Provident Financial Holdings, Inc. (PROV) Q3 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the third 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, objective 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 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 third quarter results. Credit quality is improving and we continue to believe further improvement is likely but at a slower pace. Total nonperforming assets on March 31, 2013, were $22.4 million, a 78% decline from what appears to be the peak of $100.7 million on December 31, 2009. We recorded a $517,000 recovery from the allowance for loan losses during the quarter ended March 31, 2013; while net charge-offs were $1.2 million, which was lower than the $1.6 million in the December 2012 quarter and to the net charge-offs of $4.3 million in the March 2012 quarter. As we have described in the past, improving credit quality going forward will be inconsistent and irregular. Our 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 slowed economic growth may last through much of 2013, 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 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 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 370 FTE in Mortgage Banking on March 31, 2013, similar to the 368 FTE count at December 31, 2012. But we remain vigilant in monitoring the operating environment so we can adjust our model as we have done in the past, commensurate with changes and loan origination volumes. We have recently slowed the pace of mortgage banking new hires but we'll continue to look for new retail mortgage banking opportunities. In fact, last week, we opened our newest retail branch in Santa Barbara. The volume of loans originated for sale in the third quarter of fiscal 2013 increased significantly from the same quarter last year but is down from the record levels in December 2012 and September 2012 quarters. New applications remained strong for the March 2013 quarter, resulting in a significant locked pipeline for the start of our fourth quarter of fiscal 2013 when compared to the same quarter of fiscal 2012, suggesting a higher volume of loans originated for sale in the June 2013 quarter, in comparison to the June 2012 quarter. The loan sale margin for the quarter ended March 31, 2013, declined from the prior sequential quarter, but remains at the higher end of this historical range. Overall, loan sale execution remains favorable at very liquid markets for agency conforming loans, and we're working diligently to maintain our loan sale margins at these more profitable levels. We will note that the recourse reserve for loans sold decreased to approximately $2.3 million in the March 2013 quarter as result of reaching a global settlement with the bank's largest legacy loan investor, which was described in more detail in our December 31, 2012 Form 10-Q. The settlement was paid in the March 2013 quarter and was fully reserved in the December 2012 quarter. In addition to our improving but guarded view of credit quality and our positive outlook on mortgage banking, there's been other developments regarding our operating results. For example, during the third quarter, we originated and purchased a total of $16 million of primarily 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 to 60% for the 9 months ended March 31, 2013, demonstrating the increases in revenue generated from the investment mortgage banking as outpacing increases in operating expenses. 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 in the June 2012 quarter. Our net interest margin decreased by 15 basis points this quarter in comparison to the same quarter last year because of higher liquidity balances. Nonetheless, the key takeaways with respect to our third quarter results are the improving credit quality trends and the returns we're now realizing from the investment we've 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 commercial real estate loan platform to take advantage of loan opportunities as they arise. For the foreseeable future, we believe that maintaining regulatory capital ratios is above 9% for Tier 1 Leverage and 12.5% total risk-based is critical and we're confident we will be able to do so. Additionally, in the March 2013 quarter, we repurchased approximately 161,000 shares of common stock and approved a new stock repurchase plan because we continue to believe that executing on stock repurchases is a wise use of capital in the current low growth environment. We also raised our quarterly cash dividend by 40% to $0.07 per share and the first of which was distributed to shareholders on March 5, 2013. We encourage everyone to review our March 31 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.

[Operator Instructions] Your first question comes from the line of Jason Stewart from Compass Point. Jason Stewart - Compass Point Research & Trading, LLC, Research Division: A macro question to start and then 2 follow-ups, if I may. In terms of housing activity, have you seen in your markets a material pickup in institutional, or should I say just change in institutional investor activity, and maybe a thought or 2 of how that might have impacted transaction volume?

Jason, what do you mean by institutional activity? Jason Stewart - Compass Point Research & Trading, LLC, Research Division: So some of these like Blackstone's single-family, we had a rental unit where they're on the court steps buying for closed properties and then renting them instead of turning around and setting them.

Well, certainty, it's affected the amount of supply where inventory of homes for sale. Our realtors are telling that everyday because, as you just mentioned, one of the examples says that investors are buying these on the courthouse steps, which means they never get to the realtor to be sold. So supply is definitely an issue today and we can only hope as values rise that more individuals will finally start putting their homes back on the market for sale. Jason Stewart - Compass Point Research & Trading, LLC, Research Division: Okay. So I guess the follow-up to that would be, there's probably some more near-term appreciation in prices although lower opportunity to originate mortgages on a lot of that transaction volume. Would that be a fair way to characterize it?

