Provident Financial Holdings, Inc. (PROV) Q1 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the first quarter earnings release conference call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Chairman and CEO, Mr. Craig Blunden. Please go ahead.

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, 2012, 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're 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 first quarter results. Credit quality is stable and we continue to believe improving is likely but at a slower pace. Total nonperforming assets on September 30, 2012, were $34.1 million, a 66% decline from what appears to be the peak of $100.7 million on December 31, 2009, recorded at $553,000 provision for loan losses during the quarter ended September 30, 2012. While net charge-offs were $1.9 million, which was significantly lower than the $4.8 million in the June 2012 quarter and to the net charge-off of $2.8 million in the September 2011 quarter. As we've described in the past, 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, slow economic growth may last 'til the remainder of 2012 keeping our nonperforming assets elevated. It's important to note though that the delinquencies in charge-offs in our multi-family and commercial real estate portfolios have remained 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 been written about the state of the single-family housing markets. And we're 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 349 FTE in mortgage banking on September 30, 2012, but we'll remain vigilant in monitoring the operating environments so we can adjust our model as we have done in the past commensurately changes in loan origination volumes. We're pleased to report that we have opened 2 new retail mortgage banking offices. One is located in San Diego and the other will be soon located in Stockton. We expect after the start-up period that the new offices will become a meaningful component to our retail mortgage banking channel. The volume of loans originated for sale in the first quarter of fiscal 2013 increased significantly from the same quarter last year and from the June 2012 sequential quarter levels. New applications remained at elevated levels for the entire September 2012 quarter, resulting in a robust locked pipeline for the start of our second quarter of fiscal 2013, which suggests that the volume of loans originated for sale in the second quarter maybe similar to current quarter's levels. The loan sale margins for the quarter ended September 30, 2012, improved from the prior sequential quarter, establishing a new high to the range that 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 example, during the quarter, we originated and purchased a total of $16 million of multi-family and commercial real estate loans to augment loans held for investment. Additionally, while our operating expenses have increased as a result of hiring additional mortgage banking personnel, our efficiency ratio has improved at 56%, demonstrating that the increases in revenue generated from the investment mortgage banking is outpacing the increases in operating expenses. Simply said, the investment is paying off. We continue to maintain higher liquidity balances in response to the uncertain operating environment are our less concern we're doing so today and this time last year, which is another reason we're expanding our multi-family 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 in the June 2012 quarter. Our net interest margin increased by 17 basis points this quarter in comparison to the same quarter last year because liquidity was redeployed to support higher average balance and loans held for sale. Nonetheless, the key takeaways with respect to our first quarter results are the stable and improving credit quality trends and returns we are 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 de-leveraging the balance sheet is required but we recognize that loan demand is weak and it maybe difficult to generate a sufficient volume of loans held for investment to replace payoff. Nonetheless, we're investing our multi-family and commercial real estate loan platform to take advantage of loan opportunities as they arise. For the foreseeable future, we believe that maintaining regulatory capitals above 9% for Tier 1 Leverage and 12% Total Risk-Based is critical and are confident we will be able to do so. Additionally, in the September 2012 quarter, we repurchased approximately 194,000 shares of common stock. We 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, a first of which was distributed to shareholders on September 5, 2012. We encourage everyone to review our September 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 own portfolio and favorable mortgage banking fundamentals. We will now entertain any questions you may have regarding our financial results. Thank you. Greg?

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

Craig, I had a question about the reserve ratio, do you have a target reserve ratio in mind?

You mean with respect to the loan -- for loan losses?

Right, on the portfolio, yes.

Well there's really no target per se because the target can change over time depending upon improving or deteriorating credit conditions. What I would describe is that we think the credit conditions for our portfolio are stable to improving and as a result, I think the trend that has been established with a lower charge-off amount over a 12-month horizon and then ultimately, a lower provision over that same 12-month horizon is something that can be replicated as we think about it for the next 12 months, for instance or next few quarters. Remember that our charge-offs in the March quarter and the June quarter of 2012 were influenced by adopting OCC criteria and moving up from under the thrift financial report into the call report. So while if you look back, those charge-offs were elevated the essentially accelerated charge-offs that would have occurred in a later quarter. And I think that's one of the things that you see in the September quarter with the charge-off going down to $1.8 million from the $4.6 million or $4.7 million in the June quarter. So to answer your question, I don't think the provision has to remain elevated and it would be consistent with what is actually occurring in the portfolio with respect to what we see with the credit risk.

