chargeoffs were $4.8 million, which was higher than the $4.3 million in the March 2012 quarter and similar to the net chargeoffs of $4.8 million in the June 2011 quarter. We're pleased that loans in the 30 to 89 days delinquent category remained manageable and have declined substantially from prior-year level. As we have described in the past, the improving credit quality going forward will be inconsistent and irregular. Performance is closely tied to general economic conditions. And 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 assets elevated. It is important to note, though, that the delinquencies in chargeoffs in our multi-family and commercial real estate portfolios have remained very low throughout the poor credit cycle of the last few years. Unfortunately, the single-family portfolio did not perform as well during the same period. We note, though, that many positive articles have recently been written about the state of the single-family housing markets and are cautiously optimistic that we may have found the bottom. We continue to believe that the mortgage banking environment remains favorable and provides us an excellent opportunity to enhance earnings. We've been investing in the business primarily by hiring additional personnel. We had 337 FTE in mortgage banking on June 30, 2012, but we'll remain vigilant in monitoring the operating environment so we can adjust our model as we have done in the past to commensurate with changes in loan origination volumes. We are pleased to report that the 3-office retail mortgage banking group in Northern California that we acquired in February 2012 are now operating on a profitable basis and should add to our earnings in fiscal 2013 in contrast to the drag on earnings in fiscal 2012. They have become a meaningful component to our retail mortgage banking channel. The volume of loans originated for sale in the fourth quarter of fiscal 2012 increased significantly from the same quarter last year and from the March 2012 sequential quarter levels. New applications remain at elevated levels in the June 2012 quarter, resulting in a robust locked pipeline for the start of our first quarter fiscal 2013, which suggests that the volume of loans originated for sale in the first quarter may be similar to current quarter levels. Our loan sale margin for the quarter ended June 30, 2012, improved significantly from the prior sequential quarter, establishing a new high to the range we have come to expect. Overall, loan sale execution remains favorable with very liquid markets for agency conforming loans, and we're working diligently to maintain our loan sale margins at these more profitable levels. In addition to our improving but 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 $9 million of multi-family and commercial real estate loans to augment loans held for investment and allocated additional resources to the commercial real estate loan platform with the goal of increasing loan production for our portfolio. Additionally, our operating expenses have increased as a result of hiring additional mortgage banking personnel, which also resulted in higher origination volumes, and we expect the investment we're making in the retail mortgage banking channel to pay off in the near term as we increase the percentage of retail originations to total origination. We continue to maintain higher liquidity balances in response to the uncertain operating environment, but are less concerned with doing so today than this time last year, which is another reason we're expanding our multi-family and commercial real estate capabilities. Additionally, we continue to invest in our retail deposit franchise, resulting in higher core deposit balances as demonstrated by opening our 15th full service branch. Our net interest margin increased by 28 basis points this quarter in comparison to the same quarter last year and increased by 20 basis points on a sequential quarter basis because liquidity is redeployed to support a higher average balance of loans held for sale. Nonetheless, the key takeaways with respect to our fourth quarter results are the stable credit quality trends and the returns we're now realizing from the investment we made in the mortgage banking business during fiscal 2012. Our short-term strategy for balance sheet management is unchanged from last quarter. We do not believe deleveraging the balance sheet is required, but we recognize that loan demand is weak and it may be difficult to generate a sufficient volume of loans held for investment to replace payoff. Nonetheless, we're investing in our multi-family and commercial real estate loan platforms to take advantage of loan opportunities as they arise. For the foreseeable future, we believe that maintaining regulatory capital ratios above 9% for Tier 1 Leverage and 12% Total Risk-Based is critical, and we're confident we will be able to do so. Additionally, in the June 2012 quarter, we repurchased approximately 158,000 shares of common stock and continue to believe that executing on our stock repurchase plan is a wise use of capital in the current low growth environment. We also raised our quarterly cash dividend by 25% to $0.05 per share, which will be distributed to shareholders on September 5, 2012. We encourage everyone to review our June 30 Investor Presentation posted to our website. You will find that we 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. Tom?