Well, I think we've been dealing with investor activity in the SFR market for a significant period of time. In other words, that's not just a new phenomenon going on today. It's been going on for a year, 1.5 years, 2 years. Those funds were in place for that length of time specifically to do that. So I'm not certain that, that dwindles in a pure sense the supply that is available today relative. Now to the extent that there are more funds coming in or that they become more active, then I would agree that potentially, it reduces the ability for mortgage volume as a result of that. But I would also argue that if that is occurring, we will see housing prices rise, and then there will be more entrants into the sales activity because borrowers will finally be able to unload their homes, if that's what they've been wanting to do, but haven't been able to do so because of LTV issues.

Jason, another thing that I've been wondering is, how -- at what price level did the investors finally decide that there's not as much immediate upside in over, let's say, 3 to 5 years on prices. And so will they start backing out at a certain level from the marketplace because it really had driven up prices substantially from the lows that we saw a few years ago. Jason Stewart - Compass Point Research & Trading, LLC, Research Division: Right. I guess that's something that deserves watching. On a different topic, on gain on sale, would -- could you give us any color on margin and how it progressed through the quarter?

If I think about coming out of the December quarter and out of the holidays, there certainly was more margin compression at the beginning of the quarter in comparison to the end of the quarter because everybody was trying to build their pipelines to begin the new year. Additionally, we saw interest rates, mortgage interest rates, go up. Let's say, the first half of the quarter, which again brought volumes down a bit, so I think people started shaving their loan sale margins to generate pipeline growth as well. As we got into the latter stages of the quarter, in fact, the reverse occurred where interest rates started coming down, pipelines began to build a little bit better and as a result, I think there was less pressure on the loan sale margin. And frankly, today, we saw the tenure go down again as a result of the GDP number coming out. And I guess, this might be a good segue to discuss where pure mortgage rates are today in comparison to where they might have been in the lows. This morning, in the L.A. Times, there was an article describing what the GSE's average weekly rates were. The 30-year fixed rate mortgage last week was 3.40%. Well, that compares to the all-time bottom last fall of 3.31%. So we're seeing 30-year fixed-rate mortgages only 9 basis points above where the bottom was last fall when volumes were very good. Additionally, the 15-year fixed-rate declined to 2.61%, which is an all-time low ever. So the mortgage interest rate impediment with respect to volume, does not really seem to be there today as it may have been at the start of the quarter.

Our next question comes from the line of Tim Coffey with FIG Partners.

If I can take the other side of that question, can you give us a little color of how the pipeline for mortgage is built through the first quarter?

I think it's pretty similar to what the margins were doing. Toward the end of the quarter, pipelines were building in comparison to the beginning of the quarter when we were coming out of the holiday season. In fact, if you look at the investor presentation, our pipeline at March 31 was larger than at March 31 of last year, which suggests to me that our volumes for the June 2013 quarter will be better than the volumes at June 2012 quarter, $790 million of volume in the March quarter. I guess I would have to go back and look, but that's a very good performance for us, historically. That's a big number for us. It was up from the March quarter of 2012, largely the result of our adding of staff in branches which were fully functional and driving volume this year and compared to last year. And so I think there are many positive signs with respect to both volume and margin, as we think about where we're at today in comparison to what the thoughts may have been at the beginning of this quarter or maybe even at the end of last quarter when everybody was suggesting that maybe the refi wave is going to really tail off and that purchase money activity may not satisfy the tail off in refi. And that still may be true, but I don't know that it's going to be as significant a drop in volume as what the initial thoughts may have been.

And then, do you see any near-term opportunities for jumbo production?

Well, we're seeing our own activity increase from what was essentially 0. For the past 2, 2.5 years as this mortgage environment has been good for us, it's primarily been conforming or the GSE jumbo conforming, because that's where the liquidity was in the market with respect to the secondary. Today, we are doing volume in jumbo. It is still a small percentage of our total volume, but it has been growing over the last 4, 5, 6 months. And additionally, what we've been seeing is that the secondary market seems to be developing more where there are more than just the 2 or 3 aggregators that are putting out jumbo packages. More have -- are seemingly jumping into that market, which will certainly create more liquidity and demand for jumbo. So today, it's a small portion of our total volume, but that doesn't mean it will be a small portion of our total volume as we go forward. We do think there's opportunity there.

