Provident Financial Holdings, Inc. (PROV) Q3 2014 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 call is being recorded. I would like to turn the conference over to your host now, Mr. 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, forecasts 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 on April 29, from the Annual Report on Form 10-K for year ended June 30, 2013, 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. First, I would like to point out the increased importance we're placing on our community banking business. You will note that have been more successfully in originating loans held for investment during the first 9 months of this fiscal year than we were during the same period last year. We have essentially doubled our volume and in doing so has resulted in 3 consecutive quarters of growth in loans held for investment, after many quarters of contraction. Additionally, the pace of growth has accelerated from each of the prior 3 sequential quarters. I believe we have an ongoing opportunity to increase loan balances, and we have been investing in the personnel and systems to capitalize on this opportunity. Second point I would like to make regarding community banking is that we have not taken full advantage of our mortgage banking platform to augment loans held for investment, which was by design. We were uncomfortable with the loan yields and the interest rate risk characteristics of the single-family loan products, given the historically low interest rate environment coming out of the recession. Our view is changing, consistent with the improving economic environment. Recently, we launched single-family held-for-investment products for our mortgage banking platform. These products include conforming and jumbo arms, as well as owner-occupied, one-time close construction loan product. As a result, we anticipate we'll originate more single-family loans for the held-for-investment portfolio during fiscal 2014 and in recent prior fiscal years. Indeed, we expect the pace of growth in single-family held-for-investment loans to accelerate from current levels. For the first 9 months of this fiscal year, we have originated approximately $13.6 million of single-family loans for held-for-investment portfolio compared to $7.8 million during the same period last year. Credit quality continues to improve, and we believe further improvement is likely. Total non-performing assets on March 31, 2014 were $19.2 million, the lowest level in many quarters. We recorded $849,000 recovery from the allowance for loan losses during the quarter ended March 31, 2014, while net charge-offs were just $168,000, similar to the net charge-offs during the December 2013 quarter, which were $166,000, and significantly lower than the net charge-offs of $1.2 million in the March 2013 quarter. We believe that the mortgage banking environment has deteriorated because the recent rise in mortgage rates has significantly reduced refinance activity. While we have been transitioning our business model to a more profitable retail production platforms for some time, we're not immune to deteriorating market fundamentals. As a result, we will continue to reduce the mortgage banking FTE count. We employed 296 FTE in mortgage banking on March 31, 2014, down from the 315 FTE on December 31, 2013, and from the 358 FTE at September 30, 2013. We'll continue to adjust our business model as we have done in the past, commensurate with changes in loan origination volumes. Volume of loans originated for sale in third quarter fiscal 2014 decreased significantly from the same quarter last year, but less significantly from the December 2013 quarter. In fact, new applications volume grew throughout the March 2014 quarter, resulting in a higher locked pipeline for the start of our fourth quarter of fiscal 2014 and for the start of our third quarter, suggesting a higher volume of loans originated for sale in the June 2014 quarter and during the March 2014 quarter. Some degree, we expect that given the traditional spring and summer volume season, average [ph] should be noted that new and existing home sales have slowed in the recent months as a result of the lower inventory of homes for sale and fewer first-time buyers. This combination may lead to a weaker buyers season than we had experienced in the most recent prior years. The loan sale margin for the quarter ended March 31, 2014 increased from the prior 2 sequential quarters to 144 basis points to approximately the midpoint of the recent historical range. Loan sale execution remains difficult as competitors price at unsustainably below levels to keep up their volumes up. We're working diligently to optimize our pricing models, but we may not see loan sale margins recover to the high end of the recent historical range because the mortgage banking industry has too much origination capacity for current demand, given the decline in refinance volume. In addition to our improving view of credit quality and our cautious outlook on mortgage banking, there have been other developments regarding our operating results. For example, during the fourth quarter, we originated a total of $36 million of primarily multifamily and commercial real estate loans to augment loans held for investment. And for the third consecutive quarter, loans held for investment increased from the prior sequential quarter's ending balance. We're working diligently to fulfill our more aggressive origination goals for fiscal 2014, and I believe the positive momentum is building, particularly since we're now offering more held-for-investment products through our mortgage banking channel. I should also point of that we've reduced operating expenses by approximately 20% in the March 2014 quarter in comparison to the same quarter last year, primarily by reducing salaries and employee benefits expense. We understand that our efficiency ratio is currently too high as we transition from the [indiscernible] fee income derived from mortgage banking activities to the slower growth in net interest income from our community banking activities, as we relever the balance sheet. We have made good progress reducing operating expenses, but more work remains with respect to growing the balance sheet. Liquidity balances are higher than we would like, which is another reason we're expanding our multifamily, commercial real estate, single-family and construction loan capabilities. And while our net interest margin was unchanged this quarter in comparison to December 31, 2013's sequential quarter, we are seeing ongoing opportunity to increase our net interest margin. To do so: we plan to use these available cash currently invested at nominal yields to increase our portfolio of loans held for investment with newly originated loans at higher yields; realize a higher yield on loans held for sale, given the recent rise in mortgage interest rates; and by paying off existing FHLB borrowings, as they mature. Our short-term strategy for balance sheet management manage is unchanged from last quarter. We believe that relevering the balance sheet is essential, but we also recognize that loan demand is weaker than we would like, making it difficult to generate a sufficient volume of loans held for investment to replace payoff. Nonetheless, we are investing in our multifamily commercial real estate construction loan platform to take advantage of loan opportunities, as they arise, and are much more open to single-family loan products for the portfolio. For the foreseeable future, we believe that maintaining regulatory capital ratios above 9% for Tier 1 leverage and 12.5% for total risk-based is critical, and we're confident we'll be able to do so. We remain confident that our existing capital base is comprised to the quality and quantity that we will need to fulfill the Basel III capital requirements, while still being able to execute on our business plan and capital management goals. Additionally, in the March 2014 quarter, we repurchased approximately 195,000 shares of common stock, and we continue to believe that executing on stock repurchases is a wise use of capital in the current low-growth environment. We encourage everyone to review our March 31 investor presentation posted on our website. You will find that we've included slides regarding financial metrics, community banking, mortgage banking and asset quality, which we believe will give you additional insight on our strong financial foundation supporting the future growth of the company. We will now entertain any questions that you may have regarding our financial results. Thank you. Linda?