Okay, now that's super helpful, Donavon. And then the loan sale margins that we saw this quarter, should I anticipate it stays in this 2% range?

Well, Tim...

Well maybe describe the kind of the market dynamics that are putting this -- the loan sale margin at the 2% range.

Right. Yes, everyone is so busy that you were able to get these margins that you really can't get when people are pricing to get more business. I think what you're saying is you're seeing people price to slow down now the business because they can't handle the volume, and that's really forced margins up.

One of the other things that has impacted the quarter most recently and which may actually work through future quarters when QE3 was announced and the government steps in to buy mortgage-backed securities, there was a disconnect between the 10-year treasury, which actually, the yields went up a bit while treasuries have improved. So the margin that we saw and the execution that we saw in mortgage-backed securities was far better. And I think the reason for that is I think the latest numbers, the government is purchasing something like 55% of all mortgage-backed securities production. So that is also influencing our ability to price and the industry's ability to price.

Okay. The growth and the strength of the mortgage banking operations, has that allowed you to be more selective in determining what loans come into the loans held for investment?

I think we have an opportunity because we essentially run 2 businesses. We run traditional community bank business and we run mortgage banking business. And at any particular point in time, given the economic circumstances that we're in, we can direct where we believe the better opportunities are. So we can direct what it is we wish to do. And right now, the opportunity is in mortgage banking and that's where we've been investing. As a result, there is less pressure on us than in similar institutions of our size or labeled community institutions, if you will, because we don't have to grow the loan portfolio as others may have to with respect to meeting earnings numbers, getting up satisfactory return on equity, EPS, et cetera. But having said all of that, we're also not in the business of shrinking our balance sheet. We are very interested in growing balance sheet. Our capital ratios are very strong, but it is very competitive in what we call preferred loan group, which is commercial real estate, multi-family real estate loans primarily. And I can't comment on somebody else's underwriting criteria. I just know that ours has not changed. In fact, that might have even tightened a little bit from where we've been historically and as a result, we're not seeing the product that we once saw in better economic times. And that, unfortunately, is influencing the decline in our loan portfolios because we can't keep up with our payoffs.

Okay. And then I just have one follow-up question. Has anything changed with your goals towards capital management?

No, not that what we've talked about in the past, Tim, no. Nothing's changed in the capital management.

Your next question comes from the line of Jason Stewart from Compass Point.

On the -- in the mortgage banking segment, if we could take a step back and think about the environment not just profit environment in general, what kind of investments do you see competitors making today to expand capacity?

Generally speaking, the capacity is expanded by hiring personnel. You have to have the personnel to open offices and to generate the production volume. So in general, that environment is very competitive. What works to our advantage in that environment is that we are a smaller mortgage banking company, if you will, than many of the largest in the nation. For instance, Wells Fargo. It has about 1/3 of the entire mortgage market. If you are an originator with Wells Fargo or a similar organization to Wells Fargo, the backlog of that origination machine in getting the loan through, what is it? 2, 3, 4 months? It's an extended period of time. And I think there's some frustration with respect to the originators as it relates to the capacity issue. And so ultimately, what we're finding is that we can attract some of those producers, bring them into our organization and then we build an office around them. That's what's happened this quarter with a group in San Diego and that's what's happened with the group in Stockton. And what we do when we bring these groups on, we pair them up with an existing office so that the underwriters and processors get trained by an existing personnel to the extent the originators don't have underwriters or processes, we direct their origination flow to existing offices and it allows us to expand in a careful, thoughtful manner while still controlling the credit quality from these new producers.

Okay. And when you're hiring new producers or offices, do they generally come with the back-office support, the processors and underwriters or is it usually just a producer?