And at the peak, what percentage of your production was jumbo?

Back in the last cycle?

Yes.

A lot.

A lot.

I don't remember the percentage. It was a big portion because of the type of product that it was back then.

Because if you remember, there wasn't the jumbo GSE product. And then additionally, we were in California -- or we're largely in California -- or California origination market, which were very high home prices. So the volume associated with that last cycle, again, I'm not going to quote you a percentage, but it was a significant component of overall volume.

So could you see yourself getting back to that or near that percentage?

Well, it's going to depend upon the market, certainty. But absolutely, we have the capability to be able to do so. But we have to see the secondary market develop to be able to take the product. And I think there's still a little bit -- the QM thing -- QRM thing is still out there holding it up a little while it seems. But yes, absolutely we can see ourselves doing more of that product as a percentage of our total volume.

Okay. Our next question comes from the line of Tim O'Brien with Sandler O'Neill. Timothy O'Brien - Sandler O'Neill + Partners, L.P., Research Division: Regarding jumbo and the looks [ph] you get from secondary market buyers potentially, if you hold up that gain-on-sale margin from, I guess, your overall sales this quarter, what was it? 170 basis points?

Yes. Timothy O'Brien - Sandler O'Neill + Partners, L.P., Research Division: How would jumbo margins today compare to that and how should we look at that even?

I'd be honest with you because it's been such a small component of our total volume, I haven't really looked at jumbo loan sale margins per se. I would expect that they would be similar to what we're getting in our GSE products or the GSE product lines, but I think they would be lower than the FHA/VA product lines with respect to our volumes. So I don't -- it's difficult for me to say because I haven't specifically looked at that. But I have -- I'm not hearing from our mortgage banking personnel that jumbo is significantly less profitable than our other product lines. Timothy O'Brien - Sandler O'Neill + Partners, L.P., Research Division: And then do you see opportunity to -- are you guys involved in HARP business?

We're really not involved in HARP. Timothy O'Brien - Sandler O'Neill + Partners, L.P., Research Division: Okay. Not interested?

Well, no, a lot of it has the servicing. If you're servicing those loans, HARP makes a lot of sense. But as you know, for many years, we've sold all of our loan servicing released.

Yes.

So the servicer has never thought of those and I -- we might... Timothy O'Brien - Sandler O'Neill + Partners, L.P., Research Division: So there's no way to tap that, I guess, because there's fees and money to be made, but it's just not efficient to pursue probably?

No, we stumble on one here or there, but more like by accident. Like I said, if you're Wells or somebody that's servicing those loans, I mean, you're all over them. Timothy O'Brien - Sandler O'Neill + Partners, L.P., Research Division: Yes. And then have been hearing rumblings about payoffs of warehouse line, mortgage warehouse lines, pretty sizable pay offs in some quarters. Have you guys -- are you aware of that or what that -- is there any significance to that as far as your view of what's going on in the marketplace? Do you have any color you could provide or expertise or insight?

Well, I think it's a function of what the volumes did in the March quarter in comparison to the December and September quarters. And quite frankly, you can see it in our own balance sheet because we ended the quarter with a sizable amount of cash on our balance sheet that was essentially the result of a lower held-for-sale pipeline. We're essentially our own warehouse lender. And so you can see that movement and it's really purely a function of what total volumes are doing. So I think, again, there's seasonality in the March quarter, at least based upon our specific experience, and I think that's probably industry-wide. And so when you look at the March quarter's activity with respect to warehouse, I think that's a large component. And perhaps the other component, we've heard a number of people entering that business. So there may be more supply of warehouse lines out there, such that the originators have more choices. And perhaps, the other price-cutting and the like and originators are moving elsewhere than their original warehouse lenders. Timothy O'Brien - Sandler O'Neill + Partners, L.P., Research Division: I was looking over the jobs, California job support number for March, and it showed a big spike. I think construction jobs were way up on a year-over-year basis, but also up year-to-date quite a bit. By extension, do you see -- are you seeing more jobs created in the mortgage space? Are you guys able to keep tabs on that and how is competition changing these days? What's your perspective there, your expert perspective, Craig and Donavan?