[Operator Instructions] We do have a question from the line of Brian Zabora with KBW.

A question on the new products that you plan to hold for sale. Is there a limit that you'd like to hold as far as a percent of total loans, or any kind of parameters there? And also, are these generally one-year ARMs or are they maybe 5- or 7-year ARMs?

Brian, it’s Donovan. The thing that we look at with respect to single-family products is the mix relative to our total loan portfolio. Right now, I think we are at about 53% of our loans held for investment in, what we call, our preferred product lines, which are multifamily, commercial real estate, very little in the way of construction and a little bit in business banking. And then single-family, obviously, is the remaining 47%. I think, an optimum mix for us as we go down the timeline is about 50-50. So to the extent that we're originating, as we did this last quarter, $36 million in new production in the preferred loan group, we would be comfortable with $36 million, $40 million in single-family product for the quarter as well, thereby keeping our composition and our mix about 50-50.

Very helpful. And did you roll these products out in the first quarter or is this kind of a new -- new products in the second or third quarter?

We had a second TD product that we rolled out in Q2 or the December quarter. The single-family permanent product came out in towards the end of the March quarter. And to answer your other question, it's primarily 5/1 ARM product with respect to that. And the construction loan program through the mortgage banking channel was just released within the last couple of weeks.

And just lastly, you commented on the competitive environment as far as the impact on gain held for sale as far as the margins. Just a sense of has that change at all over the last 3 months and your thoughts around the competition?

I think it's very competitive. In fact, if you read many of the industry trade publications, they describe that some vendors seem to be on the ropes with respect to their financial condition. And I think, as a result, everybody has reduced their margins very significantly to the extent that it's sometimes hard to believe that they can be originating these products profitably. And so at the end of the day, I think it's a very competitive and I think it will remain so until we get a clearing out of weaker originators, if you will.

Brian, this is Craig. I'll add to that. In fact, we really believe there are some of the originators in the marketplace that are originating at a loss and then valuing -- keeping the servicing and then valuing it to make money on the deal. And we don't think that's a long-term strategy, honestly.

We have a question from the line of Jason Stewart with Compass Point.

Just a follow-up to that. Have you seen any change in the mix of buyers for loans? Is there new competition on that end too, or are you seeing it mostly on the origination side?

With respect to our investor profile, that really hasn't changed. We seem to add 1 or 2 or 3, 4 investors each quarter as we source new investors that might become more aggressive in the secondary side of things. But there's really not a huge change there. I think the one difference, at least in the March quarter, was the reduction in some of the jumbo production, or jumbo MBS. It declined significantly from what we saw in the September and December quarter. A lot of people just couldn't make the metrics work, and so they might be accumulating and looking to originate that product and securitize it later. We don't really know. So there has been a slowdown in jumbo securitization.

Okay. And then as a follow-up to that, actually, I know, historically, you have done -- you have originated jumbo product for your investors. But correct me if I'm wrong, that's not been an outlet recently, right?