Many times, they do. They follow their producers around. They've had a long-term relationship, so what we've seen for the most part is that has. Although, the group that we're doing in Northern Cal are just originators and they did not come with the back office. So they're hooked up with an office we already have near them up there.

Okay. Along the same lines, what we've been hearing is that the biggest bottleneck, the challenge really has been to hire the back office to support production and that's really where the bottleneck has been. Has that been -- is that a fair characterization of the market? And are you seeing similar issues or any thoughts on that?

Yes, you're right. We're finding the same thing. If you need to fill a spot in the back office whether it's an underwriter or a funder, something like that, that with the business where it is today, that's the toughest type of job to fill. And that's why it's been helpful when we've hired the new originators that they've been able to bring some of those qualified people with them.

Okay. And then just to go back to the previous question. this is -- it looks like the first quarter that the balance sheet at least from the asset side is growing some time a trend assuming that we should expect to continue. I know it's a desire to grow but is it, given the flow that you're seeing out there, is it a reasonable expectation to see the balance sheet continue to grow?

Well I think if you start looking at where the growth of the balance sheet occurred, it did not occur in held-for-investment loans, which is where we would want the balance sheet growth to come from. It probably grew as a result -- and I haven't looked at it to -- but it's probably grown as a result of held-for-sale loans. And that's terrific because that's an earning asset on our balance sheet as well. But it's a transitionary item on the balance sheet and it is dependent upon the origination volume of the mortgage bank. So we're cautious with respect to our ability to grow the balance sheet but everyday, we are working very hard to make sure that our held for investment group, the preferred loan group, has the staff necessary -- has the pricing necessary to generate origination volume in multi-family and commercial real estate. And at some point, we're going to get the traction necessary to grow the balance sheet in that area. Right now, we're a bit cautious on that.

Yes, the other unknown, of course, is what are the levels of payoffs going to be and we've had some pretty hefty payoff months in the last quarter, which were tough to cover with originations. And it's hard to forecast those payoffs maybe looking forward to the next few months.

It is also, though, a good time to make the point. We are beginning to look at bringing some loan production, single-family production onto our books from the mortgage banking area. In fact, we picked up $3.2 million in the September quarter of single-family loans. It's not a program per se but we look at their pipeline every week or so and we begin to designate some of the loans in those or in that pipeline to be transferred to the portfolio or held for investment rather than held for sale. And I expect that we'll be doing more of that as we go down the timeline. We've indicated that, that was the case and that we would be doing so and we're starting to do so now.

Well we're starting to see the jumbo markets finally after years start to pick up recently in the last month or 2 and accelerate, which is really a good thing looking at volumes in the future.

Craig, that was my question. At the loans that you're retaining in single-family are -- would be eligible for sale they are not being originated just to be put on the balance sheet, is that right?

That's correct. And in fact, primarily right now, because of the interest rate issue, the bulk of all loans being originated today are 30-year fixed, which we're not necessarily interested in retaining. But there are also some other products being originated and the predominant balance is coming into the portfolio for mortgage banking is 10-year fixed fully amortizing. The cash flows of the 10-year fixed product is very similar to an adjustable-rate product and so that's what we focus on with respect to bringing them on the balance sheet.

And we're also looking at very low loan-to-value levels.

Your next question comes from the line of Don Worthington from Raymond James.

In terms of the breakdown between refi and purchase, where is that running currently on your mortgage banking?

That's running about 38% purchase right now, which is much lower than it had been running just a couple of quarters before. So refi has really accelerated in the last quarter.

Okay. And then in terms of -- I just noticed there was a little uptick in 30- to 89-day delinquencies in the quarter. Was that 1 or 2 loans or more broad-based to that?

It was a few loans. It was single-family only again. And we're still finding, Don, every so often people still have problems in this economic environment. And it just happened these loans were a bit higher average balance than we've seen in the past and that's what drove the number up.

Okay. And I know you had a small gain on REO sales, are you getting a little bit better pricing there or is it just a function of maybe a being a little conservative on the write-down and then getting a smaller gain on the sale?