[Operator Instructions] Our first question comes from the line of Tim Coffey representing FIG Partners.

I wonder how much of the production in the quarter is from some of the government programs?

When you're talking government, you mean FHA/VA?

No, more of the special programs held on to a lot of borrowers.

Very little. Our production volume is tied to any of the government programs that you're referring to. It seems like the servicers of those loans have a better shot of obtaining that volume because they're already servicing the loans for borrowers. And the fact that we have been selling servicing released for some time, puts us at a little bit of a disadvantage with respect to those programs.

Okay. But how much of the percentage of this quarter's production came from the new hires?

Well, if you're referring to Northern California, the MetLife group, it was substantial, but we don't break out those percentages, if you will. I think the takeaway there, Tim, is to realize that they're now operating on a profitable basis and, indeed, beginning with our July 1 fiscal 2013 year, will be contributing to earnings rather than having been a cumulative drag to earnings through June 30, 2012.

Okay. I was kind of looking at the salary expense line item, what's the appropriate run rate there?

Our salary and expense benefit costs are directly tied to our production volume. And to the extent you were to model our production volume in mortgage banking increase, you would also have to model an increase in our salaries and benefits expense mainly tied to commission. If, on the other hand, you were to model a decline in our origination volume from current quarter levels, you would have to bring those numbers down. We don't describe, for competitive reasons, what our run rate should be or what our commission structure is or anything of that nature. So you really have to look at historical data with respect to our firm in particular to get that information.

Okay. And then there's kind of one follow-up question. Given kind of the core charge-off levels you saw this quarter, absent of any kind of regulatory guidance you're giving, are you finding any additional impediments to sell your SFRs that are currently in NPAs or performing [indiscernible] at this point?

We've really not, Tim, gone out to look to liquidate or sell our NPAs. We have done some one-off note sales, but it primarily hasn't been SFR that's been in some multi-family and commercial credits. It seems to us that the better liquidation strategy given our ability to ultimately sell the REO has been to work with the borrower to the extent we can and to the extent we can't, take them down the foreclosure path as quickly as we are able and then ultimately dispose of the property. What we're finding is that if you are to sell nonperforming assets or loans in the market today, there's a profit margin that you're giving away to someone else. And we are ultimately maximizing our returns on those assets by dealing with them internally in our view, at least at this juncture.

Right, yes. I'll be a little clearer, do you have any problems exposing those foreclosed properties when it's time to do so?

The REOs?

Yes.

No. I mean, you can see in our earnings release, we disposed off more than what we took back. The biggest impediment in many cases is getting the borrowers who have now become our tenants or the tenants that were put in place by our borrowers out of the properties so we can take possession, clean them up and ultimately market properties.

[Operator Instructions] And we will go to Don Worthington's line with Raymond James.

Any color on where you expect the margin to go and kind of in particular, if you have more room to reduce your cost of deposits?

So you were speaking to our net interest margin, not our loan sale margin?

Correct, yes.

Our net interest margin, to a large degree, is a function of the origination volume that we're doing in mortgage banking. Because to the extent that held for sale increases during a particular quarter because volume has gone up, we are essentially redeploying cash out of overnight investments with the Fed back in the held for sale, and we're picking up 350 to 400 basis points. And that's where you see some of the volatility come in from one quarter to the next on a sequential quarter basis. If you see that held for sale level elevated, we would expect our net interest margin to improve. And the reverse is true to the extent you would see held for sale decline. Now with respect to kind of the fundamental margin, if you will, and the question of whether or not deposit costs can decline from where they are, we think they can decline from where they are at least to the extent we have CDs maturing, which we do because they get repriced downward to current market interest rates. But if you look at our transaction account deposits, already we're paying mid-range, if you will, in our markets with respect to those deposits. And it's very difficult to reduce the cost of funds in those particular products. And they are now taking a larger -- or they are a larger percentage of our total deposit balances. So to drive deposit costs lower from here can be done, but I think it's at a slower pace.

Okay, great. And then shifting to the loan sale margin, do you expect those premiums to continue at the current level?