Well, I think that there was -- especially towards third quarter and fourth quarter last year, there was a dearth of experienced mortgage banking personnel and everybody was out there bidding against each other for the talent that was available. I think that slowed down a little bit earlier. But when you see rates like this, and you know that people were running their institutions or mortgage banking companies with a lot of overtime, you can only do that for so long. You've got to find some other help. And so yes, I think it's still pretty tough out there. But then we're -- on the other side that we're hearing that some of the large lenders have started consolidating more of their operation centers, and one in particular, I believe in Northern California, and all of a sudden, we think there's an opportunity to hire a bunch of those back-office talent, underwriters and processors and so on, because of some consolidation in the big companies. Timothy O'Brien - Sandler O'Neill + Partners, L.P., Research Division: You -- that's something despite kind of what your current views are you might take advantage of, is if you find good back-office talent, you'd -- you're going to take a good hard look at that?

Well, absolutely, because, I mean, during some of these periods, we've been working everybody pretty hard and paying a lot of overtime and you can only do that for so long. You just burn people out. So yes, it's incumbent when we can find great talent like that, that we hire them, and we're looking at that now. Timothy O'Brien - Sandler O'Neill + Partners, L.P., Research Division: One last question actually. Housing price appreciation, it's -- San Francisco this month hit its all-time high on median home prices. Now, it's quite a bit beyond -- quite a bit ahead of the pack as far as other counties are concerned. But do you guys see price appreciation this year? I'm not going to hold you to it, but remaining strong, as strong as it was last year, is it -- are the conditions right for strong additional appreciation here going forward in 2013, in your views, in your opinions?

Yes, I think so. I think it's going to be probably as strong -- certainly, it's got a better chance to be stronger on the jumbo side, in other words, the high-priced home, because you're getting more and more sales and we've seen at least -- let's just talk about Riverside in the higher-priced markets. We're seeing houses that are selling the first day they come on the market. We're talking about anywhere from $800,000 to $1 million, $2 million in sales prices and let me tell you, this is no San Francisco here. And those houses, as soon as they get on the market, are getting multiple bids over the asking price. So that gives me some confidence that we'll continue through the year we're seeing increased housing values.

Yes. When we look at -- again, in the same L.A. Times article this morning that I quoted earlier, Southern California, new homes sold jumped 19% in price year-over-year in February. So I do think that the bottom has been found, that we're moving up in price as a result of having found that bottom. And the thing I'd like to point out with respect to that as it relates to our business, we talked about the jumbo production kind of being dependent upon liquidity in the secondary markets, but we also have the ability for additional refi legs on -- or for those borrowers who now have a year-over-year price appreciation in their home where they were once not able to qualify on an LTV basis for a refi, they are today because values have gone up. So there's another bit of refi legs, if you will, with respect to the mortgage business to the extent we continue to see appreciation in housing.

One other thing, Tim, that we've noticed in the REO and foreclosure area, and not that we have very many these days, but we're seeing these deals get bid out on the courthouse steps in the last 6 months, and we weren't seeing that at all for years, and that's only because, guess what, values are coming up. And when we do got an REO back and we finally get the people out, which seems to take forever, we get it fixed up, we're getting multiple bids and we're actually making money, if you look on that line on the income statement. It's no longer an expense line because values are up.

Your next question comes from the line of Don Worthington from Raymond James. Donald Allen Worthington - Raymond James & Associates, Inc., Research Division: I want to shift to the margin on the portfolio as opposed to the gain on sale margin. That was quite -- it was down about 14 basis points in the quarter. What's your outlook there for the margin going forward?

It's really going to be dependent upon what our held-for-sale line does. The reason the margin compressed as much as it did in the March quarter is because cash-on-hand went up because held-for-sale went down. So to the extent we see increased volumes from what we've seen in the March quarter such that held-for-sale increases in balance sheet line item, cash comes down and margins are not necessarily then compressed, if you will. So that's really the big driver of our compression in comparison to a traditional community bank, which really doesn't have a held-for-sale line. Donald Allen Worthington - Raymond James & Associates, Inc., Research Division: Okay, great. And then in terms of the multi-family, commercial real estate originations in the quarter, what was the breakdown between the 2, multi-family versus commercial real estate?