It's a much smaller percentage of the total. The large percentage are originated for sale is conforming. We do have a small percentage that is nonconforming vis-à-vis the size of the deal. And that has been sold to some of the aggregators and conduits. But now, with us flipping the switch with respect to putting a portfolio product on our books, we might see that coming into portfolio rather than being sold.

Got it. And then on the disposition side, on the single-family. Have you seen the expiration of the mortgage debt forgiveness act slow? Any dispositions at all?

I think it's hard. I've read some material that has suggested that, but I think it's very hard to describe what is occurring or what to attribute that, how much to attribute as a result of that. I've read some anecdotal data that suggest that that might be the case, but I don't know that we have seen that.

We have a question from the line of Don Worthington from Raymond James.

In terms of adjusting the mortgage banking model -- I know it's hard to answer this with any precision, but how far along would you say you are in the adjustment process? Or maybe to ask it another way, do you have kind of a target efficiency ratio you'd like to get to working both sides of that equation?

I think we're pretty far along on that process, depending, Don, upon what happens in the market with volumes. We expected, and I think many expected, that the market was going to be a lot more robust by this time, this year. And as you know from everything you've read, it isn't. There are just limited product out there, certainly on the purchase side, and there is not a lot of refis [ph] going on. So we've had to readjust that rightsizing a couple of times. I think we probably still have a little bit more work to do. Again, we're watching to see what happens with volumes as we move into the summer buying season.

I think the thing that I would add, as we look at the September quarter, I think our pretax loss in mortgage banking was $900,000, in the December quarter it was $800,000, and in the March quarter it was a loss, pretax loss of $700,000. And the March quarter, from a seasonality perspective, is typically the weakest quarter of a given year. So we've been making slow progress down the path to profitability, and we have a certain expectation that the spring and summer buying season will result in better volumes than we saw in the March quarter. And in fact, our locked pipeline, to start the June quarter, is higher than what we saw to start our March quarter at December 31. So I think we have an expectation that we'll see better volume in the June quarter. But to hold hard and fast numbers with respect to what that expectation is, I think the environment is very fluid and it's hard to gauge.

Okay. That's fair. And then in terms of -- I think I might have asked you this before, but do you take a look at possibly buying loans in order to help leverage the balance sheet a little quicker than what you can do with the originations?

I think we've talked about this in prior quarters, Don. We do, and we have looked at quite a few loan pools for the past -- for the last couple of years now. And unfortunately, by the time that we weed through what is our criteria for underwriting, then it becomes a pricing issue and that just hasn't made sense at all for us to buy the loans at these big premiums. So we continue to look.

[Operator Instructions] We do have a question from the line of Brett Villaume with FIG Partners.

Don nailed a couple of my questions. But I wanted to ask about, you had a several quarters of recovery of reserves, would you mind commenting on what we can expect in the next couple of quarters in terms of reserve -- negative provisions?

I think everything is dependent upon what our actual loss experience is doing, which has been recently improving significantly. But secondarily, it will also be dependent upon whether or not our loans held-for-investment portfolio is growing more dramatically than what it is currently, or what it has been. So we will get to a point, and it's hard to forecast when that point is, where recovery or negative provisioning will no longer be on the table because, hopefully, we'll be in a position of outstripping that ability or the ability to do so, because growing the held-for-investment portfolio and essentially putting up reserves as a result. With respect to the absolute ratios, I think we've suggested in the past that 100 basis points to 125 basis points of allowance is probably the range that the allowance should be, dependent upon what our actual delinquencies are, dependent upon what our actual charge-off loss experience is, and depending upon what our actual portfolio mix is between single-family, commercial and multifamily.

Okay. That was very helpful. And only other question I have was just on whether or not you care to comment on if you might get more aggressive with the buyback with the stock down at these levels?

I think the appropriate response there is that we have an existing buyback plan. I forget the exact number, but it's in 120,000, 125,000 share range remaining. And our business plan calls for the repurchase consistent with those plans, and we expect to do so. Historically, when we've completed a plan, we've looked at our business plan and spoken with our Board and have generally renewed the plans, depending upon growth opportunities that we see, and I expect that's what we'll prefer again.

Okay, fair enough. And I'll ask one last question. Actually, it's about just the geography of your markets. Do you have any further comments about where you're seeing growth or where you're seeing more competition, say, Inland Empire versus other markets?

You're referring to retail banking or mortgage banking?

Well, maybe both, actually.

Well, we compete state-wide in mortgage banking from north of the Bay Area to San Diego, and I think we've already commented on the competitive nature of that. Retail Banking, we're really focused on Riverside County for the most part. And we think there is competition, but there is a lot of opportunity right now with all the consolidation in the small and midsized financial institutions in our region. So I think we can compete quite well for those products and deposits in our region.