I think it's always going to be somewhere around breakeven because we think we've estimated the prices and values correctly, but sometimes there's more cost in rehabs and more expenses that way getting people out and other times there aren't those costs. And I think that's the variable there, not so much how much we've reserved on the individual loans.

Your next question comes from the line of Tim O'Brien from Sandler O'Neill. Tim O’Brien: Question on the funding side. Now that you have a quarter under your belt for the new fiscal year, do you guys -- in looking out, do you feel like, given what -- how the -- how the people is running, your funding situation is adequately taken care of? I know you're going to likely rely on deposits and are going to be able to do that to the degree that you did in the last fiscal year here in the new fiscal year?

With respect to the mortgage banking business, we're very comfortable with respect to our ability to fund that business with the current balance sheet. As it relates to being able to grow the balance sheet when we see that we're able to generate more than what is paying off, our preferred course is to bring in retail deposits. And in order to do so, we would probably have to pay up a little bit to bring that in or those deposits in, in comparison to where we are today. But there's also opportunity in that we have CDs that are maturing that were originated at higher rates than current market rates. So we'll be able to reprice those CDs down. And then coupled with that are our federal home loan bank advances, which frankly, we've been running off for essentially 3 or 4 years. We have opportunity in that regard and that we have $20 million maturing in 3 to 6 months and the average cost of those advances is 3.39% and then in 6 months to 1 year, we have another $50 million maturing. The average cost of those advances are 4.09%. We would expect that we wouldn't necessarily simply let those advances mature without replacing them and given where current FHLB advance rates are, we could pick up a quite of the few basis points on that component. And then secondarily, even we ran them off we have sufficient cash on hand given our current business. Tim O’Brien: Historically, Donavon, can you just give us a little bit of color? When you guys have added FHLB advances in the past, have you intended to gravitate towards longer term or is it really just there's no rhyme or reason -- I mean, there's always a reason behind what you're going to do. But have you used a wide variety of borrowings depending on the circumstances or have you intended to go in one direction or another or avoid longer term?

It's a function of the interest rate environment that we're in. For instance, we're in very low interest rate environment today. Our preference today would be adding long-term advances rather than short-term advances because I think everybody suspects that at some point, interest rates are going to rise. There's other occasion where we may fund ourselves short if we believe we're in an economic environment where interest rates are going to be declining. So it's dependent upon the economic circumstances, first of all. And then second of all, it's dependent upon what the use of those proceeds are. For instance, if the use of those proceeds are to fund the mortgage banking held-for-sale pipeline, which turns every 45 days, our preference would probably be short term. On the other hand, if those advances are taken down as a result of growing held-for-investment loans, we would gravitate toward the longer-term advance. Tim O’Brien: Switching gears back to the gain-on-sale mortgage -- or about margin, can you tell us what that margin was like at the beginning of the quarter versus end of the quarter after that quantitative easing news was finalized?

I think it did widen out toward the end of the quarter in mid-August, September in comparison to the beginning of the quarter. But quite frankly, the margin was pretty south through the entire quarter. Tim O’Brien: Okay, great. And then -- that's good to hear. Last question, as far as buildout of the new retail platforms in Stockton and San Diego, so are those groups online right now that they've already been hired or what's the timing for ramping up production through those offices?

The group in San Diego is up and running. In fact, we put them in a space next to an existing group that we had down there so that we can get them up and running quicker with respect to communication lines, IT, et cetera. Eventually, we may end up finding space for them elsewhere. The group in Stockton is very early on. In fact, I don't think we've even signed for the space yet. Although, the individuals themselves are already starting to originate production into one of our other offices. But at some point in the near term, we'll have some space for them in Stockton. Tim O’Brien: How big are the groups?

These are small and the Stockton group was 3 or 4. The Escondido group or San Diego group was a little bit more than that, maybe 5 or 6, as I recall.

[Operator Instructions] And at this time, there are no further questions.

All right. Well I'd like to thank everyone for joining us on our quarterly conference call and I look forward to speaking with all of you again at our next quarter. Thank you.

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