Multi-family, we did $9.6 million; commercial real estate, we did $6.5 million; and single-family, we did $2.6 million.

Your next question comes from the line of Matt Johnson from River Oaks Capital.

My first question relates to the buyback program. I saw that you bought back 160,000 shares in the quarter. And I was just curious, given the very strong profitability, the valuation right around tangible book or the small premium to tangible book and kind of the shrinking core loan portfolio, just why not be more aggressive with the buyback program? Why not buy 2x, 3x, 4x, that many shares and it still really wouldn't put any noticeable pressure on the capital ratios?

I don't know that it wouldn't put any noticeable pressure on the capital ratios. It would obviously bring those ratios down. But as you know, the holding company receives its funding from dividends from the bank. And the bank dividends are a notice or application item to the regulators. Federal Reserve and then the OCC looks at that application, if you will. And we agree that in the low growth environment, repurchase of stock is a good investment at these levels relative to tangible book. But at the same time, we have to be cognizant of funding that relative to the regulator's view of how much of that activity we should actually be doing. And then the second part of that, we want organic growth. I mean, we're not uncomfortable with growing balance sheet. In fact, that's what we want to do and we've been adding staff in our multi-family and commercial real estate group to take care of that for us. The dilemma is there is just very little demand with respect to those product lines that we prefer and competition is very fierce. So we want to keep some of that capital powder dry as well as we think about the course of the next couple of years such that we're able to grow balance sheet in a better environment as loan demand picks up.

Okay, I understand that. And that -- I think obviously would be welcome from us as well shareholders. But I mean, at 12.5% or 12.9% TCE right now and with obviously, the mortgage, if it stays as busy as this is, you're going to have plenty of earnings. And if it shrinks, that's going to obviously take some pressure off the capital. It seems like you probably have enough room to grow the bank by 50% right now with the current capital. So I guess I just -- I guess I would ask that you and the board kind of go back and please reconsider whether a more aggressive buyback might be more appropriate just given the valuation and given the capital levels. The other question I had for you was related to the, I'll call it the core bank origination engine. First of all, of the $18 million, what percentage of that is purchases versus originations?

All of that were -- was originations.

Okay, okay. So that's just -- the purchases is a just leftover word in the press release. And how many people do you figure you have in kind of a loan origination capacity? I know some of it's just going to drip through from the branch offices, but kind of the true multi-family CRE lending group, how big is that in people?

Well, we have -- if I count them in my head, it will probably be wrong. But I believe there are 7 or 8 originators, and we have them in Northern California and in Southern California.

Okay. I mean, I guess my initial reaction was just that for a full quarter's worth of work, that $18 million is a really low number for a bank your size. I mean, are you kind of -- do you feel like you have the right people in the right chairs, just kind of -- I know the market is tough, but everybody is finding loans some place. I just -- I'm always kind of shocked at the lack of origination volume that you guys have been able to find outside of obviously the tremendous work you've done on the mortgage banking side. I guess I'm trying to just find out if you're frustrated with that level of activity as much as we are.

The answer will be -- okay, I'll make that simple. Yes, we're frustrated. But I've got to tell you, we turned down a lot of deals and we see deals that people make everyday that don't make sense and certainly don't meet the underrated [ph] guidelines that we're seeing our regulators talk about, so there is -- and then, like I said, there's just not as many deals to look at as we'd like, so -- and we've moved some originators in and out too here that haven't worked out in the last years. So again, yes. It's frustrating. But we know that things will get better over time, and we should be able to get more volume over time, but I can't tell you when that is.

Yes. I guess from an origination standpoint, I mean, you have the 7 or 8 originators and you have the 15 offices, is there an opportunity -- I mean, you mentioned the new office opening up. I mean, is there an opportunity to have a lender in each office or more than one and kind of deploy a little bit more aggressively on a local level?

No, I don't think so. I don't think that would necessarily work. What we do is we have these originators look [ph] between offices rather than having them assigned in a particular branch like La Quinta, let's say. They will be there, there's office there for a lender in each of our offices. It may be used for multiple purposes as well as uninsured products or even the mortgage banker may even sit in that room at some time. But to have 15 of them sitting around, not counting home office, in today's market doesn't make much sense to me.

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

Right. Well, we'll conclude our quarterly conference call. Thank you everyone for being on and look forward to speaking to all of you at our next quarterly conference call.

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