We described our loan sale margin in ranges, and Craig mentioned in his prepared comments that 190 basis points is kind of setting a new high to the range that we've come to expect over the course of the last couple of years. It's a function of demand in the marketplace, and right now, there's a great deal of demand in the marketplace. Rates are at historically low levels, borrowers that refi-ed last year can refi again. And so production volume has essentially taken over all of the capacity in the industry, and as a result, everybody is able to raise their margins and ultimately we see that in the loan sale margin. For us to expect, to set new highs every quarter, I think is a little bit unrealistic, but I do think given where we are in the demand curve that we can stay at the upper end of our range. So what would be a range, probably 140 to 190 basis points as we look down the quarter for September. And it's very difficult to see what's around the quarter beyond one quarter from here.

Okay. And then lastly, I think last quarter you mentioned that you had an OCC exam scheduled to start in May. Has that been completed?

Yes. They've left and just wrapping it up, and we're expecting our exam report within 30 days, the written report.

And next, we'll go to the line of Tim O'Brien. [Operator Instructions] Tim O’Brien: Donavon, question for you. Another way of looking at what you were describing as far as profitability of the MetLife group higher kicking in this quarter. Could I look at it like this, that, that profitability or lack thereof that is derived by their production is predicated by their top line production? Kind of in a sense, there's a breakeven point from a revenue standpoint. And if they hit that mark, then they swing into profitability and that takes into account fixed costs and variable costs or comp costs -- or takes into account fixed and variable costs, is that a good way to look at it?

Yes, because ultimately they're there to produce production volume and retail production volume. And when they come on board, they obviously don't have their pipeline and they have to build it up, but we have all of their costs associated with bringing them on board. And so now they've got their pipelines built and, indeed, they're delivering revenue through gain on sale as a result of their increased volume. So I would expect there to be top line growth in the form of revenue from that group and not necessarily a commensurate growth to operating expenses because essentially we've had a large portion of their operating expenses embedded in the income statement already. Tim O’Brien: Do you evaluate their -- that part of the business, the MetLife group business, do you evaluate it in terms of -- do you have kind of some capacity number in the back of your mind where they're capable of generating x volume of loans just based on how many head that people are working in that group and how many hours in the day there are -- do you look at it that way? And if so, kind of what was their -- how much of capacity did they reach in the last quarter and what's your runway look like for growth in that business, I guess, through the end of the calendar year? Could you give a little color on that?

For obvious reasons, we're not going to give away what our -- what we expect for each branch as it relates to their production volume. But each of our branches are on a separate P&L, and we understand what they should be doing relative to their production volume and relative to their headcount. We use metrics such as number of loans produced per retail channel, FTE, number of loans produced per wholesale channel, FTE, and all of that is embedded, if you will, in all of our models and, if you will, in their separate P&L. So let me just, I guess, suggest that they were not close to full capacity because literally they came on in February, and in many cases you're looking at 90 to 120 days simply to build your pipelines to the point that they should be relative to a normalized run rate. So they really didn't get there until May or June of 2012. We saw profitability from the group in June of 2012. It was around breakeven, I suspect, in May. I would have to look for certain to see that. But ultimately, for the quarter, the June quarter, they were unprofitable, and for the fiscal year, they were unprofitable. Maybe another way to think about it is the distribution between the retail and the wholesale channel. In our earnings release, we described what our activity is between the 2 channels and you'll see that we grew retail in the fiscal year in comparison to the prior fiscal year by approximately $250 million of volume, and that was predominately done without the MetLife group. And then if you contrast that to the wholesale volume, we increased wholesale by about $120 million for the fiscal year. So the increased production volume that we realized in fiscal 2012 by a 2:1 margin came out of retail, which is far more profitable than wholesale. And frankly, that's what we're trying to do, is redistribute production volume into the retail channel versus the wholesale channel. So wholesale is not predominant. Tim O’Brien: And if those trends -- carrying in on that last point that you just made, if that trend continues of a shift in the business production toward retail versus wholesale, well, first of all, do you consider that a good possibility that the business is going to continue to shift over there based on your efforts?