If I -- I would add one thing is, I think about Northern versus Southern California. It does seem that Northern California, with respect to loan products, whether it is multifamily, CRE or single-family, is a bit more competitive than Southern California. It just seems like perhaps the tech industry up there has generated outsized competition. A lot of lenders are in that market. So I think Northern California is a bit more competitive, in general, on the loan side than Southern California.

And we have our question from the line of Tim O'Brien with Sandler O'Neill and Partners. Tim O’Brien: Donavon, you, or Craig, you mentioned that the suite of single-family residential products that you're offering in the mortgage products, one of the channels for origination is through your mortgage banking platform. It's not all going to come through retail, it's going to come through mortgage banking too -- the held-for-investment stuff, that suite of products that you are offering now, is that correct?

Well, all of our single-family will come from the mortgage banking channel. In other words, we don't have a different channel than that with respect to the origination of single-family product. Tim O’Brien: Okay. Thanks for the clarification. And then will you -- portfolio loans tied to housing from throughout the state or are -- is the portfolio of product going to be more weighted towards SoCal and -- or even Riverside?

Well, it's weighted toward where we originate loans, which -- single-family, which is statewide. Tim O’Brien: Great. Okay. And you said comparable production, 50-50 ratio would be managed towards -- got that. And as far as potential benefit to the margin from that suite of products, do you see upside growth to potential for your net interest margin when you add those loans from here, or is that market pretty competitive where it's not going to benefit the NIM you think? What's your sense?

It's going to benefit the NIM because we're going to be redeploying cash on hand where we're earning 25 basis points. Tim O’Brien: Great. Okay. And then, obviously, I am assuming the same for CRE multi-construction loans in spades the pricing of that's probably higher still, correct?

Correct. Tim O’Brien: And do you anticipate that given your -- the sensitivity -- asset liability management of the balance sheet and where you stand right now kind of is a baseline with the new single-family that you're putting on? Is that going to move you towards a more liability-sensitive profile going forward, incrementally?

It will move us more toward neutral. Right now, we are very asset-sensitive. And as we originate 5/1 ARM product, it's obviously fixed for the first 5 years. So that will move us more toward neutral. But we're so asset-sensitive right now with respect to where our adjusting portfolios are that I don't expect that to be a near-term complication. Tim O’Brien: And last question. Can you describe a typical -- tell us what -- if I was a consumer of wanting to build a house, I guess, and was looking at your construction loan product, what would I be looking at? What are you offering there exactly? How does it work?

Well, a construction to firm is essentially a one-time close product where the borrower of a single-family construction loan comes in and we originate the loan with respect to our underwriting criteria. And that loan is made. The construction period is tagged for 12 months. But subsequent to 12 months, whether or not that loan has been -- or that construction has been completed, it will roll automatically to permanent financing, where it then turns into a -- essentially a 4/1 hybrid. So during the first 12 months of the construction period, it's fixed at a margin over prime. And then in the 13 month, when it rolls to permanent status, it rolls to a 4/1 ARM essentially where we have predetermined the interest rate at the roll date. And then it completes out its 4-year cycle and turns into regular ARM loan in portfolio. And the advantage of that is obvious. The takeout is essentially built-in. And this is predominantly for owner builders, if you will. It is not spec construction or anything of that nature. Tim O’Brien: And it's not for purchasing the property, the land. Do they own the land or...?

It can be a combination. We would look at something where they already own the land, or we would look at something where the purchase of the land is part of the loan application. But with respect to the equity that they will have in the deal, we have loan-to-cost and loan-to-value criteria that we will not exceed. And so that's all part of underwriting. They're going to have equity in the project. Tim O’Brien: What's the maximum loan-to-value, and what is the value that you determine? Is that the salable value of the completed house that's the loan-to-value that you peg it to, or how does that work?

Well, yes, an appraisal will give us the value of the completed home, given the current market conditions. So that's one ratio, if you will. That's one loan-to-value. And I believe our cap there is 75%. And then there is another calculation that we do, which is a loan-to-cost, to make certain that they have a minimum amount of hard equity in where we're not giving back appreciated lot value, for instance. We won't give them credit for that. So I forget what our loan-to-cost is right now, since it's a new program, but we also have an underwriting threshold there. Tim O’Brien: And have you booked some of those loans already? Are they out there, or is it too new?

We haven't booked anything yet. I think we have 3 or 4 in the pipeline right now.

[Operator Instructions] I don't see anyone queuing up right at this time.

All right. I want to thank everyone for joining us on our quarterly conference call. I look forward to having our next call next quarter. So thank you.

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