Well, we think so. But much of this... Tim O’Brien: I mean, you never know and you're going to keep your power dry on the wholesale side. I understand that, but if that happens, that should be supported to gain on sale margin too, correct?

Correct because the gain on sale margins are healthier in the retail than wholesale. Tim O’Brien: Okay, fair enough. Let me ask you this, on the FTEs, Craig, you gave a number a minute ago. Your FTEs for the bank including the mortgage group at the end of the second quarter or your call report was 543 and it was 515 in the first quarter, so you added 28 FTEs this quarter. Now could you tell us what -- am I correct there?

Yes, I would have to look at the number, but that sounds correct. Tim O’Brien: And again, characterize, who were those hires right there, some of those were in -- those where commercial real estate lenders and such and multi-lenders in that group you hired plus you have staffed that branch, the La Quinta branch, I'm assuming that some of the hires from that 28 were there?

Yes. Tim O’Brien: And then what about -- could you add -- did you say you added mortgage, single-family mortgage lenders as well? Continue to have...

Yes. I think I would have to go back in and look where we ended March with respect to the FTE count in mortgage banking, but I'm going to say it was around 320 and at June 30 we were at the 337. So of that FTE count that you see in our call report, call 17 or 18 of the increase in the mortgage banking area and then the remainder we're staffing out the branch in La Quinta as well as putting on some originators in our CRE group. Tim O’Brien: Those mortgage banking hires that you gained, were those hires, were they throughout your footprint or more North Cali-ers or Southern California or where they come aboard?

They were throughout our footprint adding to existing offices. Tim O’Brien: Got it. And then, did you guys have your annual meeting -- strategy meeting and such this quarter? Is that down the road? What time -- when in the year do you guys -- when does the board get together and talk strategy and what you want to accomplish for the coming fiscal year?

Yes, we did, Tim. We always do that the last week in June right before the end of our fiscal year when we're doing our financial planning for the next fiscal year so that they can look at the proposed budgets and talk about strategy at that point. So yes, that was about a month ago. Tim O’Brien: Well, that's wonderful then because then I can ask a question of you, Craig. Could you give a little bit of color on given what we've just gone through this year as far as changes in the industry are concerned and also all the work that you guys have done and looking out, looking forward, what do the board talk about? Can you share a little bit of color about -- give us an incremental on strategy for the coming year. Is that something you might just even touch on?

I really can't, Tim. Not anything specific. I mean, we talked about the challenges that are there in the marketplace. We talked about controlling growth in mortgage banking, trying to become more efficient with the bodies that we have because we were steadily growing the mortgage banking personnel. And we think we can be more efficient in that area. We talked about the possibility of opening retail banking offices, but we want to do that really slowly and carefully. And we talked about the regulatory headwinds and the legislative headwinds that we still see coming, not at least of which was having a new regulator, OCC, and making sure they understand what we're doing and we understand what they're looking for. So all of that was a lot of what was discussed in that planning retreat.

One of the other things that we spent, put a good bit of time on was with respect to balance sheet growth and essentially coming up with some plans to begin to grow the balance sheet again rather than shrinking the balance sheet as has been the case for the last 3, 4 years. The markets have to cooperate with us, obviously. But part of the strategy is building up the commercial real estate, multi-family loan group, get them in a position where we're actually able to fund higher volumes of those products. And then, perhaps, even start looking at single-family loan production into the portfolio again since we obviously have the mortgage banking platform there and we can do so relatively easy. Again, depending upon what the market is doing and what the products are that are predominant in the marketplace. We don't want to add 30-year fixed-rate loans to the portfolio. It's very difficult to generate any sizable production in hybrid arms today because 30-year mortgage rates are so low. So we have some challenges to overcome, but obviously as we think about the next year, the next couple of years, we're interested in growing the balance sheet. We're no longer interested in shrinking balance sheet.

Gentlemen, there are no further questions at this time.

All right. Well, I want to thank everyone for joining our conference call, and we look forward to speaking with all of you again next quarter. Thank you.

Ladies and gentlemen, that does conclude our conference for today. We thank you for your participation and for using the AT&T Executive TeleConference. You may now disconnect.